By Alex Xu, Research Partner, Mint Ventures
This article is part of the #Mint Clips series by Mint Ventures. Mint Clips are some of our thoughts on industry events after internal and external exchanges. Compared with our #进具研究报 and #运车进入 series of articles, Mint Clips does not discuss specific projects, but mainly presents "period insights" on specific issues.
introduction
The content of this article comes from an online discussion in the Mint Ventures group. At that time, I raised two questions. Our researcher Lawrence and investment manager Scarlett gave their own ideas, combined with my thinking and extension of the question, constituted The main content of this Clip.
The two questions I have are:
1. Should token incentives on the trading platform encourage Liquidity or trading volume? Why?
2. Assuming that the platform has a trading incentive mechanism, which one is more pros and cons for the protocol to obtain Wash Trading for wash trading? Why?
*It should be noted that the "trading platform" in the above two questions refers generally, including spot Dexs (Uniswap, Curve), decentralized Derivatives projects (GMX, Gains) and NFT trading platforms such as Blur, and even Centralized exchanges (although most of them currently have no direct Liquidity or transaction mining mechanisms).
The content of the following article is the staged opinion of the author and the team as of the time of publication. There may be errors and prejudices in facts and opinions. It is only for discussion and we look forward to corrections from other investment and research peers.
Origin: Why does the trading platform issue equity tokens and provide incentives?
In my opinion, there are three main reasons why trading platform projects (including spot, NFT, and Derivatives) need to issue equity tokens:
1. Token fundraising. This is easy to understand, so I won't repeat it.
2. Decentralized governance. The emergence and distribution of equity tokens is a prerequisite for community-based governance.
3. Means of growth and economic system regulation.
However, from the perspective of Web3 business practice, 1 and 2 are not mandatory, because:
1. The project can carry out equity financing.
2. Centralized governance is still the mainstream of enterprise and project operations, and even the governance content and voting of most projects that have begun to decentralize governance are actually concentrated in the hands of teams and related institutions.
Perhaps the third item is really important: after a project has tokens, compared with projects without tokens, its incentive resources for growth and the adjustment ability of the project’s economic system are greatly improved.
While trading platform projects carry out token incentives (whether it is to stimulate Liquidity or to stimulate trading behavior), there are generally only two core purposes, namely:
1. The new project achieves a cold start, and attracts the initial bilateral users for the product through token incentives (Uniswap also implemented token incentives in the early stages of the Dexs war).
2. Expand the bilateral market, and expect to accelerate the expansion of cross-border network effects through token subsidies, forming barriers to competing products.
The "bilateral" mentioned here, for most trading platforms, is the side of the Liquidity Provider and the side of the trader. Because the two sides of the platform are interdependent and mutually beneficial, that is: if no one provides Liquidity, the transaction cannot be carried out; and no transaction means that there is no fee return, and no one is willing to provide Liquidity. On the contrary, the richer the Liquidity(under the same product mechanism), the lower the transaction loss, the more traders are willing to come here to trade, the more the handling fee will be, the more the handling fee, the greater the return on Liquidity, and the more abundant the Liquidity.
This situation because "the growth of users on one side will provide greater value to users on the other side" is a kind of network effect, that is, "cross-side network effect". The network effect is one of the most important moats for commercial projects.
This is especially true for new projects.
If at the beginning of Uniswap’s creation, due to the lack of competition (the value of DeFi has not yet reached a consensus), the initial growth can be achieved only by relying on the natural needs of early adopters and early users, then in such a crowded trading platform track, product iterations are changing with each passing day. At present, it is extremely difficult for a bilateral/multilateral trading platform to successfully cold start without providing incentives (or AirDrop expectations).
Therefore, purpose 1 (cold start) is the pre-action of 2 (cross-side network effect), and the ultimate purpose of 2 is to form a competitive advantage (monopolistic position), based on which to realize and expand profits (protocol revenue > token subsidy expenditure).
Then, due to the existence of cross-side network effects, whether it is to motivate Liquidity Provider or traders, the trading platform seems to be able to incentivize users on the other side in a roundabout way. Does this mean:
Motivate LP = Motivate Trader?
Practice: Liquidity Incentives VS Trading Incentives
Early Practice of Cexs
In fact, whether it is to incentivize Liquidity or incentivize transactions, it has existed long before DeFi Summer. For example, most centralized exchanges have incentive plans for cooperative market makers, the purpose of which is to allow them to provide good trading depth on their own platforms, so that other traders can obtain a low-slip trading experience, which is similar to Liquidity incentives. It’s just that most of these incentives are carried out in the form of fee reduction and return, and most of them have nothing to do with the platform’s own equity tokens.
