Detailed explanation of liquidity mining: the road to wealth or the wrong path of DeFi

Source: Odaily Planet Daily (ID: o-daily)

On the afternoon of August 6, Odaily Planet Daily held the second episode of the "Singing the Counter-Tune" online debate - DeFi liquidity mining boom: a bright future or a flash in the pan?

Among them, the affirmative side believes that " the flow of the protocol layer brings new opportunities and the future is promising ." The guest team includes: OKEx CEO Jay Hao, YFI-yip8 proposal initiator Lao Bai, Multicoin Capital Executive Director Mable Jiang and The Force Frotocal & ForTube founder David Lei.

The opposing side believes that " the liquidity mining model is unstable and the road ahead is long and difficult ." The guest team includes dForce founder Yang Mindao, NestFans Forum Shier, Axia8 Ventures founder Wayne Lin and FTX COO Constance.

The entire debate lasted about two hours, with debaters on both sides exchanging sharp words and frequently delivering golden sentences. I hope that readers can gain some market inspiration through the brainstorming of the guests, seize the wealth opportunities brought by this DeFi liquidity mining, and also learn to avoid the risks involved.

The following is a transcript of the community debate:

01
Soul torture

The host asked the affirmative side:

1. Why does DeFi need liquidity mining and yield farming, and why is it so popular recently?

2. What value does liquidity mining bring to the DeFi ecosystem? Is this value sustainable? Why?

Jay Hao : First of all, liquidity is the basis for the survival and development of DeFi. If DeFi wants to survive and grow, it must be provided with liquidity. Liquidity mining and yield farming inject huge amounts of liquidity into DeFi projects through economic incentives, which is very successful so far.

From an economic perspective, liquidity mining is essentially a "user subsidy" because the project party issues tokens at almost zero cost to reward yield farmers who provide liquidity for DeFi.

Similarly, in order to obtain higher returns, yield farmers continue to trade in the DeFi system, indirectly providing liquidity for DeFi. It can be said that liquidity mining and yield farming complement each other in "providing liquidity - obtaining token returns". As token prices rise, people's enthusiasm for providing liquidity increases, thus forming a positive cycle and causing DeFi to show explosive growth.

In other words, most of the incentives of the entire Compound are given to DAI arbitrageurs, rather than the real demanders of the protocol. This is the biggest side effect of hard-coding incentives at the protocol level. It can be said that every day the Compound ecosystem has to burn 250,000 US dollars in useless subsidies to these pure arbitrageurs. Of course, for us, we are happy to see it happen. We help everyone mine COMP and dig down the wall of capitalism.

Advice to investors: For liquidity mining, everyone should pay attention to Uniswap's fake coins . Various fake coins are issued through IUO. This is a pure scam. When you want to invest in such tokens, you must pay attention to whether they are official tokens.

Another thing is the risk of various forked coins. For example, there have been several forked coins based on YFI that have run away recently. In addition, we have also heard that there are now queues in the market to fork AMPL and Uniswap, etc. The fund pool ratio of such projects is generally the most extreme 98/2. If investors do not understand the risks of providing liquidity on Uniswap and Balancer, it is not recommended to participate.

Most projects compete to see who can run faster, and the projects that have run away before have preset backdoors. For this type of forked coins, everyone should be extra careful about the projects of anonymous teams. The anonymization of this type of project is often a prelude to running away secretly.

I think there are several important issues:

The first is the code security issue of the DeFi protocol itself. The newly launched DeFi has not been verified by the market, but liquidity mining has been started immediately, which may lead to some code-level security issues. This is very fatal. Once a code vulnerability occurs, it usually involves fund security issues, causing significant asset losses to participants.

The second is the design of the incentive mechanism of the DeFi protocol. Is the design of the economic model correct? Is it an effective incentive? Because most DeFi developers are not professional financial players, they may be more inclined to solve the problem of cold start of the project in the early stage, while ignoring the long-term development of the protocol itself.

The third is the high threshold for user participation. DeFi is built by on-chain smart contract code. Ordinary users need to have a certain understanding of the properties and characteristics of smart contracts in the process of participation, and there are some learning and cognitive barriers.

My advice to ordinary investors:

1. Be cautious when operating assets or interacting with smart contracts, and don’t make mistakes ;

2. Before participating, you should fully research the target DeFi protocol itself, including the protocol code and mechanism design;

3. At the same time, you should also ask yourself whether you have a demand for DeFi. If not, it is not recommended to participate, and you must not do FOM.

