Liquidity Mining

Basics

•  Also known as Simple Agreement for Future Governance (SAFG) or yield farming

• What is Yield Farming by Zerion.
• Yield Farming in DeFi by DeFi Rate.
• Pioneered by IDEX in October 2017, refined by Synthetix in July 2019, and implemented at scale by Compound in June 2020, liquidity mining (LM) has captured the imagination of dozens of protocols as a better way to distribute tokens.
• Meet the SAFG: DeFi’s Emergent Framework for Participatory Investing and Protocol Development

• From DeFi Rate (12-6-2020):

"After initially listing on Uniswap for $16, COMP tokens have soared in value. That may be an understatement too. In less than a week, the protocol’s native governance token has risen to over a $2.2B valuation as COMP trades at around ~$225 per token, making it the highest valued DeFi protocol by market cap while dwarfing its incumbent, MakerDAO. Moreover, value locked in Compound went stagnant for the better part of a year. But the launch of a tokenized incentive drove a massive wave of new capital into the protocol almost immediately, increasing its total value locked by over 4x in less than a week to reach over $400M.

This isn’t a one-time thing either. A few weeks ago, Balancer also launched a similar token distribution mechanism where users who provided liquidity to its protocol earned BAL, the network’s native governance token. Within days of launch, the emerging liquidity and asset management protocol surged in all metrics across the board, putting it in striking distance with its main competitor Uniswap. Even looking back further, Synthetix‘s launch of liquidity incentives last year along with native inflation for Synth minting (i.e. SNX staking) revitalized the project and allowed it to surge to #2 in total value locked in 2019. The effects of liquidity mining and similar token distribution mechanisms are extremely apparent. It drives growth.

While the concept of yield farming isn’t new, DeFi may have finally found the right recipe as protocols take a page out of the SAFG token model.

The trend is just getting started too. Just yesterday, we saw a hint of what’s to come with Synthetix, Ren Protocol, and Curve teaming up to launch a tokenized incentive for building BTC liquidity on Ethereum. Anyone who deposits sBTC, renBTC, or WBTC on Curve will receive an attractive basket of tokenized incentives including SNX, REN, BAL, and CRV (along with trading fees). The SNX and REN incentives will come wrapped in a Balancer Pool Tokens, effectively allowing users to earn BAL on top of the tokens issued by the Ren and Synthetix core teams. Moreover, Curve recently announced their CRV native governance token which will be distributed via a similar yield farming mechanism. Adding to the narrative, the announcement of Curve’s governance token has driven the protocol to reach new all-time-highs in volumes, surpassing Uniswap, and other leading liquidity protocols in daily volume earlier this week. The launch of this multi-asset yield farming incentive (while having exposure to BTC) ultimately displays the potential for Ethereum’s best attribute – composability."

• From Set Sunday School (21-6-2020):

""Yield Farming" is a new term that entered the crypto lexicon over the last 7 days and it tends to sound more complex than it really is. The basic explanation is that speculators are "stacking" yields across different protocols by using tokens. For example, users who are yield farming on Compound are putting up an asset as collateral (usually a stablecoin or ETH) and then borrowing against it. By doing this, they are earning both the yield from lending their collateral as well as being paid in COMP tokens which greatly increases the overall yield.

Yield farming starts to get a lot more complex once we look at other protocols like Curve.fi and Balancer because speculators can use the liquidity provider (LP) tokens from these protocols as collateral in other protocols to generate yield. This is where the "stacking" comes into it."

• From DeFi Rate (4-5-2020):

"a framework that distributes tokens granting future governance rights based on participation in a network or protocol.

Unlike traditional token frameworks where investors and issuers sign off on an agreement, the SAFG contract is embedded directly into the protocol and requires no lawyers. It’s a simple, permissionless token distribution mechanism where participation in X and earns Y tokens that grant the ability to vote on future changes.

This rather simple yet elegant design enables decentralized protocols to more effectively launch, grow, and govern their communities in a legally compliant manner.  With a SAFG framework, anyone can participate in a series of value-added ways to earn future voting rights on important protocol decisions. The structure for this distribution framework:

• Can only be earned through the participation of the protocol
• Is likely non-transferable and cannot be acquired on the open market at launch
• Guarantees no additional benefits (i.e. economic rights)
• Is used as the primary mechanism for voting on protocol changes

While on the surface these tokens seem marginal given their non-transferrable and non-economic attributes, the design provides a simple mechanism for getting the tokens into the hands of the people that matter – the community.

SAFG In the Wild

In the past month, we’ve seen the launch of Futureswap’s FST token. The native token behind the decentralized futures exchange is distributed to the users of the protocol and will primarily be used for governance. As it stands today, FST tokens are non-transferable and cannot be acquired on the open market. That said, the only way to acquire FST is by active participation in the exchange as a trader, referrer, or liquidity provider. Moreover, while the tokens don’t represent direct economic rights, users are given the option to hold the token for discounted trading fees.

