The desolated forests of DeFi - incentivising non-existing users with money

The silent forests of DeFi

Recently Synthetix and Optimism ended one of their token incentive programs. Based on the on-chain metrics, the number of active users radically dropped after the incentives ended. What other DeFi projects can learn from this, and what are successful incentive programs?

In this post, we lay out the successes and pitfalls of different incentive programs, like airdrops and liquidity mining. Decentralised finance is still in its early stages. There are not that many users to begin with, and blindly throwing money at growth might be counterproductive.

Incentive programs in decentralised exchanges

The unique aspect of decentralised protocols is that projects can use their own token as incentive payment. Although this can be done in the equity markets as well, e.g. startups pay their advisors in pure equity-based compensation packages, it cannot be executed over large audiences. The largest audiences in stock incentive schemes are various employee compensation schemes. The reason for this is that there does not exist a cost-efficient way to distribute small values of equities due to its regulations being tailored for larger investors (funds, banks, etc.). Paper and lawyers just do not scale.

Since "the DeFi summer of 2020" token projects have been actively using token incentivise mechanisms. Here are some notable examples:

Successful incentive program examples

A successful incentive program increases adoption, robustness, awareness, and reputation long term. Incentives are gasoline for the fire of growth. Earlier, this was seen in the 2010s software-as-a-service venture capital wave: Companies like Uber subsidised rides with venture capital in order to accelerate their growth.

Cryptocurrencies and tokens enable more direct-to-user incentive programs. Protocols and intangible digital goods are global first, making the total addressable markets large from the very beginning.  Open access protocols are also fairer: no one is privileged as long as they have an internet connection and the necessary communication skills to participate in online discussions.

One of the more successful incentive programs came from Aave, lending protocol. In this program, for example, Aave incentivises liquidity for its token on Balancer, and the usage did not drop even after the incentives ended.

Aave daily users have been growing despite incentive program slowly being winded down. Read more in Coinshares 2023 Outlook report.

In developer-oriented programs, like hackathons and Gitcoin grants, any success may not materialise until a few years later. For example, Uniswap was started with a grant from Ethereum Foundation in 2018, and its success materialised in its version 2.0 in 2020.

Uniswap started as a $100k grant from Ethereum Foundation.

The problems of gaming and the birth of mercenary capital

Like all incentive programs, token incentive programs may incentivise wrong behaviour if the incentives are not correctly aligned. It is a well-known problem in any large enterprise, especially in banking. An incorrectly implemented program may end up wasting the incentive money by not creating a long-lasting positive impact. In worse cases, badly executed incentive programs may actually end up harming the project.

The latest case of high-profile incentive programs not creating long-lasting effects appears to be Optimism Quests.  One of the program participants, Synthetix protocol was utilising Optimism Quests to educate users about decentralised finance by asking users to accomplish various tutorial tasks. The usage fell off the cliff when the incentive program ended.

Synthetix's daily active users rapidly fell around January 9.

Synthetix Daily Active Users in Token Terminal

We can also see Optimism's daily transactions overall in decline after the Quest incentive programs ended.

Optimism daily transactions in Artemis dashboard

An overall view of the Optimism Quest program can be found in the Dune dashboard.

Dune dashboard for usage growth of projects participating in Optimism Quests

One of the best examples of poorly-thought incentive programs is the airdrop for Juno blockchain, a Cosmos-based community-driven EVM clone. Juno airdrop did not have any proof of liveness in it. A single airdrop farmer managed to game the airdrop to acquire a Juno stake that was worth of $100M in its peak. This had to be resolved through a messy governance vote, leaving a long-lasting impression that the Juno team might not be up to their task.

A good example of an airdrop that was negatively perceived was the ParaSwap airdrop. ParaSwap attracted users for months by hinting an airdrop, but when it actually happened, some legit users did not fulfil the inclusion criteria for Paraswap airdrop. While this was justified from the point of anti-bot and gaming prevention, the overall net result was PR damage for ParaSwap.

Why DeFi incentive programs have problems?

Like all incentive programs, ones with wrong metrics and measurement instruments are risky.

  • Is the program targeting the right users and the right behaviour?
  • Are correct metrics being measured?
  • How hard is it to game the incentive program?
  • How do they create lasting benefits?
  • Will the incentive program give a net positive perception of being fair?

The problems are exaggerated by the early stage of the DeFi ecosystem. After a decade of cryptocurrency development, we are finally starting to see some really good use cases and very good protocols addressing them. However, we are still in the chasm of adoption: as there are few real users, protocols are chasing this same little user base and are willing to do it at high costs. Just throwing money at the problem does not seem to solve the adoption.

For example, many airdrop incentive programs are easily gamed. What is wanted is not actually measured but a proxy of it. For example, instead of rewarding real protocol users and adoption, you are rewarding addresses for interaction. Because addresses are free, anyone can set up a bot farm and whitewash their way to rewards.

This is a hard problem and not a unique problem for DeFi, though. Even with tougher anti-bot restrictions, a lot of rewards can be gamed. An example from Web 2.0 world is business reviews: here is a recent discussion about gaming Google Business Profiles on Google Maps.

Another contentious topic is liquidity mining. Designed to bootstrap initial liquidity for a publicly floated token, sometimes these schemes have failed to have a long-term impact.  Mercenary capital shows up to maximize their farming yields through compounding. Then it moves forward to the next project when the incentives are over without having the wished long-term effect of increased liquidity.

How should the DeFi incentive program evolve?

The DeFi ecosystem can learn from its past failures.

  • Don't give out free money, although it makes some blazingly hot PR and social media sentiment short-term
  • Focus on long-term, more human-oriented incentive programs, like developer grants, education grants and hackathons
  • Focus on programs that onboard new users instead of giving out rewards to existing professional incentive hunters and mercenary capital
  • If one is set on giving out free money, use proof of liveness and anti-botting techniques to reduce fraud in airdrops
  • Make sure any reward tokens are linearly vested over a year or two in lessening the impact of any problematic incentive distribution
  • Find alternatives to liquidity mining and boosted staking rewards as a means to bootstrap liquidity

Focusing on the long term might be counterintuitive. It might also be difficult if the project funding depends on certain metrics goals like total-value-locked (TVL) or daily active users (DAU). In this case, the damage has already been done earlier by setting up metrics in a way that can be gamed.  

More human-oriented programs like developer grants are long-term. Uniswap's success and its positive impact on the Ethereum blockchain did not start to materialise until two years after the grant. Yearly time windows are often outside the marketing and investment decision-making horizon.

As we are now in a cryptocurrency bear market, there is no need to rush to raise quick funding with incentive programs implemented to inflate numbers. Any actions can be piloted with smaller amounts, evaluated and adjusted based on the tested outcomes. With patience and proper management of expectations, token-based incentivising can make DeFi grow faster but can also lead the way to more generalised token incentive schemes applicable to any startup and any industry.

We'd like to thank the podcast and its community for aiding with the research. operated by Trading Strategy Operations Ltd., Victoria, Mahe, Seychelles.