4. Finally, it is not recommended to buy DeFi Tokens in the secondary market , because it is difficult for early DeFi Tokens to have a balanced market pricing; if you are really optimistic, participate in liquidity mining to obtain the Token.

Wayne Lin : I personally think that the problem behind the popularity lies in this "subsidy". New projects directly get token subsidies, and old projects (even suddenly switching to DeFi) launch liquidity mining subsidies to gain attention. Market and marketing gains are certainly possible, but I think DeFi subsidies are subsidizing "equity", so unlike Didi, ofo, Luckin, etc., long-term sustainability is important.

Of course, many great and successful companies rely on subsidies to start up, but you don’t see these companies giving out “shares” to their users and customers as subsidies. This is equivalent to giving out their own equity as a “cash red envelope” or “transaction enhancement”, so for a period of time, the market’s perception of your “shares” and relative “functions” will be like this.

I personally believe that there will still be liquidity mining, PNL mining, etc. in the future, but this model is currently a bit over-hyped, and the differentiation of liquidity mining between different projects is also very small.

As for the risks that investors should be wary of, it depends on their own level of awareness and motivation. Investment depends on the future value and performance prospects of a product/protocol. For investment, you are welcome to study and discuss a bunch of IUOs every day on various teles (then we may be mutual friends). Study the rules and rhythm clearly before making your own decision. The key is to be responsible for yourself.

Constance : First of all, I don’t think liquidity mining can be considered as a real mining behavior. Different from the computing power mining we are familiar with, liquidity mining refers to rewarding users who participate in lending (fund flow) at the smart contract level.

We know that computing power mining is backed by resource consumption and then obtains token income, but for liquidity mining, the tokens obtained by users through liquidity mining are usually officially issued, and their value endorsement relies on the credibility of the project itself.

Secondly, liquidity mining will largely create bubbles. The total locked value of DeFi is billions, and Compound alone exceeds 100 million US dollars. The Compound project has attracted widespread attention and remains popular, and the value of its token has also been rising. However, the current source of this popularity is mostly speculators who want to get a piece of the pie, so behind this superficial prosperity, the real value generated by lending may not be much, so liquidity mining will largely create bubbles.

Finally, let me talk about the challenges of liquidity mining. Due to the need to pay high transfer (gas) fees, DeFi has always been jokingly called a " rich man's game ". This also shows that there are very few retail players in the current DeFi field, and more are large players or even institutions. For example, before Compound launched the liquidity mining model, the total number of users did not exceed 1,500, but the locked amount reached 100 million US dollars. It can be seen that the asset locked amount of a single user is relatively high. Once there is selling pressure, the market value of the project may fall sharply.

02 Jay Hao VS Yang Mindao

Jay Hao : Good afternoon, Mr. Mindao. My question is that dForce has also issued its own token DF, but you are representing the opposing side. It should be because the incentive model of DF is somewhat different from that of most current projects. As a "DeFi OG", which incentive mechanisms of liquidity mining do you think are more desirable? Which ones do more harm than good to the ecosystem?

Yang Mindao : There are several mining modes in DeFi. From the distribution mode, for example, Compound is written at the protocol level at one time. Modification and adjustment require complete on-chain governance, which is very troublesome. I mentioned the side effects before.

Another distribution system is a phased and flexible mining model similar to Sythetix, which dForce is also adopting now. The advantage of this model is that it is flexible enough and can be linked through multiple pools and multiple protocols.

dForce is building a protocol matrix. At this stage, it mainly incentivizes USDx, GOLDx, and dToken. The mining distribution of DF will come from our gravity pool. We are now divided into three pools, which incentivize different protocols. For example, the "Champagne Tower" pool mainly incentivizes our interest-bearing asset protocol (interest-bearing assets help users mine COMP); Pool No. 2 is GOLDx/USDx, which mainly incentivizes the minting of our gold tokens and USDx; Pool No. 3 is the DF/USDx pool, which incentivizes the liquidity of DF and USDx while incentivizing minting.

I will just say that the data is easier to understand:

Moreover, the size of GOLDx's liquidity pool on Uniswap is 20 times that of PAXG, which means that the slippage of trading GOLDx on dex is the best among all gold tokens.

