How did the liquidity mining that set off the DeFi wave finally die?

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Let me talk about two concepts first: "liquidity" and "mining"

fluidity:

fluidity:

Any market needs to be traded at any time, that is, there needs to be buying and selling orders. The matching of buying and selling orders is called market liquidity.

In short-term trading in the financial market, what is traded is not the securities themselves, but essentially trading risks. The market only provides a place for risk circulation, and traders gain benefits from taking risks. Market participants also price current risks, and voting on risks is buying and selling pricing.

Anyone who has ever speculated in coins or stocks should know that in the financial market, you are not afraid of not making money, nor are you afraid of being trapped. The most fearful thing is that liquidity will dry up.

Thinking about this year's surges and falls, do they represent a sudden increase in the value of Bitcoin? Not! It is because the market lacks rivals. When the liquidity in the market is exhausted, the price will have a violent unilateral trend, which may even endanger the survival of the entire market. This is the importance of liquidity to the market.

On the other hand, tokens have no value at first, and through mining, the anchoring and capture of value is finally completed, making tokens scarce and "acquiring costs". For example, under the framework of the POW mechanism, miners invest in computing power and operation and maintenance in exchange for block rewards and participate in transactions in the secondary market, thus having the concept of "shutdown price".

On the other hand, tokens have no value at first, and through mining, the anchoring and capture of value is finally completed, making tokens scarce and "acquiring costs". For example, under the framework of the POW mechanism, miners invest in computing power and operation and maintenance in exchange for block rewards and participate in transactions in the secondary market, thus having the concept of "shutdown price".

Liquidity mining:

Liquidity mining:

Take the Compound project as an example. As an Ethereum-based DeFi protocol, Compound's main business is mortgage lending. According to data from DefiPulse, on July 7th, the lock-up amount of Compound was about 650 million US dollars. Users can mortgage their own assets to obtain annualized income, or pay corresponding interest to lend assets, and at the same time of borrowing and lending, they can obtain a certain amount of governance token COMP distributed by the system.

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Let me talk about the conclusion first: In liquidity mining projects, the price of project tokens often rises with the increase of participating funds. In this case, the increase in the number of participants and funds locked in the platform will drive up the price of project tokens, which in turn will continue to stimulate more funds to participate in the liquidity mining of the platform. The participation of high liquidity funds will further increase the price of tokens, thus forming a cycle, and even giving birth to a "false prosperity" and a "pseudo-Ponzi spiral".

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Source: Feixiaohao

Source: Feixiaohao

Taking the popular YFI project as an example, users can complete different liquidity mining strategies through yearn.finance, which belongs to the liquidity mining aggregation platform. On July 17, 2020, yearn's locked volume (TVL) on Curve was approximately $8 million. Three days later, as of Monday, July 20, 2020, that figure had risen to $147 million. The increase in TVL drove the price of its governance token YFI, which soared from an initial valuation of $30 to $13,616.

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Can the high yield of liquidity mining last?

Liquidity mining is something new to Westerners, and they even named it “Yield Farming”. However, after analyzing this wave, we found that the model seems very familiar. Isn’t this the model of FCoin back then?

FCoin launched a liquidity incentive policy back then and used its own platform currency FT to reward users who traded on the platform. The trading volume of the platform exploded within a month, and such a rapidly growing trading volume was not a real trading demand, but a lot of trading robots of investors speculate in it. Ultimately, the FCoin platform was shut down in February of this year, failing to pay users between $67 million and $125 million.

Let's go back to the example in the previous section. As long as the borrower borrows money on the Compound platform, he can get 50% of the COMP token distribution on the platform every day, and as long as the value of the obtained COMP can cover the repayment interest rate, he can arbitrage without loss. This is also the main reason for the rapid increase in the number of borrowings as the price of COMP rises.

We quickly discovered the root of this pattern, whose money are the speculators making? Speculators transfer the risk to those who buy the reward tokens by circulating the rewarded tokens in the secondary market. As a speculator, they have no real demand for loans or transactions, but simply for the sake of Earn reward tokens and sell them for profit on the exchange market.

Obviously, this model incentive itself does not stimulate real lending or transaction demand, nor does it really solve the mismatch between supply and demand. Most traders come for the stimulation itself, not for transaction demand.

The risk point of this stimulus model is that due to the positive growth cycle, speculators flood in quickly, and the proportion of speculators in the system is much higher than the proportion of real transaction demand. Once for speculators at a certain moment, other When costs (commissions on transactions or borrowing costs) exceed the distribution of benefits, speculators will exit the transaction, leaving only a small number of real traders.

Therefore, how to flow in a positive cycle with the scenery, the ending will be the end of the death spiral. Once the situation is reversed, the system has not had time to establish the support of negative feedback (or due to the explosive growth of the release volume, it is impossible to carry out any effective negative feedback management), which will accelerate the price drop, accelerate the exit of speculators, and cause the system to collapse.

At the time of the negative cycle, the FCOIN team tried to carry out artificial negative feedback, such as acquiring some assets in the secondary market, but in the end it was a drop in the bucket, and it still could not withstand the torrent of negative feedback.

In addition, liquidity mining is now exposed to security and systemic risks. The lightning loan attack against bZx is a typical case. The attackers arbitraged more than one million US dollars in ten seconds according to the rules without stealing tokens. Defi products with the spirit of cross-chain agreements are getting closer and closer to traditional financial leverage games. The popularity of liquidity mining aggregation platforms has intensified the mutual influence between mainstream projects, which may cause certain systemic risks.