Editor's Note: This article comes fromEthereum enthusiasts (ID: ethfans)Editor's Note: This article comes from

Ethereum enthusiasts (ID: ethfans)

Ethereum enthusiasts (ID: ethfans)

, Author: Dmitriy Berenzon, translation & proofreading: shooter@RebaseCommunity & A Jian, reproduced by Odaily with authorization.

Liquidity Mining was first launched by IDEX in October 2017, perfected by Synthetix in July 2019, and implemented on a large scale by Compound in June 2020. Liquidity mining has captured the imagination of dozens of protocols and is considered a better way to distribute tokens.

The impact on DeFi has been staggering — as of this writing, the total value locked in DeFi applications has exceeded $10 billion, and on June 16, 2020, this figure was just over $1 billion. This has also put pressure on the Ethereum network, with gas prices and transaction fees reaching all-time highs as users rush to make profits. While the mania is reminiscent of the ICO bubble of 2017, the fundamentals are stronger.

In this post, I explain what yield farming is, which designs have worked well, and what can be improved. The field is evolving rapidly, and I hope to capture most of the interesting developments and share them with protocols wishing to implement such programs and users wishing to participate.

Liquidity mining is a network participation strategy where users provide funds to a protocol in exchange for the protocol's native token.

• But not all liquidity mining projects have the same design and purpose. Looking at the situation over the past few months, three categories have emerged:

• Fair start. The main goal is to distribute the majority of tokens through some objective criteria (such as being an active user of the protocol), rather than direct sales, and to ensure that everyone has an equal opportunity to earn tokens. You can imagine Uber being owned by drivers and riders from the beginning.

• Programmatic decentralization: The main goal is to gradually achieve community ownership and minimize fund management. Think of this as Uber signing a legally binding agreement to distribute the majority of its stock to drivers and riders over the next few years.

Growth Marketing: The main goal is to incentivize specific user behavior over a period of time. Think of this as Uber using Uber stock to reimburse some riders for their rides.

Each category has advantages and disadvantages. Some protocols’ mining schemes may combine multiple categories (such as Uniswap’s hard-coded 2% inflation for long-term programmatic allocation), and there is no absolute comparison between the schemes , only if it meets the purpose of the agreement.

• Liquidity mining is important for the following reasons:

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- Both YAM and YFI are advertised as "fair launch" projects. source -

Closer integration: The benefit of the liquidity mining program is that token holders are more likely to be protocol users. After analyzing their token holder base in late 2019, 0x has the following insights. Liquidity mining is essentially making the intersection of this Venn diagram bigger:

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Which designs work well

Dozens of trials have been staged on the market over the past four months, and while it's easy to notice failures, many design choices were successful and should be incorporated into future iterations.

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Most of the current liquidity in LM projects comes from "hired capital" who have no loyalty to the protocol and instead pursue the most profitable opportunities at the time. It's like your friend signed up for every delivery company for free delivery. The problem here is that short-term liquidity is not as valuable as long-term liquidity, and LM projects should be adjusted to reflect this.

Ampleforth solves this problem nicely with their procedural "time multiplier" mechanism in their Geyser, which rewards deposits based on how long they have been deposited. The rewards go from 1x on day 1, to 2x on day 30, to 3x after day 60, and so on (and retroactively). Therefore, many people are willing to wait two months before withdrawing cash.

Retention data was mixed, but the outlook was positive. According to the team's update on August 4th (43 days after the project started), approximately 6,036 unique users tried Geyser, of which 4,242 were still active on that date (approximately 70% retention rate). According to unconfirmed internal sources, on September 8 (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 to be expected given the launch of many other LM projects, but the drop in liquidity was more dramatic - as of September 8, the AMPL-WETH pool had around 950 out of $83 million in total deposits million dollars of liquidity (approximately 11% of liquidity retained).

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• Adjustment parameters

• Liquidity mining programs should not be expected to work "once and for all", and while the protocol team will do their best to predict how these programs will perform in reality, they will need to adjust over time.

• In the first few weeks, Balancer did an excellent fine-tuning of its LM program by adding five additional parameters designed to reward specific types of liquidity, such as:

feeFactor: Penalizes high transaction fees because they make the transaction pool less attractive for transactions

wrapFactor: Penalizes highly correlated token pairs for attracting useless liquidity

It turns out that Balancer's rapid and continuous adjustments have been responded by liquidity providers. The number of liquidity providers was in the range of 1-15 before the project started on June 1st. That number jumped to 71 on June 1 and hasn't looked back. In September, single LPs ranged from 861-1517.

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Liquidity mining projects don’t operate in a vacuum — liquidity providers actively assess their opportunity cost of participating in the project, and an effective way to get them to participate is to be compatible with the community incentives they are currently in.

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

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- Source: YAM Data Dashboard -

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Adding a liquidity miner to a bad project doesn't make it better. Compound, Curve, and Uniswap have all done a good job here, and they had an efficient and useful protocol before launching the LM project, which made it easier for people to want to participate in the liquidity mining project in the first place.

