Compiler: Perry Wang
IDEX first started the trend in October 2017, Synthetix improved it in July 2019, and then Compound was implemented on a large scale in June 2020. Liquid mining, as a better token distribution mechanism, has attracted Dozens of DeFi agreements use their imagination to blossom.
An incomplete list of liquid mining plans launched between June and September 2020
The impact of liquidity mining on the DeFi field is exciting. As of this writing, the total value of TVC locked in each DeFi protocol exceeds US$10 billion , compared to only US$1 billion on June 16, 2020. This also puts pressure on the Ethereum network. While users are pouring into DeFi for income farming to realize profits, the gas price and transaction fees have also reached the highest level in history.
Although this enthusiasm is reminiscent of the ICO bubble in 2017, the fundamentals of the current DeFi project are stronger.
I will explain in this article what liquid mining is, which aspects have successes , and which aspects can be improved . While the DeFi field is developing rapidly, I hope to record most of the interesting developments, which can provide useful information for users who want to implement liquidity mining plans and users who want to participate in liquidity mining.
Liquidity mining 101
Liquidity mining is a network participation mechanism. The specific principle is: users provide funds to the agreement in exchange for the original token of the agreement.
This term was coined by CoinFund founder Jake Brukhman a few years ago. He discussed the concept of ” Generalized Mining ” in the context of the participation of various networks. The nuance of liquidity mining is that the network has a specific demand, that is, liquidity supply . Users do not need to buy tokens, but will receive token rewards. Tokens are often a governance token that allows holders to Voting on protocol parameters, including value acquisition mechanism. Many people often refer to it as ” income farming .”
Although these terms are often used interchangeably, revenue farming does not necessarily require tokens-for example, liquidity provider LP can obtain revenue from Uniswap through transaction fees alone .
Not all liquid mining plans are created equally. Looking at the newly launched agreements in the past few months, there are three categories:
Some items are not drawn to scale, data source:
- Fair start-up : The main goal is to distribute most tokens not through direct sales, but based on some other objective criteria (for example, being an active user of the protocol) and to ensure that everyone gets the distribution equally. It’s like assuming Uber was owned by its drivers and takeaway riders from day one.
- Procedural decentralization : The main goal is to gradually realize community ownership and minimize asset management. It’s like assuming Uber signs a legally binding agreement to distribute majority shares to its drivers and takeaway riders in the next few years.
- Growth marketing : The main goal is to motivate specific user behaviors within a predetermined period. It’s like supposing that Uber uses stock to give customers a rebate on part of their trip.
Each of them has its advantages and disadvantages. The agreement may involve multiple categories at the same time. For example, Uniswap’s hard-coded 2% inflation rate is a long-term programmatic allocation. The “best” approach will depend on the goals of the agreement.
The importance of liquid mining comes from multiple reasons:
- The distribution scope is wider : The ICO in 2017 made many retail investors very angry. The private placement round caused a high percentage of tokens to be sold to large investors, who later sold their positions and led to a sharp drop in prices, causing heavy losses for retail investors. Liquid mining attempts to achieve a level playing field and provide institutional investors and retail investors with equal opportunities to own the original tokens of the protocol.
YAM and YFI are highlighted as “fair start”, source:
- Closer linkage : The advantage of the liquid mining plan is that token holders are more likely to become protocol users. After analyzing the user base of token holders, the 0x protocol reached the following conclusions at the end of 2019, and liquidity mining effectively promoted this Venn diagram to be more closely integrated:
The data was collected on October 30, 2019, and does not reflect the current currency holdings distribution. Source:
- More inclusive governance : Users with partial ownership of the agreement are motivated to help it succeed. By sharing the potential financial benefits as early as possible, the liquidity mining plan can enhance community participation and help the protocol initiate or transition to the decentralized organization DAO.
- Speed up experimentation : In the DeFi field, liquidity = availability. The reflexive nature of the liquidity mining plan internally promotes the appreciation of tokens, which in turn promotes more capital inflows, forms a flywheel effect , and lowers the entry barrier for the team’s new projects to gain market appeal. This may also lead to a downward spiral in the opposite direction-just as Bitcoin miners shut down their mining machines when the price of BTC drops below a certain threshold, if the economic mechanism of a certain DeFi protocol cannot generate revenue, the cultivation of liquid mining The farmer will also withdraw funds from the automatic market maker AMM or liquidity pool. This cycle accelerates the pace of innovation and ultimately benefits the industry.
Success
Dozens of experiments have been conducted in the past four months. Although it is easy to notice a failed protocol, many of the protocol design choices are successful and should be included in future iterations.
Reward for long-term liquidity
Most of the liquidity in the current liquidity mining plan comes from ” Pure Boli Capital “. They are not loyal to any agreement and just seek the most profitable opportunity at the time.
You may have friends like this. Register an account on each takeaway startup app to enjoy discounts or overlord meals. The problem here is that short-term liquidity is not as valuable as long-term liquidity, and liquidity mining plans should be adjusted to reflect this.
