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Explore the incentive model of trading platform, which is more worthy of incentive, liquidity or trading behavior?

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At present, the incentives of most trading platforms are mainly liquidity incentives, and there are few explorations in trading incentives.

原文标题：《交易平台激励模式思考，流动性和交易行为哪个更值得激励? 》

Original source: Mint Ventures

introduction

This Clip comes from an online discussion held by the Mint Ventures team. At that time, I asked two questions. Lawrence, our researcher, and Scarlett, our investment manager, gave their own ideas.

My two questions are:

1. 交易平台的代币激励，是应该激励流动性，还是应该激励交易量？为什么？ 2. 假设平台有交易激励机制，为了获得激励的刷量交易（wash trading）对于协议来说利弊哪个更大？为什么？

To be clear: The term "trading platform" in these two questions is a general term that includes spot Dexs (Uniswap, Curve), decentralized derivatives programs (Gmx, Gains), NFT trading platforms such as Blur, and even centralized exchanges (although most of them currently have no direct liquidity or trade mining mechanism).

The following article is the periodical opinion of the author and the team as of the time of publication. There may be errors of facts, opinions and biases, for discussion only

Origin: Why do trading platforms issue equity tokens and incentives?

In my opinion, there are three main reasons why trading platform projects (including spot, NFT and derivatives) should issue equity tokens:

1. Token fundraising. This one is easy to understand and will not be repeated.

2. Decentralized governance. The emergence and distribution of equity tokens is the prerequisite of community-based governance.

3. Growth and means of regulating the economic system.

However, from the perspective of Web3 business practice, options 1 and 2 are not required because:

1. Equity financing is available for the project.

2. Centralized governance is still the mainstream of enterprise and project operation. Even for most projects that have started decentralized governance, the governance content and voting are actually centralized in the hands of teams and related organizations. What really matters, perhaps, is number three: when a project has the means of tokens, both the incentive resources for growth and the regulatory capacity of the project's economic system are greatly increased compared to a project without tokens.

On the other hand, the core purpose of token incentive for trading platform projects (whether it is to stimulate liquidity or trading behavior) is generally only two, namely:

1. Cold start of new projects, with token incentives to attract initial bi-lateral users to the product (Uniswap also did token incentives in the early stages of the Dexs battle).

2. Expand the bilateral market, and expect to accelerate the expansion of cross-border network effects through token subsidies, so as to form barriers to competitive products.

The "two sides" here, for most trading platforms, are the providers on one side and the traders on the other.Because the two sides of the platform are interdependent and mutually beneficial, that is, if no one provides liquidity, no transaction can take place; And no trading means no fee returns and no one willing to provide liquidity. On the other hand, the more liquidity (under the same product mechanism), the lower the trading losses, the more traders are willing to trade here, the more fees, the more liquidity returns, the more liquidity.

This is a kind of network effect because "the increase of users on one side will provide greater value to users on the other side", namely "cross-border network effect". And network effects are one of the most important moats of business projects.

This is especially true for new projects.

If Uniswap was able to generate initial growth from a lack of competition (DeFi's value is not yet agreed upon) and rely solely on natural demand from early adopters and early adopters, then with the trading platform circuit so crowded and product iterations so rapid, It is hard enough for a bilateral/multilateral trading platform to get off to a cold start without providing incentives (or the expectation of airdrops).

Therefore, objective 1 (cold start) is the pre-action of objective 2 (cross-border network effect), and the ultimate objective of objective 2 is to form a competitive advantage (monopoly position) on which to achieve and expand profits (agreed revenue > token subsidy expenditure).

Therefore, due to the existence of cross-border network effects, it seems that trading platforms can motivate users on the other side in a roundabout way, no matter they motivate liquidity providers or traders. Does this mean that:

Incentive LP= Incentive Trader?

Practice: Liquidity incentives vs. transaction incentives

Early practice of Cexs

In fact, both incentives for liquidity and incentives for trading predate DeFi Summer. For example, most centralized exchanges have incentive programs for cooperative market makers, which aim to get them to provide good trading depth on their own platform and give other traders a low slip trading experience. This is similar to liquidity incentives, except that most of these incentives are in the form of fee waivers and rebates, and are mostly independent of the platform's own equity tokens.