The multi-pool rotation, mutual value reinforcement, and multi-point detonation in the mining model are the biggest differences between us and most mining incentives on the market.

As shown in the above picture, in the future OKEx will also strengthen its cooperation with its existing DeFi star projects in business segments such as coin listing, mining pools, and Yubibao. Finally, in the field of DeFi infrastructure and development tools, we are currently also cooperating with ChainLink, BNT, etc.

03 Lao Bai VS Shi Er

12 : On Monday, the price of YFFI, another fork of YFI, plummeted from a high of 501.14 USD to 5.85 USD, a drop of 98.3%. Many analysts say that they are a professional "exit scam". What do you think of this situation? How should users judge the risks of these emerging projects?

Lao Bai : According to various sources, YFFI is a project initiated by a member (OG) with close ties to the YFI community. It has been officially endorsed by yearn. Perhaps it is a measure taken to counterbalance YFII's syphoning of yCRV liquidity (YFII's yCRV mining pool has attracted up to $200 million in yCRV, while the Dai mining pool has attracted up to more than $60 million in Dai).

Liquidity mining is a means of growth hacking. If a project lacks the support of the community and actual business, it will fall to this point and become pure ZJP.

In addition to the three officially endorsed projects, there are many more projects such as YFIII, YYFI, YFX, etc. that have backdoors implanted in the mining contracts, specifically targeting novices who do not understand technology.

The early fraud methods were relatively primitive: without destroying the additional private keys, a large number of tokens were directly over-issued to exchange for the users' DAI in the balancer pool; later, more advanced methods added the function of allowing the project party to withdraw funds in the mining pool, and all the money deposited would be withdrawn.

If ordinary users want to obtain high returns, they need to conduct a comprehensive investigation of the project, including the development team, community atmosphere, code review, etc. This is undoubtedly a high threshold that prevents the public from participating. In order to solve this problem, YFII developed the Vault DeFi financial management agency protocol, which provides an interface for wallets and exchanges to participate in DeFi mining with one click.

The YFII project itself is positioned as a DeFi financial management protocol for the general public, which can avoid the complex contract operation of Yield Farming, save high gas fees, and facilitate the participation of small assets. Users only need to recharge assets to the YFII Vault agent to obtain the best returns in the market.

I heard that many users spent more than 0.5 eth in handling fees when participating in YFI. If you use YFII Vault, you only need one deposit + one withdrawal to complete it.

The following are the advantages of YFII:

1. YFII Vault is audited by multiple contract engineers in the YFII community to ensure the security of the contract to the greatest extent possible. In the future, it will also strategically insure with decentralized insurance services such as NXM to further ensure the security of funds.

2. Community members can submit Yield Farming strategies, and the YFII governance mechanism will vote to select the best strategy and deploy multiple strategies in the Vault.

3. YFII Vault adopts a strategy that is more in line with the characteristics of the Chinese market to help ordinary users optimize the DeFi financial management yield.

Lao Bai : Brother Shier, you should be the first person to write an article comparing liquidity mining and FCoin. Later, many opinions have been discussing that the current incentive model is ineffective. So what do you think is an effective incentive? Do you have any examples?

Twelve : A professional player in the NEST community has written an article like this, which is indeed very well written, but it was not written by me, and it is worth learning.

If the incentive itself is not to solve the mismatch between supply and demand, but to incentivize the entire closed loop of transactions, then a problem will easily arise, that is, transactions are for the incentive itself, rather than for transaction needs ; that is, the person who receives the incentive needs to complete the closed loop himself, so once the incentive is added, the original real needs will no longer be taken into account.

At this time, most of the incentives are for speculators. Because speculators' order-scalping theoretically also provides a certain amount of liquidity, and because the benefits of the entire system are evenly distributed to participants (excluding operating costs), as long as the entire system can maintain positive value, traders will get better returns than without incentives.

But this benefit is just a spillover effect of incentives, with more speculators chasing a "return illusion" in which early participants receive higher distributions because of the increase in later participants.

If an enterprise, project, product or system does not create unique value, no matter what incentive mechanism is adopted, it will not bring about real prosperity and stability. Everything will be temporary, and there will always be someone subsidizing someone else.

In the incentive mechanism, it is very difficult to minimize unnecessary incentives and ensure the compatibility of each incentive. The pursuit of explosive incentives is doomed to be wishful thinking and will collapse sooner or later.

