Tokens, Tokens Everywhere - The Daily Gwei #375

To token or not to token - that is the question.

Liquidity mining/yield farming has taken the crypto world by storm over the last 18 months and resulted in an explosion of activity on Ethereum and other networks. These token incentives are a powerful way to bootstrap a new ecosystem whether it be at the protocol-layer or the app-layer. Now, with the layer 2 rollout in full swing, people are wondering when rollups are going to use token incentives to supercharge their growth.

To get some more context and history on tokens, we need to look back to 2017 where there were no token incentive programs - only hordes of scam ICOs raising millions of ETH on the back of useless utility tokens. Then, of course, came the inevitable unwinding which lead to the brutal bear market of 2018. Because of this, there was a general consensus in the Ethereum community during the bear market that tokens didn’t really have any fundamental value and that all we needed was ETH. This view persisted all throughout the bear market until Compound’s liquidity mining campaign was launched and the game was changed forever. People began to understand that tokens could be used as an extremely powerful bootstrapping mechanism for both new products/services and existing ones - and so DeFi summer kicked off with a bang. Since then, tokens have been used extensively to seed growth across almost every single application and protocol with airdrops also becoming a popular distribution/growth mechanism.

As Scott mentions in his tweet above, we’re now at a point where the token bootstrapping mechanism is so powerful that it is leeching value off of the Ethereum network and into competing ones. Due to this, it is basically now a requirement for generalized rollups like Arbitrum and Optimism to launch a token in order to bootstrap growth and fend off these competitor networks. In saying that, both of these networks have already had decent growth without native token incentives, but a token is also a powerful way to build a loyal community of supporters and can also act as a way to incentivize developers to build on a network.

There are also many debates surrounding whether the protocol itself should bootstrap the growth or if it should be left up to the app-layer. People will point to Ethereum as a network that never had any ETH liquidity mining programs launched by the Ethereum Foundation but it still succeeded in spite of that. Though on this point, I’d argue that Ethereum is an aberration because it basically kick-started the entire token incentive paradigm and was able to grow its ecosystem through just app-layer liquidity mining programs because it already had a large network effect. Other networks, such as the EVM sidechains and layer 2’s, do not have this luxury so they need to be much more aggressive with their token incentive programs across all layers - if they don’t do this, another network will.

People also often wonder what these layer 2 tokens would be used for - well, there are a few obvious use-cases to me (and no, paying layer 2 fees is not one of them - we have ETH for that). While layer 2 networks outsource their consensus/security needs to Ethereum, they still need a way to decentralize their own sequencers/validators to guarantee greater liveness, censorship-resistance and decentralization. So given this context, the obvious way a token could be used is to incentivize people to run sequencers/validators, stake their tokens, and then those stakers would be rewarded with a share of the fee revenue + possible inflationary rewards. On top of this, a token could be used to govern the layer 2 network (for things such as upgrades) and it can also be used to secure data availability networks (such as zkPorter and Polygon Avail).

Now, the final question becomes: will these token incentives actually create a long-term sustainable moat for these networks? I don’t think anyone has a definitive answer to this just yet but I personally believe most of the EVM sidechains will be obsoleted by rollups (just based purely on the technical merits). In saying that, token incentive programs can drive growth for a very long time - especially if the general market sentiment is bullish. They also lead to at least some sort of moat for any network that uses them where users will choose to stay after the token incentives end because they simply enjoy the product/service. We’ve already seen this play out with the Polygon PoS chain where there was a massive MATIC token incentive program initially but now there is little-to-none and the network is still growing and has a loyal user-base.

In the end, I think that all networks are basically going to be forced into doing at least some sort of token incentive program if only as a defensive mechanism against competing networks. It reminds me of how when SushiSwap first launched it began leeching a lot of liquidity from Uniswap because it had token incentives. Then, Uniswap fought back by launching its own token which helped to fend off the vampire attack. Though ultimately, both projects went on to succeed in their own right and I suspect the same dynamic will play out across these different networks over the coming years.

Have a great day everyone,
Anthony Sassano

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All information presented above is for educational purposes only and should not be taken as investment advice.