Author: Dmitriy Berenzon
Translation: Li Hanbo
Liquidity Mining as a better way to issue tokens
Its impact on the DeFi field has been enormous-at the time of writing, the total value locked in is more than $10 billion, and on June 16, 2020, it was only more than $1 billion. This has also put pressure on the Ethereum network. As users are eager to obtain and realize profits, gas prices and transaction fees have reached historical highs . Although this craze is reminiscent of the ICO bubble in 2017, the fundamentals are stronger.
In this article, I will explain what liquid mining is, what is effective, and what can be improved. Although the field is developing rapidly, I hope to capture most of the interesting developments that can provide information for agreements that want to implement such programs and users who want to participate.
Liquidity mining
Liquidity mining is a network participation strategy in which users provide funds to an agreement in exchange for the original token of the agreement. The term was proposed by CoinFund’s Jake Brukhman several years ago, and he participated in the supply-side network. “Generalized mining” was discussed in the context of The subtle difference of liquidity mining is that the network has specific needs, that is, liquidity supply. Users do not need to buy tokens, but get Token rewards. Tokens are usually governance tokens that allow holders to control protocol parameters. Voting, including value acquisition mechanisms . Many people often refer to it as “yield farming”; although these terms are often used interchangeably, yield farming does not require tokens (for example, liquidity providers can obtain income, but only pay on Uniswap transaction fee).
Not all liquid mining projects are the same. Judging from the startup situation in the past few months, there are three categories.
- Fair start-up : The main goal is to distribute most of the tokens through some objective criteria, rather than direct sales (for example, to become an active user of the agreement), and to ensure that everyone has an equal opportunity to distribute. Think of this as Uber being owned by its drivers and passengers from day one.
- Decentralized startup : The main goal is to gradually realize community ownership and minimize financial management. Think of this as Uber signing a legally binding agreement to allocate most of its stock to drivers and riders in the next few years.
- Growth marketing model issuance : The main goal is to motivate specific user behavior within a predetermined time. Think of it as Uber returning part of customers’ rides to Uber stock.
Liquid mining is important for several reasons:
- Wider and fair distribution : The ICO of the 2017 era made many retail investors angry. In the private placement round, a large proportion of the Token supply was sold to investors, causing pain for many retail investors because these investors gained their positions. Liquidity mining attempts to balance the competitive environment, so that institutional and retail investors have an equal opportunity to own a protocol native Token .
YAM and YFI are fair start models
- Closer connection : The advantage of the liquid mining plan is that Token holders are more likely to be protocol users. After analyzing their Token holder base at the end of 2019, 0x has the following Lynn diagram.
The data is from October 30, 2019 and does not reflect the current distribution
More inclusive governance: Users who own the agreement have an incentive to help the agreement succeed. By sharing potential financial gains as early as possible, the liquidity mining program strengthens community participation and helps the agreement initiate or transition to DAO.
- Faster experimentation : In DeFi, liquidity is everything. The liquidity mining plan attracted more capital inflows , and the token appreciation subsequently created a virtuous circle, which lowered the entry barrier for the team to obtain financing in the market. And some poor projects have led to a vicious circle in the opposite direction-just like Bitcoin miners shutting down miners when the BTC price drops below a certain threshold, if the economic benefits are no longer reasonable, liquid miners will also borrow from AMM or borrowing pools. Withdraw capital from China. This cycle increases the speed of innovation and ultimately benefits the development of the industry.
What good results in the past four months, dozens of experiments have been carried out, although it is easy to see that fail, but many design choices to be successful, it should be included in future iterations.
Reward long-term liquidity
They have no loyalty to the agreement, but pursue the most profitable opportunities at the time. Short-term liquidity is not as valuable as long-term liquidity. Ampleforth’s “time multiplier” mechanism in their Geyser plan solves this problem well. The mechanism Rewards are given according to the deposit time. The rewards increase from 1 time on the 1st day, to 2 times on the 30th day, and 3 times after the 60th day (and issued retroactively). Because of this, many people are willing to wait two months before withdrawing money.
Retained data is mixed, but also very promising. According to the team’s update on August 4 (43 days after the project started), about 6,036 independent users tried Geyser, and 4242 users were still active that day (about 70% retention rate). According to unconfirmed internal sources, on September 8 (78 days later), Geyser (especially the AMPL-WETH Uniswap pool) had 7,318 unique users and 3,193 active users (approximately 44% retention rate). Considering the launch of many other liquid mining projects, the decline in users is expected, but the decline in liquidity is even more acute-as of September 8, AMPL-WETH pool has approximately $83 million in total deposits Approximately US$9.5 million in liquidity (approximately 11% liquidity retention rate).
Parameters can be adjusted continuously
The liquidity mining program should not be a “setting and forgetting effort”-although the protocol team did their best to predict the unexpected behavior of these programs, they need to be prepared to adjust at any time .
In the first few weeks, Balancer has fine-tuned its liquidity mining program by adding five additional parameters designed to reward specific types of liquidity, for example.
- Transaction ratio penalty: Penalize unbalanced pools, which provide traders with less useful liquidity.
- Transaction fee penalty: Punishes high transaction fees because the liquidity they provide is less useful. Punish high transaction fees because they make the pool less attractive to traders.