The core of motivation is: there is a certain uncertainty in the process of value creation, and the current cost of certainty is exchanged for a better future where uncertainty is gradually eliminated.

For example, the gap between supply and demand. When the supply is not stable enough, the demand cannot enter the market. At this time, supply incentives are provided. Or when the demand is not strong enough, the supply cannot be invested (the scale is too large), thereby subsidizing a certain amount of demand. These incentives are meaningful.

It is reasonable that the providers of incentives should be compensated through market value with stable supply and demand.

04 Mable Jiang VS Wayne Lin

Wayne : Vitalik Buterin recently criticized Yield Farmers and said that high interest rates are "unsustainable in the long run." How long do you think the current high interest rates in DeFi can last? Will speculators withdraw and the bubble burst and everything will be in chaos? From what dimensions do you judge whether a DeFi target is reliable and invest?

Mable : Before answering this question, let me mention something off topic. I previously did a statistics on Twitter and WeChat at the same time - "Where will the DeFi bubble go?" The highest vote on Twitter was ETH, accounting for 36%, followed by Bitcoin - 30%, stablecoins - 18%, and "staying in DeFi" accounted for 16%. The statistical results on WeChat showed that stablecoins accounted for as high as 41%, ETH and "staying in DeFi" accounted for 22% and 20% respectively, and BTC only 17%.

This voting comparison is quite interesting and can explain a lot of problems. You can interpret it in many ways. Although the respondents are definitely biased, my feeling at the time was that the domestic participants in the survey preferred profit realization over long-term belief in decentralized finance and Bitcoin value storage.

Then back to the question just now, high interest rates are indeed unsustainable in the long run, but I think a lot of the money behind the bubble will remain in the ecosystem. I personally agree with the result of Twitter. So it won’t be a mess.

When Ethereum surged a few days ago, it was visibly seen that many DeFi profit-taking investors directly rolled into Ethereum instead of selling and withdrawing funds. As long as Ethereum is relatively stable and healthy, the current situation is fine. One core point is that many of the funds for mining the first batch are still relatively smart. Those who come later may be attracted by the high interest rate, but when they see that the mining income is not ideal, the gas fee is too high, or the impermanent loss is large, they usually choose to withdraw.

The most significant difference between DeFi mining and ICO fever is that there is no private placement lock-up, and everyone can enter and exit at any time. Of course, even if capital liquidity is easy, the game of passing the parcel is still passing the parcel, and there will definitely be a group of victims in essence.

To take a broader view, it is not just about liquidity mining, but the topic of blockchain as a financing tool. Now as the new coin model on Uniswap becomes more and more popular, as I just said, compared with the previous ICO, there is a significant difference that everyone will find that the cycle of "issuing coins - pulling - selling" is getting shorter and shorter, and many people who participate in speculation have their funds recovered (or lost) very quickly.

It is undeniable that some have returned to zero, such as pure forks of some DeFi mining projects (I won’t mention the names), but the administrator’s private key was not destroyed and he ran away, but this is unavoidable in any hot market environment.

Each investor should still make his own risk assessment of his own odds to allocate how much to participate in liquidity mining, how much to participate in IDO IPOs, and so on.

If we invest ourselves, we will carefully examine whether the design of a mechanism incentivizes the part of the system that should be incentivized (for example, the purpose of the balancer is to incentivize LP to come in, and the incentives and results are matched accordingly), or whether these incentives/subsidies mistakenly create a false prosperity.

A good liquidity mining mechanism design should be able to better help the project cold start and attract participants who can provide value in the ecosystem in the long term.

Another very important point is to consider the composability risks of DeFi and the cumulative risks caused by the interaction of different contracts.

I have recently seen some improved AMM designs that have indeed used other protocols to effectively increase depth and reduce slippage, but the risks that come with it are the risk of introducing external lending pool liquidity, the risk of short-term liquidation, etc. Or some DEXs have designs similar to BancorV2, which introduce external oracles to make the market making curve smoother within a certain price range, theoretically eliminate impermanent loss, and greatly improve the capital utilization of market makers. In this case, the risk of front running attacks by arbitrageurs must be considered. I think these explorations are very good, but we need to pay attention to the fact that good fortune is closely related to misfortune, and misfortune is closely related to good fortune.