The earliest tester of trading incentives\mining is also a centralized exchange, which was first practiced by Dragonex in 2018. It launched a reward platform token (DT) based on the transaction volume, and distributed transaction fees based on the platform token The "transaction mining" mechanism.
This mechanism was further "prospered" by Fcoin. After the transaction mining was launched, the businesses of these two exchanges have achieved rapid growth. Especially Fcoin, as a latecomer to the "Exchange Wars", its single-day trading volume during its peak period was the sum of all other first-tier CEXs.
However, neither Dragonex nor Fcoin's brilliance lasted long. The former collapsed due to insolvency due to stolen funds, and the latter collapsed due to a huge deficit due to so-called "internal financial errors". The reasons for the collapse of the two platforms are slightly different, but the commonality is the financial deficit. The former is due to external attacks, while the latter is due to internal problems.
But we can’t help asking: If there were no theft incidents and internal financial problems that year, could transaction mining help them stabilize their market share in transaction volume and form barriers?
Later practice of DeFi projects
The emergence of Uniswap has further pushed the AMM mechanism to the market. This mechanism has greatly lowered the threshold for Liquidity market-making, and also provided natural convenience for the incentives of Yield Farming. Sushiswap once quickly pumped out LP subsidies through its own token Without the large amount of Liquidity of Uniswap, Uniswap also launched a Yield Farming plan for a short time as a response.
In addition to Dexs, NFT trading platforms such as Looksrare, X2Y2, and Blur have also carried out a lot of practice on Liquidity incentives, moving the subsidy battlefield from homogeneous tokens (FT) to the NFT field, starting from Blur, Opensea feels After seeing the obvious threat, we started to practice 0 handling fee to deal with it.
On the other hand, perhaps due to the tragic failure of Fcoin, the practice of relatively large transaction mining in the DeFi field will not be until DyDx launches tokens, and then practitioners include the Dex project Cherry on Okchain, and BSC on BSC. Dinosauregg, etc., relatively new projects that include transaction incentives include level, gridex, kwenta, etc. But on the whole, there are still a few projects that use trading as the main incentive object.
Liquidity Incentives VS Trading Incentives
As mentioned above, the purpose of token incentives on the trading platform is to quickly take the lead in cross-border network effects and form a monopoly advantage. One of the prerequisites for monopoly is [ users are difficult or unwilling to leave the existing platform ], and the relevant indicator in the operation of Internet products is [retention rate].
Therefore, whether the trading platform should encourage Liquidity or encourage transactions, the important consideration is "which behavior or behavior object" is easier to retain for a long time after the incentive decays? Users and behaviors that are easier to retain for a long time can contribute a higher "user lifetime value" (LTV) to the platform, and they should be the main incentive objects of platform tokens.
So, which behavior habit is more solidified Liquidity Provider and traders? The answer in our current thinking is Liquidity Provider , for reasons including:
- Compared with traders, LP users are more likely to be bound by the platform
For example, the project represented by Curve uses the ve mechanism to guide LP users to increase their market-making income by pledging CRV tokens, which increases the migration cost of LP and the consistency with the interests of the platform.
- LP's product migration willingness and concernsMore
The trader and the platform have a transient capital interaction relationship. There is no fund entrusted to the agreement, and the capital risk is very small; while LP's funds are authorized to the smart contract of the platform, the risk is greater, so they tend to choose familiar and safe records. 1. A platform with a long history provides Liquidity. Trying a new platform has a high psychological risk. Even if the APR is higher, they are often unwilling to migrate.
- With the existence of aggregators, the transaction behavior is more rational, and the only principle is the lowest transaction loss
Although there are also aggregators for providing Liquidity(depositing funds in smart gun pools or income aggregators), but because investing funds through aggregators will have an additional smart contract capital authorization risk, and aggregators often have higher income commissions ( In contrast, transaction aggregators often do not charge explicit fees), and people tend to make the market directly by themselves, especially for large funds, which hardly need to consider the gas friction caused by the reinvestment of income.
- Incentives for transaction behavior are dissipated due to the existence of transaction friction
The frequency of transactions is much higher than that of market making, and the frictions generated in transactions, such as GAS (including MEV) and NFT transaction royalties, are taken away by third parties other than the agreement and users, which means that part of the incentive is lost.
