Editor's Note: This article comes fromCrypto Valley Live (ID: cryptovalley)Editor's Note: This article comes from

Crypto Valley Live (ID: cryptovalley)

Crypto Valley Live (ID: cryptovalley)

Its impact on the DeFi space has already been enormous — at the time of writing, the total value locked was over $10 billion, up from just over $1 billion on June 16, 2020. This has also put pressure on the Ethereum network, with gas prices and transaction fees reaching all-time highs as users rush to capture and realize profits. While the frenzy is reminiscent of the ICO bubble of 2017, the fundamentals are stronger.

Liquidity mining

In this post, I will explain what yield mining is, what works well, and what can be improved. While the field is evolving rapidly, I hope to capture most of the interesting developments that can inform protocols wanting to implement such initiatives and users wanting to get involved.

first level title"Liquidity mining"Liquidity mining is a network participation strategy in which users provide funds to a protocol in exchange for the protocol's native token."The term was coined a few years ago by CoinFund's Jake Brukhman, who discussed it in the context of supply-side network engagement"Generalized mining

. The nuance 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 a governance token that allows holders to control protocol parameters. Voting, including value capture mechanisms. Many people often refer to it as

• yield farming

• ; although these terms are often used interchangeably, yield farming does not require a token (for example, liquidity providers can earn yield, and only pay transaction fees on Uniswap).

• Not all yield mining projects are created equal. Looking at startups over the past few months, three categories have emerged.

Fair launch: The main goal is to distribute most of the tokens by some objective criteria, rather than direct sales (such as becoming an active user of the protocol), and ensure that everyone has an equal opportunity to distribute. Think of this as Uber being owned by its drivers and riders from day one.

Decentralized startup: The main goal is to gradually achieve community ownership and minimize financial management. Think of this as Uber signing a legally binding agreement to distribute most of its stock to drivers and riders over the next few years.

• Each of these categories has its advantages and disadvantages, a protocol can have multiple categories (for example, Uniswap implements 2% inflation for long-term programmatic allocation), and the so-called optimal token issuance method will depend on the protocol The goal.

Liquidity mining is important for several reasons:

• image description

YAM and YFI are fair startup models

• Closer docking: The benefit of the liquidity 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 Lynn diagram below.

• Data is from October 30, 2019 and does not reflect current distributions

More inclusive governance: Users who have ownership in the protocol have an incentive to help the protocol succeed. By sharing potential financial gains early on, liquidity mining programs enhance community engagement and help protocols launch or transition to DAOs.

first level title

what works well

Dozens of experiments have been performed over the past four months, and while failures are easy to see, many design choices were successful and should be incorporated into future iterations."secondary title"Incentive for long-term liquidity

At present, most of the liquidity in liquidity mining projects comes from"mercenary capital", they have no loyalty to the agreement and instead pursue the most lucrative opportunity at the time. It's like your friend signing up for every food delivery startup for free food. The problem here is that short-term liquidity is not as valuable as long-term liquidity, and yield mining projects should adjust to attract more long-term funding.

time multiplier

The mechanism solves this problem very well, and the mechanism gives rewards according to the deposit time. The rewards will continue to increase (and be distributed retroactively) from 1 time on the first day, to 2 times on the 30th day, and then to 3 times after the 60th day. Because of this, many people are willing to wait two months before withdrawing their money.

Retention data is mixed, but also promising. According to the team’s update on August 4 (43 days after the project started), about 6,036 unique users tried Geyser, and 4,242 users were still active on that day (about 70% retention rate). According to unconfirmed internal sources, on September 8th (78 days later), Geyser (specifically the AMPL-WETH Uniswap pool) had 7,318 unique users and 3,193 active users (~44% retention rate). The decline in users was expected given the launch of many other liquidity mining projects, but the decline in liquidity was more acute - as of September 8th, the AMPL-WETH pool had ~$83 million in total deposits Has liquidity of about $9.5 million (about 11% liquidity retention rate)."secondary title"Parameters can be adjusted continuously

A liquidity mining program should not be a

• Set it and forget it

• -- While the protocol team does their best to anticipate the unexpected behavior of these programs, they need to be prepared to adjust at any time.

• Balancer fine-tuned its liquidity mining program in the first few weeks by adding five additional parameters designed to reward specific types of liquidity, eg.

Transaction Fee Penalties: Penalize high transaction fees because the liquidity they provide is less useful. Punish high transaction fees as they make the pool less attractive to traders.

It turns out that Balancer's rapid and continuous adjustments are supported by liquidity providers. Unique liquidity providers are on a scale of 1-15 before the project kicks off on June 1st. That number jumped to 71 on June 1 and hasn't dropped. In September, independent LPs (liquidity providers) were between 861-1517.

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Source: Balancer Dashboard

Cross-Protocol Community Engagement

Liquidity mining programs do not operate in a vacuum - liquidity providers actively assess their opportunity cost of participating in the program, and an effective way to get them involved is to align with the communities they currently participate in.

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YAM’s growth has been impressive — it had more than $500 million in total value locked in 24 hours before the contract loophole was discovered.

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Source: Yam Dashboard

Continuous Product Innovation

A yield mining scheme for an inferior protocol does not make it a better protocol. Compound, Curve, and Uniswap have all done a great job at this point by having a useful protocol up and running before launching their liquidity mining projects, which makes it easier for people to want to participate in liquidity mining in the first place mine project.