The earliest experimenter of trading incentive mining is also the centralized exchange. Dragonex took the lead in the practice in 2018 and launched the "trading mining" mechanism, which rewards platform token (DT) according to the trading volume and based on the trading commission of platform token dividend.

This mechanism has since been "carried forward" by Fcoin. Both exchanges have seen their business grow rapidly since the mining came online. Fcoin, in particular, was a latecomer to the "exchange wars", with peak daily trading volume of all the other first-tier CEX's combined.

However, neither Dragonex nor Fcoin's glory days lasted long, with the former collapsing due to stolen insolvency and the latter due to a so-called "internal financial error" with a huge deficit. The reasons for the two platforms' collapse are slightly different, but the common denominator is financial shortfalls, the former due to external attacks and the latter due to internal problems.

But it is hard not to wonder: if there had not been thefts and internal financial problems, would transaction mining have helped them maintain market share in volume and form a barrier?

Later practice of the DeFi project

The emergence of Uniswap pushed the AMM mechanism further into the market, which greatly lowered the threshold of liquidity market making and provided a natural convenience for liquidity mining incentives. Sushiswap quickly withdrew a lot of liquidity from Uniswap through its own token subsidy to LP. Uniswap responded by launching a liquidity mining program at short notice.

In addition to Dexs, NFT trading platforms such as Looksrare, X2Y2 and Blur have also carried out a large number of practices on liquidity incentives, shifting the battlefield of subsidies from homogeneous token (FT) to the field of NFT. It was also from Blur that Opensea felt the obvious threat. Start practicing zero fees to cope.

On the other hand, perhaps as a result of Fcoin's spectacular failure, some of the biggest transaction mining practices in the DeFi space didn't begin until DyDx launched its token, followed by Cherry Dex on Okchain, Dinosauregg on BSC, etc. Newer programs that include trading incentives include level, gridex, kwenta, and more. But on the whole, there are few projects with trading as the main incentive object.

Liquidity incentives vs. trading incentives

As mentioned above, the purpose of token incentives for trading platforms is to build a lead in cross-border network effects faster and form a monopoly advantage. One of the preconditions of monopoly is that[Users have difficulty or reluctance to leave the existing platform]The relevant metric in the operation of Internet products is [retention rate].

Therefore, whether a trading platform should encourage liquidity or trade, the important factor to consider is "which behavior or behavior object" is more likely to be retained for a long time after the incentive decline? Users and behaviors that are more likely to be retained over a long period of time contribute to a higher "lifetime value" (LTV) and should be the primary incentive for platform tokens.

So who has the more entrenched behaviour, liquidity providers or traders?The answer to our current thinking is liquidity providers,Reasons include:

LP users are more platform bound than traders

For example, the project represented by Curve guides LP users to improve their market-making returns by pledging Crv tokens through ve mechanism, which improves the migration cost of LP and the consistency with platform benefits.

LP is more willing and concerned about product migration

It is a transient fund interaction between traders and the platform. There is no fund trusteeship agreement, so the fund risk is very small. While LP's capital is authorized to the smart contract of the platform, which is more risky, so they tend to choose the platform they are familiar with, have a good safety record and a long history to provide liquidity, trying a new platform has higher psychological risk, and they are often reluctant to migrate even if the APR is higher.

With aggregators, the transaction behavior is more rational, with the minimum transaction loss as the only principle

While there are aggregators for providing liquidity (putting money into machine gun pools or income aggregators), people tend to make their own markets directly because investing money through aggregators involves the risk of a smart contract authorization and because aggregators tend to have a higher percentage of income (compared to trading aggregators, which tend not to charge explicit fees). In particular, large funds hardly need to consider the gas friction caused by income reinvestment.

The incentive for trading behavior dissipates due to the existence of trading friction

The frequency of trading activity is much higher than that of market making, and the friction generated by trading, such as GAS (including MEVs) and NFT trading royalties, is taken by third parties other than the agreement and the user, which amounts to a partial loss of incentives.