Mable : In fact, speculation is a normal behavior in the financial market. Yield Farming not only helped some early DeFi projects complete the cold start, but also brought huge wealth effects to "early bird farmers". In contrast, the centralized crypto trading market is more prone to "being cut" due to problems such as opacity and centralization. So how do you think investors should choose reliable investment targets?

Wayne : I think regardless of whether the underlying asset is centralized or not, you should still focus on: 1. The underlying logic of the project/product; 2. Your investment strategy/evaluation ability.

Regarding yield farming, the teacher above has also explained it and I agree with it. When we invest in a project, we need to know what we are investing in, whether it is the speculative income from the exit of IUO's PND. Or for example, the value of the future token of a DeFi project. If it is the latter investment, then the originality of the project's code, the robustness of the protocol, and so on, as well as market entry, the overall market development strategy, and the quality and pattern of the team will be very important.

DeFi does have a lot of room for imagination, but I hope everyone can look a little further into the future. Finance covers many sub-sectors. For example, Injecgive Protocol, for which we are consultants, is a layer-2 derivative DEX that hopes to introduce traditional financial funds and trading volume. So we will look outside the so-called "coin circle" and "DeFi" circle for things that can expand the capacity of the crypto asset field.

For example, our ongoing IDEA derivative design creativity competition has confirmed the participation of MIT, Columbia, University of Chicago, Duke, Stanford, and other universities. This kind of outreach can allow us to see incremental value (escape zero-sum) and is also a good investment target.

05 David Lei VS Constance

Constance : According to statistics, from May to June, the transaction volume of DEX increased by 70%, but the number of users decreased. At the same time, Ethereum's transaction fees have recently hit a new high, and are constantly being pushed up by DeFi. Some people believe that this wave of enthusiasm has brought in some people who want to take advantage of the situation, but the number of real users has decreased. In addition, all projects are competing for the same group of people, which is likely to be a zero-sum game. What do you think? ForTube has just launched liquid mining. What are your expectations for the market?

David : If we only look at the data for June, we will indeed conclude that DeFi is just bloated. However, if we add the data for the whole of July:

Speaking of ForTube's newly launched liquidity mining, we have adopted a flexible mining model. This ForTube revenue mining is divided into four rounds: "Wind, Forest, Fire, and Mountain". Each round lasts for one week. The asset pool in the ForTube protocol is dynamically adjusted based on product data and market changes.

For example, the current "Wind" round supports HBTC, USDT and BUSD deposit mining. After this round of mining starts, I will provide you with the latest data:

This round of ForTube's liquidity mining started from Ethereum block 10591168 (12:36 Beijing time on August 4). As of now, ForTube's locked assets have reached 8.96 million US dollars and are still increasing. User response is currently very positive.

So the conclusion is: First, DeFi has left the zero-sum game stage and is expanding the market pie. Second, I am personally optimistic about the long-term market prospects, and will work with the team to provide good services to users.

David : FTX CEO SBF tweeted not long ago that "DeFi's hot bubble may burst, leaving an embarrassing mess, but it may also mark the beginning of true decentralized finance. Recently, FTX also launched DEX to enter DeFi. So how do you think the bubble will burst? Where should true decentralized finance start?

Constance : Actually, what SBF wants to express is that the ultimate goal of any project should be to build a product that people really want to use and can solve user needs, rather than a product that simply gives users monetary rewards to stimulate their use.

However, many DeFi products on the market now rely more on money to incentivize users to use them. Assuming that these products can attract enough customers through monetary incentives in a short period of time and eventually form a healthy closed loop, they have a chance of survival.

Otherwise, when liquidity mining fails to generate high returns and the product fails to solve the real needs of users, this bubble may burst.

There are several hidden dangers in the current popularity of DeFi: 1. The security issues of smart contracts; 2. Whether the actual demand for DeFi really exists; 3. Whether the demand for DEX itself can be sustained.

We entered the DEX market because we saw some long-standing pain points in the DeFi ecosystem that needed to be solved. The high transaction costs, lengthy confirmation times, and pseudo-decentralization of key information nodes of DEX have prevented DEX from being widely popularized and unable to provide users with a good experience. These problems have actually led to poor liquidity of DEX, and thus low user transaction volume, creating a vicious cycle.

Risk warning : The content of this article is only the personal opinion of the guest, does not represent the views or position of Zhikuang University, and does not constitute any investment opinion or suggestion.

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