- Correlation penalty: Penalize a pair of highly correlated tokens because they attract less useful liquidity balancers.
Source: Balancer Dashboard
Cross-protocol community participation
YAM has done a good job in this regard. He launched eight liquidity pools with the goal of becoming the largest and most active Token community in DeFi.
YAM V1 page
Source: Yam Dashboard
Continuous product innovation
In addition, the focus of the protocol fork should not only be to remove the distribution of founders and investors, but to meaningfully increase the utility of the protocol in a way that distinguishes it from competitors . Pickle Fiance has done a good job so far. Their product roadmap includes several novel investment strategies that generate yields, as well as the final stable currency arbitrage strategy, with the goal of returning stable coins to their anchor point. Based is also actively developing their roadmap, which includes DEX and fair start platform.
Shorten the project period
Too long liquid mining projects lose flexibility when responding to changes in market dynamics and protocol strategies. Another benefit is that you introduce enough volatility in the market to achieve more effective price discovery. At the beginning of the multi-year liquidity mining plan of a highly anticipated project, if the market value starts to be too high and early holders lose money in investment, there is a risk of harming the community.
Yearn’s YFI Token issuance is an extreme example, with 100% of the total supply allocated within 9 days. From the perspective of market structure, since there are no early holders, there is almost no selling pressure, which forms a virtuous circle , and early-entry holders benefit the most from the financial rise. Currently, the Token is held by 13,507 addresses and has one of the most enthusiastic and dedicated communities in the industry.
For teams that choose a longer plan period, one way to achieve balance is to issue early, because early liquidity is more valuable than later liquidity. Similar to the Bitcoin block reward halving, you can have a decay function. The rewards in the first few days/weeks are larger and gradually decrease. SushiSwap has done a good job here. The issuance was accelerated in the first two weeks. At the peak, they accumulated $1.5 billion in assets, which was about 73% of Uniswap’s liquidity at the time.
Longer-term projects
The release schedule also gives more time for information to spread across the market, which helps price discovery and allows token holders to decide whether this is a viable long-term project (for example, clear Token value accumulation, well-functioning Governance system, active community).
DODO made a brave decision in their liquidity mining project to lock Tokens for one week after they provided initial liquidity on AMM, and let them be released linearly within 6 months thereafter. Even with these restrictions, DODO was still able to attract more than $90 million in liquidity from 3,105 addresses.
More specific goals
UMA is doing well here. Their liquidity mining project targets a specific pool within a fixed period of time and asks such questions:
- “How many percent of the absentees sell rewards immediately?”
- “How many percent of miners vote with rewards?”
- “What is the scope of the allocation?”
Fairer participation
Today, most liquid mining projects disproportionately benefit those with large amounts of capital, which harms community participation and Token distribution. Based attempts to solve this problem by setting an upper limit of $12,000 on the amount that each address can bet in its initial liquidity pool. Pickle also tried to solve this problem by implementing a second voting to prevent large households from gaining asymmetrical influence on governance decisions. Although we don’t know if the big players have created multiple addresses to circumvent the betting and voting restrictions, this is a step in the right direction.
About the supply cap
Long-term oriented projects should not have supply caps. These agreements are more like companies than currencies. No company will limit their ability to issue shares. At the same time, the continued high inflation rate may undermine the value of all token holders. In addition, high inflation may intensify attack vectors related to governance, which may have an impact on the wider DeFi ecosystem. For example, if X Token with unlimited supply and adjustable inflation is accepted as collateral in Compound, malicious actors can vote for an unlimited amount of X Token and steal all collateral in Compound. One solution is to set the contract to have a low-inflation nature and enter the community management, or the contract setting includes the option of 0 inflation, and initially set it together with the inflation ceiling to 0%.
General question
- Speculation: Although the liquid mining scheme is not intentional, users may cheat on incentives. For example, on Compound, recursive lending is likely to result in “fake” transactions and crowd out real users. According to some unconfirmed estimates, this may be more than 30% of the supply value reported by Compound. This user behavior does not provide much value to Compound, because most of the liquidity in the agreement cannot be accessed by other users.
- Technical risks: The cost of security audits is high, and teams that want to make a fair release often do not have the resources to complete the audit beforehand. This led to the discovery of bugs in the main network contract, resulting in the loss of user funds. This also brings advantages to those with technical expertise or resources to check the authenticity/security of contracts. Fair Startup Capital is trying to solve this problem by providing unconditional funding to cover audit and startup costs .
- Liar issuers: Even if there are no unexpected errors, most liquid mining projects today are initiated by pseudonymous founders, which makes them the perfect hotbed for scammers. These malicious actors can use these contracts (for example, call the “mint()” function like Hotdog, or simply sell tokens like Yuno), with almost no impact. More technical users can learn about these attack vectors by using tools such as Diffchecker, but liquid mining is still a dangerous game for retail participants.
- Information asymmetry: Although the purpose is for fair distribution, insiders are likely to take the lead in the first few minutes/hours of liquid mining projects, which leads to an unfair advantage over retail participants. One way to solve this problem is to fully notify the liquidity mining project will start.
- Gas fees: High ether gas fees often force small participants back, leaving liquid mining projects to those who can afford to pay gas fees. This hurts Token issuance and low-value projects, such as those that focus on NFTs and games.
in conclusion
Liquid mining will always exist