Ampleforth has a good performance in solving this problem. Its Geyser project uses a “time factor” mechanism to give different rewards according to the length of the deposit. The ” time factor ” is 1 on the first day, rises to 2 on the 30th day, and rises to 3 after the 60th day. Therefore, many people are willing to wait two more months before withdrawing.
The length of the retention period varies, but overall it is gratifying. According to the team information update on August 4 (43 days after the program was launched) , approximately 6,036 unique users tried Geyser, and 4,242 users were still active that day (retention rate is about 70%) .
According to unconfirmed internal information, on September 8 (78 days later) , Geyser (especially the AMPL-WETH Uniswap fund pool) had 7,318 unique users and 3,193 active users (retention rate of approximately 44%) . In view of the emergence of many other liquid mining plans, the decline in the number of users is expected, but the decline in liquidity is even more dramatic-as of September 8, the liquidity in the AMPL-WETH fund pool is about 9.5 million US dollars . Total deposits are approximately US$83 million (liquidity retention rate is approximately 11%) .
Fine tuning of parameters
Liquidity mining plans should not be “one-time-for-all”. Although the agreement team will try to predict possible deviations from these projects, they need to make adjustments at any time.
Balancer has performed well in fine-tuning parameters within a few weeks of the launch of the liquidity mining plan. Five new parameters have been added to reward specific types of liquidity, such as:
- Proportionality factor : penalize unbalanced capital pools and provide traders with less available liquidity
- Cost factor : Penalize high transaction fees, because this will reduce the attractiveness of the fund pool
- wrapFactor : Penalize highly correlated asset pairs, because this will reduce the useful liquidity attracted by Balancer
Facts have proved that the rapid and continuous adjustment of Balancer has resonated with LP. Before the project started on June 1, the number of LPs was between 1-15. This number jumped to 71 on June 1st, and has continued to rise. The LP value for September is 861-1,517 .
source:
Cross-protocol community interaction
The liquidity mining plan has not been smooth sailing. LPs will actively assess the opportunity cost of their participation in the project, and one of the effective ways to get them to participate is to be consistent with their current community.
YAM has performed well in this regard. They launched eight liquidity capital pools , targeting the largest and most active token community in the DeFi field:
YAM v1 interactive interface
The rapid development of YAM is impressive. Before the loopholes in the agreement broke out, the total locked assets in 24 hours exceeded 500 million US dollars :
source:
Continuous product innovation
The liquidity mining plan of the DeFi protocol, which is above the standard value, does not make it a better protocol. Before launching the liquid mining plan, Compound , Curve and Uniswap had excellent performances, and established functions and useful agreements before the launch of the liquid mining plan, making it easier for people to start participating in its liquid mining plan as soon as possible .
In addition, protocol forks should not only focus on deleting the founders and investor allocations, but should focus on effectively adding new utilities to the agreement, so that the new forked agreement has a different competitiveness from the original agreement.
Pickle Finance ‘s product roadmap so far has done a good job, including several novel investment strategies that generate income, and the final stable currency arbitrage strategy, which aims to restore the stable currency to a fixed exchange rate with the anchored asset.
Based is also actively developing its roadmap, which includes a decentralized exchange DEX and fair launch platform.
Token distribution time is shorter
Liquidity mining plans that have been distributed for too long have lost flexibility in responding to market dynamics and changes in protocol strategies. Although it is said that projects with a longer distribution time are more suitable for token distribution, this token distribution can also be carried out on the open market according to the decisions and time preferences of buyers and sellers.
In addition, price discovery can be realized more effectively when sufficient circulation is introduced in the market. If an extremely promising agreement adopts a multi-year liquidity mining plan, but if the token is priced too high in the initial stage, and the circulation of the token is low in the early circulation , early token holders will face investment losses, which will hurt Community risk.
The release of Yearn’s YFI token is an extreme example, with 100% of its supply being distributed within 9 days . From the perspective of market structure, there is almost no selling pressure from sellers, because there were no previous token holders, which formed a virtuous circle . Alliance token holders who entered the market early benefited the most from the rise of tokens. The token is currently held by 13,507 addresses and has one of the most enthusiastic and engaged communities in the industry.
For teams that choose a longer plan duration, one way to achieve balance is top-heavy distribution , because earlier liquidity is more valuable than later liquidity.
Similar to the Bitcoin block reward halving, your agreement may have a decay function , and the reward function will reward you higher in the first few days/weeks and gradually decrease.
SushiSwap has an outstanding performance in this regard. Its token issuance in the first two weeks has been accelerated by 10 times , which allowed them to accumulate $1.5 billion in assets at the peak, accounting for approximately 73% of Uniswap’s liquidity at the time.
Longer reward unlocking schedule
For a liquid mining plan with a long duration of token distribution, there is a vector that is subject to economic attacks . In this case, other revenue-generating protocols (such as Yearn yVaults, Harvest Finance) can participate in the plan without intending to hold it for a long time. There are tokens. This reduces the rewards for participants who are willing to advance and retreat with the agreement’s long-term vision.
The team exit bonus schedule may reduce the likelihood of such attacks, because mercenaries will think twice before participating in the plan. A longer timetable for unlocking rewards can reduce the likelihood of encountering such attacks, because Pure Boli Capital will think twice before entering the game.