Furthermore, the point of a protocol fork should not just be to remove distributions from founders and investors, but to meaningfully increase the utility of the protocol in a way that differentiates it from competitors. Pickle Fiance has done a great job so far, their product roadmap includes several novel yield generating investment strategies and eventually a stablecoin arbitrage strategy with the aim of getting stablecoins back to their anchors. Based is also actively developing their roadmap, which includes a DEX and a fair launch platform.

secondary title

Shorten the duration of the program

Another benefit is that you introduce enough volatility into the market for more efficient price discovery. At the start of a multi-year liquidity mining program for a highly anticipated project, there is a risk of damaging the community if the market cap starts too high and early holders lose money on their investments.

Yearn’s YFI Token offering is an extreme example, distributing 100% of the total supply within 9 days. From a market structure standpoint, with no early holders, there is little selling pressure, and this creates a virtuous cycle where early holders benefit the most from the financial upside. Currently, the Token is held by 13,507 addresses, with one of the most enthusiastic and engaged communities in the industry.

One way to achieve balance for teams opting for longer planning horizons is to issue early, as early liquidity is more valuable than later liquidity. Similar to the Bitcoin block reward halving, you can have a decay function where the reward is larger in the first few days/weeks and gradually tapers off. SushiSwap has done a good job here, accelerating the issuance in the first two weeks. At the peak, they accumulated assets of 1.5 billion US dollars, which was about 73% of Uniswap's liquidity at that time.

secondary title

For liquidity mining projects that last for a long time, there is an economic attack method. Other income aggregation protocols (such as Yearn yVaults, Harvest Finance) can participate in this project, but they do not plan to hold Token for a long time. This reduces rewards for participants who are more aligned with the protocol's long-term vision. A release schedule for rewards can reduce the likelihood of this attack, as mercenary capital will think twice before engaging.

The release schedule also gives more time for information to spread throughout the market, which aids in price discovery and allows token holders to decide whether this is a viable long-term project (e.g. clear token value accumulation, well-functioning governance system, active community).

DODO made a brave decision in their liquidity mining project to lock Tokens one week after they provide initial liquidity on AMM, and let them release linearly within 6 months thereafter. Even with these limitations, DODO was still able to attract over $90 million in liquidity from 3,105 addresses."secondary title"more specific goals

It is likely that many protocols started liquidity mining programs without a clear goal, what specific outcomes they wanted to incentivize, or a measure around the usefulness of these programs. Ideally, the team should understand that,

• "Allocating X% of the token supply in Y weeks increases the additional liquidity of the protocol by $Z" 

• ". And ideally, you'd get metrics around the dollar cost per unit of liquidity and the duration of liquidity within the protocol." 

• "UMA does a great job here with their liquidity mining program, which targets a specific pool for a fixed amount of time and asks the question:" 

What percent of absenteeism is immediately sold for rewards?"What percentage of miners voted with rewards?"The project was quite successful, at one point attracting about $20 million in locked ETH and providing the team with some important data points such as

Daily circulation cost

secondary title

fairer participation

Today, most yield farming projects disproportionately benefit those with significant capital, to the detriment of community engagement and token distribution. Based attempts to address this by imposing a cap of $12,000 on the amount each address can stake in its initial liquidity pool. Pickle also attempts to solve this problem by implementing quadratic voting to prevent large players from gaining asymmetric influence over governance decisions. While we don’t know if big players created multiple addresses to circumvent staking and voting restrictions, this is a step in the right direction.

About Supply Caps

At the same time, sustained high inflation rates may destroy the value of all Token holders. Additionally, high inflation could exacerbate governance-related attack vectors, which could have implications for the broader DeFi ecosystem. For example, if an X Token with an uncapped supply and adjustable inflation is accepted as collateral in Compound, a malicious actor could vote to mint an unlimited amount of X Token and steal all the collateral in Compound. One solution is for the contract to have a low-inflation nature, enter into community governance, or the contract to include an option for 0 inflation while initially setting it at 0% along with an inflation cap.

In addition to the above recommendations, there are still several issues that need to be addressed in the liquidity mining program.

• general questions"Fake"In addition to the above recommendations, there are still several issues that need to be addressed in the liquidity mining program.

• Speculation: While liquidity mining schemes are not intentional, users may cheat on incentives. For example, on Compound, recursive lending is likely to result in

• Fake"mint() "transaction volume and crowd out real users. According to some unconfirmed estimates, this could be upwards of 30% of Compound’s reported supply value. This kind of user behavior does not provide much value to Compound, because most of the liquidity in the protocol cannot be accessed by other users.

• Technical risk: Security audits are expensive, and teams that want to do a fair release often don't have the resources to do them beforehand. This led to the discovery of bugs in the mainnet contract, resulting in the loss of user funds. This also gives an advantage to those who have the technical expertise or resources to check the authenticity/security of contracts. Fair Startup Capital is trying to solve this problem, offering unconditional funding to cover audit and start-up costs.

• Information Asymmetry: While the aim is for a fair distribution, insiders are likely to gain an advantage within the first minutes/hours of a yield farming project, resulting in an unfair advantage over retail participants. One of the ways to solve this problem is to give sufficient notice that the yield mining project will start.

in conclusion

Gas fees: High Ethereum gas fees tend to drive out small players, leaving liquidity mining projects to those who can afford to pay the gas fees. This hurts token issuance and lower-value projects, such as those focused on NFTs and games.