Furthermore, the focus of protocol forks should not be solely to remove distributions from founders and investors, but to meaningfully increase the utility of the protocol in a way that differentiates competition.

Pickle Financ is doing well so far, with its product roadmap including several novel yield-generating investment strategies and, eventually, a stablecoin arbitrage strategy aimed at bringing stablecoins back to pegs. Based is also actively developing their roadmap, which includes a DEX and fair-launch platform.

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Shorten the duration of the mining scheme

Another benefit is that you introduce enough float into the market to make price discovery more efficient. If there is a highly anticipated project to start a multi-year liquidity mining plan, low liquidity may destroy the entire community, because the opening market value may be too high, and early holders will lose their investment.

Yearn's YFI token issuance is an extreme example, releasing 100% of the total supply within 9 days. From a market structure standpoint, since there are no early holders, there is little selling pressure, creating a virtuous circle where holders who entered the market earlier benefit the most from the rise in financial markets. Currently, the token is held by 13,507 addresses and has one of the most enthusiastic and engaged communities in the industry.

For teams that choose a long-term persistence plan, a balancing method is to release early, because 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 decreases. SushiSwap did a great job here, issuing tokens at a rate of 10x in the first two weeks, and at the peak, they attracted $1.5 billion in assets, about 73% of Uniswap's liquidity at the time.

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For LM projects with a long duration, there is an economic attack, and other revenue-generating protocols (such as Yearn yVaults, Harvest Finance) can participate in the project instead of holding tokens for a long time (sell them immediately). This reduces rewards for those participants who are more aligned with the protocol's long-term vision. An established reward staking schedule may reduce the likelihood of such an attack, as hired capital will think twice before participating in the scheme.

The unlocking scheme also allows more time for information to spread in the market, allowing token holders to decide whether this is a viable long-term project (such as clear token value accumulation, well-functioning governance system, active community), thereby helping price discovery.

DODO made a brave decision in their LM project to lock tokens until a week after they provided initial liquidity on the AMM, and let them release linearly over 6 months thereafter. Even with these limitations, DODO was still able to attract over $90 million in liquidity from 3,105 addresses.

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• More performance indicators

• Many protocols may not have a clear goal when launching a liquidity mining project, do not know what specific results they want to incentivize, and do not know how to evaluate whether these projects are useful or not. Speaking of well, the team should understand that "distributing X% of the token supply in Y weeks will cause the protocol to increase liquidity by Z dollars". And, again, the team should design performance metrics around the dollar cost per unit of liquidity and the duration of liquidity, which is actually CAC (customer acquisition cost) and LTV (debt-to-market ratio) in the real world. The corresponding version of the world.

• UMA does a great job here with their LM project, targeting a specific pool for a fixed amount of time, and asking questions like:

What % of farmers voted with rewards?

How widespread is the distribution?

The project was quite successful, at one point attracting ~$20M worth of ETH, and provided the team with some important data points, such as "daily liquidity costs" ranging from $1000 to $4500/million.

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fairer participation

Most LM projects today 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 address this issue by implementing diminishing weight voting to prevent "whales" from gaining asymmetric influence over governance decisions. While we don’t know if the “whale” created multiple addresses to circumvent staking and voting restrictions, this is a step in the right direction.

Total Supply Limit

In my opinion, long-term projects should not have a supply cap. These protocols are more like corporations than currencies, with no corporations limiting their ability to issue shares. Additionally, not having the ability to create new yield mining projects would make the protocol more vulnerable to vampire attacks.

• But on the other hand, sustained high inflation rates may destroy the value of all token holders. Additionally, high inflation rates could exacerbate governance-related attack vectors, which could have implications for the broader DeFi ecosystem. For example, if token X with an unlimited supply and adjustable inflation rate is accepted as collateral in Compound, a malicious actor can vote to mint an unlimited amount of token X and steal all the collateral in Compound. One solution is to hard-code a long-tail period of low inflation rate, and let these newly issued tokens enter the community governance warehouse; or hard-code a choice that includes the terminal inflation rate, and initialize it to 0%. Inflation ceiling.

• widespread problem

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

• Vulnerabilities: While intentionally avoided, mining mechanisms may still leave loopholes that allow users to cheat the mechanism. For example, on Compound, recursive lending is likely to lead to "fake" transaction volume and crowd out real users. According to some unconfirmed estimates, over 30% of Compound's reported supply value is this fake volume (if there is ~$1B in supply, that's only ~$700M in non-recursive 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.

• Reversed plot: Even without accidental bugs, most yield farming projects today are started by anonymous founders, making them the perfect breeding ground for scammers. These malicious actors can exploit these contracts, such as calling the mint() function like Hotdog, or simply selling tokens like Yuno, with no consequences at all. Technologists can learn about these attack vectors by using tools like Diffchecker, but LM remains a dangerous game for retail players.

in conclusion

Information Asymmetry: While the aim is for a fair distribution, insiders are likely to have a head start in the first few minutes/hours of the LM program, resulting in an unfair advantage over retail investors. One of the ways to solve this problem is to give sufficient notice that the LM program is about to start.