Incentives to trade 'inflate demand'

Even if the behavior of "trading for incentives" appears, it also seems to contribute to transaction costs and agreement income, but the possible purpose of incentive for the project, namely "realizing the advantage of cross-border network effects through token subsidies", does not help much, because these "fictitious transaction behavior" will disappear immediately after the incentive stops. Does not help the agreement achieve the purpose of "taking a greater share of the trading market".

Therefore, in general, LP users have a closer and longer relationship with the trading platform than pure trading users. Incentives invested in LP may bring back a higher total value of users in the long run. Perhaps it is because of this that most of the current trading platform incentives are mainly liquidity incentives, with relatively little exploration in trading incentives.

Outlook: How to make trading incentives Better?

Although in most cases, liquidity and trading are the two options for incentive, and liquidity incentive is often a safer choice, the exploration of incentive for trading behavior is still of great value, because the final income of trading platform still comes from trading. Incentives for liquidity are also designed to provide traders with a better trading experience in return for higher volumes and trading costs. When designing trading incentives, it may be better to pay attention to the following:

Instead of directly incentivizing trading activity or volume, incentivize pools of liquidity or trading pairs with larger volumes

A typical example of this is the idea that AC proposed in Solidly designing the ve (3,3) project, in which holders of ve governing tokens only received transaction fees for those pools in which they voted, rather than the entire protocol fees regardless of which Pool they voted in. This will lead ve token holders to vote more heavily in pools (trade pairs) that trade more and contribute more fees to the agreement, giving those pools more liquidity guidance (increasing the incentive to emit tokens to the Pool), thus better depth, and further more volume and fees. It is equivalent to "disguised incentive trading". In addition to Solidly Fork, other projects are experimenting with incentives like Pendle's move to allocate 80% of Pool fees to ve users who vote for the Pool. This means that ve users are more willing to vote for Pool with large trading volume, increasing the incentive of tokens to LP.

Control the value of incentives to avoid "inflated" transactions

As long as the incentive value of the transaction subsidy is lower than the friction cost of the transaction, people will not have the fictitious transaction behavior of "trading for incentive". Instead, they will rationally choose the platform with the transaction subsidy and carry out the "trading behavior that needs to be taken" when they have the transaction demand. In the long run, users may be inclined to trade more on incentivised platforms when conditions are the same, and when behaviour becomes habitual, the purpose of subsidies is fulfilled.

Changed transaction subsidies from "token allocation mechanism" to "operational activity"

Token allocation mechanisms are long-term and prudent, while operational activities are short-term and flexible. The trading platform can design short-term trading activities to activate key behaviors of new users (for example, the behavior of users completing their first transaction on the platform is defined as "activation"), or design trading competitions and other activities to achieve short-term business objectives for specific purposes (for example, to cooperate with financing and fight against competitors). For example, Vela, Arbitrum's Gains clone, uses short periods, rewards and constantly changing amounts to encourage users to migrate from Gains, Gmx and other platforms.

The design direction of transaction incentives above is also consistent with the retention thinking I mentioned earlier, which focuses on the real user behavior that leads to long-term retention and makes more detailed incentive design.

Epilogue: In the low-barrier Web3 business world, operating efficiency is a long-term winner or loser

An important observation of Web3 business development so far is that:Monopolies seem harder to build here. This is a combination of the Web3 world's own account system, unlicensed capital flows and project creation, open source transparent code, and composability. Building a moat in this environment is difficult because it becomes harder for users to "keep and monopolize".

If any project wants to survive and develop in such a "low barrier" environment, it must continuously strive for operational efficiency. The "operation" here is a broad term, which includes many aspects of product innovation, marketing activities, team management and so on. Accurate and efficient incentive design is also one of the important works. It is conceivable that the distribution and incentive model of tokens will increasingly need to be iterated as competition and user needs change, becoming a long-term endeavor, and that the "unaltered economic model" designed from God's perspective may eventually become a fantasy for most projects.

Therefore, as investors, when selecting long-term investment targets, whether the project team has "long-term combat capability", "continuous business initiative" and "willingness to actively respond to market changes" should be the key qualities to be examined.

The "easy business wins" of genius ideas will also become rarer in Web3.