- Incentives for transactions can "inflate transaction demand"
That is, the behavior of "trading for incentives" appears. This kind of behavior seems to have contributed to transaction fees and protocol income, but the purpose of incentivizing the project may be to "realize the advantages of cross-border network effects through token subsidies" It doesn't help much, because these "inflated transaction behaviors" will disappear immediately after the incentives stop, and cannot help the agreement achieve the goal of "occupying a larger transaction market share".
Therefore, in general, LP users have a closer and longer-term relationship with the trading platform than pure transaction users. The incentives invested in LP may be exchanged for higher total user value in the long run. Perhaps it is precisely because of this that the current incentives of most trading platforms are still mainly based on Liquidity incentives, and there are relatively few explorations on trading incentives.
Outlook: How to better conduct transaction incentives?
Although in most cases, Liquidity and trading are selected as incentives, and Liquidity incentives are often a safer choice, the exploration of incentives for trading behavior still has important value, because the ultimate income of the trading platform still comes from Trading, the incentive for Liquidity is also to provide traders with a better trading experience and obtain higher transaction volume and transaction fees. When designing transaction incentives, paying attention to the following points may achieve better results:
Do not directly incentivize trading behavior or trading volume, but incentivize those Liquidity pools or trading pairs with larger trading volume
A typical case is the concept put forward by AC when designing the ve (3,3) project Solidly, that is, holders of ve governance tokens can only get the transaction fees of those Pools they voted for, not regardless of which one they vote for. Pool, can get the entire agreement fee. This will guide ve token holders to vote more for those Pools (trading pairs) that have a large transaction volume and contribute more fees to the agreement, so that these pools can obtain more Liquidity guidance (increasing the pool’s token Token emission incentives), and then have a better depth, and further obtain more transaction volume and fees, which is equivalent to "disguised incentive transactions". In addition to Solidly's Fork project, there are some other projects that have begun to try this kind of incentives. For example, Pendle has adopted the practice of "allocating 80% of the Pool fee to those ve users who voted for the Pool", which means ve users will be more willing to vote for Pools with large transaction volumes, increasing token incentives for LPs.
Control the value of incentives to avoid "inflated" transaction volume
As long as the incentive value of the transaction subsidy is lower than the friction cost of the transaction, people will not have the inflated transaction behavior of "trading for incentives", but will rationally choose the platform with transaction subsidies when they have transaction needs. Those "transactional actions that have to be taken in themselves". In the long run, users may tend to trade more on platforms with incentives under the same conditions. When the behavior becomes a habit, the purpose of the subsidy will be realized.
Change transaction subsidy from "token distribution mechanism" to "operational activities"
The token distribution mechanism is long-term and prudently changed, while operating activities are short-term and flexible. The trading platform can design short-term trading activities to complete the activation of key behaviors of new users (such as defining the behavior of users completing the first transaction on the platform as "activation"), or design transactions for specific purposes to achieve short-term business goals Contests and other activities (such as in order to cooperate with financing and combat competitors). For example, Vela, the Gains imitation project on Arbitrum, adopts transaction incentives with a short cycle, reward mechanism and continuous adjustment of the amount to attract users to migrate from Gains, GMX and other platforms.
The above design direction of transaction incentives is also in line with the [retention rate] thinking mentioned above by the author, that is, to focus on those real user behaviors that can bring long-term retention for more refined incentive design.
Epilogue: In the Web3 business world with low barriers, operating efficiency is the winner of long-term development
Since the development of Web3 business, an important observation of the author is that monopoly seems to be more difficult to build here. This is determined by the Web3 world's own account system, permissionless capital flow and project creation, open source transparent code and composability. It is difficult to build a moat in this environment, because users become Harder to "captive and exclusive".
Any project that wants to survive and develop in this "low barrier" environment can only continue to strive for operational efficiency. The "operation" here is a broad term, which includes product innovation, marketing activities, team management, etc. In terms of work, accurate and efficient incentive design is also one of the important tasks. It is conceivable that the distribution and incentive model of tokens will inevitably need to be iterated more and more with changes in competition and user needs, and become a long-term work, based on the "economic model that does not need to be changed" designed from God's perspective For most projects, it may end up being a delusion.
Therefore, as an investor, when we select long-term investment targets, whether the project team has "long-term combat capability", "sustained commercial aggressiveness", and "willingness to actively respond to market changes" should be the key qualities to examine.
The "easy business victory" brought about by genius ideas will become increasingly rare in Web3.