The redemption timetable also provides ample time for the dissemination of information throughout the market, which can be determined by allowing token holders to determine whether this is a viable long-term project (for example, clear token value accumulation, effective governance system, Active community) to help tokens realize price discovery.
DODO made a courageous decision in liquidity mining plan, the tokens locked until they provided initial liquidity on AMM week after, then a linear cash within the next six months. Even with these restrictions, DODO was still able to attract more than $90 million in liquidity from 3,105 addresses.
More performance parameters
Many agreements may not have clear goals for the specific results they want to incentivize when launching liquid mining plans, or there may be no metrics on the usefulness of these projects. Ideally, the team should be clear that “allocating X% of the token supply in week Y will cause the agreement to increase the liquidity of Z dollars.” Ideally, you will get indicators around the dollar cost of unit liquidity and the duration of token distribution in the agreement. The more effective ones are the client acquisition cost of the encrypted native version CAC and the total lock-up volume LTV .
UMA ‘s liquidity mining plan has performed well in this respect, asking the following questions for a specific fund pool within a fixed period of time:
- “How many percent of farmers sell the rewarded tokens immediately ?”
- “How many percent of farmers vote with reward tokens?”
- “How widespread distribution?”
The project is quite successful, attracting locked once worth about $ 20 million ETH, for the team contributed some very important data points, such as “the average daily liquidity costs” daily cost-of-liquidity, corresponding per million dollars of The value ranges from less than $1,000 to $4,500.
Fairer participation
Most of the current liquidity mining plans have made large capital investors more profitable, which is disappointing and hurts the enthusiasm of community participation and the distribution of tokens.
Based attempts to solve this problem by using a single address to cap the initial liquidity fund pool’s pledge amount of 12,000 US dollars. Pickle also tried to use the ” second vote ” to prevent giant crocodiles from gaining unequal influence on governance decisions to solve this problem.
Although we don’t know whether the whale created multiple addresses to circumvent staking and voting restrictions, at least this is a step in the right direction.
Token supply capped
I believe that long-term projects should not limit the supply of tokens. These agreements are more like companies than currencies, and no company will restrict its ability to issue shares. In addition, since it is impossible to create a new liquidity mining plan, the protocol is more vulnerable to vampire attacks .
At the same time, sustained high inflation rates may harm the value of all token holders. In addition, high inflation may exacerbate governance-related attack vectors, which may have a serious impact on the wider DeFi ecosystem. For example, if a token X with an unlimited supply and adjustable inflation is accepted as collateral by Compound, then malicious participants can vote to mint countless tokens X to steal all the collateral in Compound.
One solution is to hard-code part of the low-inflation tail tokens into a community-managed vault, or hard-code it into the ultimate inflation option, while setting the initial inflation rate to 0% and setting the inflation ceiling at the same time.
Common problem
In addition to the above suggestions, there are several general problems that need to be resolved in the liquid mining plan:
- Vulnerabilities : Although not intentional, liquid mining plans may be exploited by users to steal rewards. For example, Compound, recursive borrowing/loaning may cause “fake” transaction amounts, causing real users to be crowded out. According to some unconfirmed estimates, more than 30% of Compound’s reported supply (for example, there are currently $1 billion in supply, of which $700 million is non-recursive value) fall into this category. This kind of user behavior will not bring any value to Compound, because these liquidity is not accessible to other users.
- Technical risks : The cost of security audits is high, and teams that want a fair start often do not have the resources to complete security audits in advance. This led to the discovery of errors in its mainnet contract, which resulted in the loss of user funds. This also allows personnel with technical expertise or resources to gain a runaway advantage by checking the accuracy/safety of the contract. Fair Launch Capital attempts to solve this problem by providing unconditional grants to cover audit and publishing costs.
- “Rolling money” : Even if there are no unintentional loopholes, after all, most current liquid mining projects are started by anonymous founders, which undoubtedly creates the best conditions for crooks. These scammers may exploit smart contracts with little or no response (such as calling the mint() function of Hotdog, etc., or just selling tokens in the Yuno protocol) . Users with strong technical backgrounds can understand the attack vectors using tools such as Diffchecker , but liquid mining is still a high-risk game for retail participants.
- Information asymmetry : Although the goal of liquid mining is fair distribution, insiders may seize the opportunity in the first few minutes/hours of the liquid mining plan, which has an unfair advantage over retail participants. One way to solve this problem is to fully notify the launch of the liquidity mining plan.
- Gas cost : Ethereum’s high gas fee often makes small participants ” squeezed out of the competition “, and the liquid mining plan is reserved for those who can afford to pay the gas fee. This will hurt token distribution and low-value projects, such as projects that focus on NFTs and games.
in conclusion
Although the DeFi liquidity mining project has conducted a lot of experiments , we may not yet reach the optimal allocation model, but please don’t get me wrong-liquidity mining has developed to where it is today.
In addition, although many liquid mining schemes have been successful at the time of writing, readers should note that we are not clear about the long-term impact. I look forward to reviewing it again within 6 to 12 months from now.
Thanks to Dan Elitze, Christopher Heymann, and Michael Anderson for their feedback on this article.