We’ve also seen a similar framework with the leading money markets protocol, Compound. The protocol’s governance token, COMP, allows the holders and its delegates to vote on protocol changes. Like FST, COMP tokens are currently non-transferable and only guarantee the holder the right to participate in the governance process (i.e. no economic rights).

The Big Picture

While on the surface the SAFG seems like a rather meaningless way to distribute tokens until focusing on one key factor. All of the limitations surrounding the token (i.e. non-transferable, non-economic) are all malleable.

The important part is that this framework allows project teams to quickly launch their project in almost any regulatory environment.

Upon a successful distribution and active governance, there’s nothing stopping stakeholders from voting away these limitations. Once the community is meaningfully decentralized, token holders could simply vote to make the tokens transferable or have economic rights.

With the SAFG, there’s no reason to force economic models into the protocol off the bat that may siphon away from the growth. Instead, the protocol can focus on incentivizing usage by distributing tokens to active community members and then fine-tune the long term incentives from there.

With Compound and Futureswap seemingly adopting this framework, we can expect more to come in the future. At the same time, we’ve also seen UMA take on this model to some capacity. While there were a group of investors and the Foundation launched a sale in the form of an Initial Uniswap Offering, roughly 35% of the token supply will be distributed to the community under a similar framework as the SAFG.

In the coming year, we can expect more and more DeFi projects adopt the SAFG model, especially seeing as it provides a legally compliant and fair distribution where active community members earn the right to govern the protocol in the future."

• From Daily Gwei (31-7-2020) on how the Yield Farming craze can be dangerous for investors:

"I imagine many of these copycat tokens/scams are going to play on the “yield farming” trend to juice liquidity in order for them to exit - I’ll explain how this works. Basically, this scheme is what I like to call “subsidized liquidity” - the scammers are paying out tokens to people who provide liquidity so that they can dump their share into the market. As an example, let’s say the scammer allocates 10% of the total token supply to themselves and then 90% to the “liquidity mining” incentives. While everyone is distracted by the high APY numbers, the scammer quietly dumps their tokens into the liquidity that people are providing on Balancer and Uniswap (they are doing this to earn that high APY). Creative, right?

Unfortunately, it’s very easy to get scammed in this industry and I only think it’s going to get worse from here. As a friendly warning, I implore you not to try and chase every token marketing itself as giving “1000% APY” or anything like that as the best way to make money in this industry is to simply formulate a sound investment thesis and stick to it."

Liquidity Mining as a token distribution mechanism

• From Bankless (12-2-2021):

"Liquidity mining is a proven mechanism to distribute tokens to a networks users. It also helps to decentralize a network and is a growth marketing tool. The main drawback is that it’s not a great tool for teams that need to fundraise as part of launch. An example of this, because the fair launch token YFI didn’t have a significant treasury the community recently went back to holders to mint an additional $225m worth of YFI to fund ongoing development—the plan was approved!"

Problems

From this article (2-10-2020):

1. "Loopholes: While not intended, LM programs might have the potential for users to “game” the incentives. On Compound, for example, recursive borrowing & lending likely resulted in “fake” volume and crowded out real users. By some unconfirmed estimates, this could be over 30% of Compound’s reported supply value (i.e. if there is ~$1B supplied, ~$700M of that is non-recursive value). This user behavior doesn’t provide much value for Compound because much of the liquidity in the protocol isn’t accessible by other users.
2. Technical risk: Security audits are expensive and teams who want to do a fair launch often don’t have the resources to complete one beforehand. This has resulted in bugs found in mainnet contracts, leading to losses of user funds. This also gives an advantage to those with the technical expertise or resources to check the veracity/safety of contracts. Fair Launch Capital is trying to address this issue by making a no-strings-attached grant to cover the costs of audit and launch.
3. “Rug-pulling”: Even if unintended bugs aren’t present, the fact that most liquidity mining programs today are started by pseudonymous founders makes them the perfect breeding ground for scammers. These malicious actors could exploit the contracts (e.g. by calling the “mint()” function like Hotdog or simply selling tokens like Yuno) with little to no repercussions. More technical users could understand these attack vectors by using tools like Diffchecker, but LM remains a dangerous game for retail participants.
4. Information asymmetry: While the aim is fair distribution, insiders likely have a head start in the first few minutes/hours of a LM program, which leads to an unfair advantage relative to retail participants. One way of addressing this is by giving sufficient notice that a LM program will be starting.
5. Gas costs: High ethereum gas fees tend to “price out” small participants, leaving LM programs to those who could afford to pay the gas fees. This hurts token distribution and lower-value projects like those focused on NFTs and gaming."

Stats

• From Decrypt (18-12-2021):

"Nansen revealed that “a whopping 42% of yield farmers that enter a farm on the day it launches exit within 24 hours. Around 16% leave within 48 hours, and by the third day, 70% of these users would have withdrawn from the contract.”"