Iterative Airdrops: An Answer to the Cold Start Problem

Introduction

The crypto space has long asked how best to allocate the token supply in a new network. What portion of the supply should be assigned to the community, how can the early community gain ownership in the network, and what role should the community play early in a network? This post looks at the history of airdrops, what airdrops aim to achieve and how new networks can design airdrop campaigns to overcome the cold start problem.

The History of Airdrops

Early Airdrops

In the early days of the ICO era, the public allocation of the network was largely distributed through the ICO or public sale. During this period, some projects began experimenting with airdrops to distribute tokens to community members who could not secure tokens in the public sale or as a way to bootstrap off of an existing community. One early example of this was OmiseGo in 2017, which airdropped tokens to ETH holders around the launch, helping it gain the Ethereum community's attention at the time. Early airdrops used rather basic methodologies, mainly focusing on social actions such as joining a telegram, filling out a form, or holding assets such as ETH.

Early Work-based Airdrops

In the fallout of the regulatory crackdown following the ICO era and the beginning of the 2018 bear market, the industry essentially moved away from large public sales, instead focusing on the airdrop as a way to include and engage the public community. With this shift, some projects began to look for alternative ways to engage the community further and distribute an airdrop. Rather than simply dropping tokens to registered people, these projects took this one step further. They designed token distribution programs that targeted and engaged more technical community members to earn a stake in the network by depositing and locking up assets or running software, performing useful work for the network.

The Edgeware Lockdrop

The Edgeware Lockdrop was one novel new token distribution that utilized a lockup mechanism to incentivize users to signal their intent to participate in the new network. Edgeware, a proof of stake blockchain built on Substrate, designed the Lockdrop as a new way for people to earn tokens in exchange for locking up their assets, providing a way to seed new projects or chains. Participants would lock up their ETH in a smart contract on Ethereum for 3, 6 or 12 months to earn a stake in the new network or could signal their intent to participate without locking up any ETH, however, for a much lower reward. This ETH remained dormant in the contract until the end of the lockup period, with participants who committed for longer earning a higher multiplier they would receive per ETH locked in the contract.

The Livepeer Merkle Mine

The Livepeer Merkle Mine was another notable approach that aimed to distribute tokens to an initial group of potential network users ahead of the Livepeer mainnet launch. Inspired by proof of work mining, the Merkle mine was a novel form of airdrop that distributed tokens to a parallel community likely to use the network and enabled those who participated to earn a stake in the network. The initial slow start phase worked like a typical airdrop, with ETH holders being eligible to mint tokens for themselves if they had 0.1 ETH in their address at the snapshot date. After the slow start phases ended, airdrop claiming opened up to third-party miners. These miners could generate tokens for others who had yet to claim them. In return, the miners would receive a share of the newly minted tokens. Throughout the Merkle mine, the proportion of tokens earned by the miner would increase.

The Livepeer Minecraft: Livepeer Token Miner

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To facilitate participation in the Merkle mine, the Livepeer team created Minecraft. This simple Token Mining application enabled non-technical community members to participate in the Merkle mine, paying the gas cost of claiming the airdrop for another address and taking a small cut. Over time, community members open-sourced mining scripts, enabling more technical users to autonomously specify up to what gas price they were willing to generate tokens and enabling Merkle miners to run multiple instances in parallel. As an early participant in the Merkle mine, with the help of Bison Trails (acquired by Coinbase), I was able to get their script up and running, mining a stake in the early network running at one point up to 20 instances of the Merkle mining script simultaneously generating tokens up to a specified gas limit.

While the Livepeer Merkle mine initially stayed relatively under the radar with only a limited set of participants, it became more completive over time, leading to network congestion on the Ethereum network with Merkle miners consuming 30% of all blockspace and elevating gas prices across the Ethereum network. The Merkle mine lasted for 68 days, with Merkle miners spending 2,048 ETH ($470k in value at the time) and distributing LPT to eligible addresses. While Merkle mine created some negative externalities and led to a somewhat concentrated token supply, it built a strong community of technical contributors well suited to become orchestrators in the early Livepeer Network.

Compound Liquidity Mining

Towards the end of the last bear market, the next evolution of token launches would come with the launch of COMP, the governance token of DeFi lending platform Compound, kicking off DeFi summer. The COMP launch introduced several new novel concepts, which would become the standard moving forward in token launches and how projects thought about tokens' role in a network. Compound's first novel concept popularised is governance tokens in their modern form with a governance framework for COMP where token holders could vote on proposals regulating risk parameters for the protocol and inclusion of new assets to the platform. One of the benefits of a governance token model was that it allowed teams to defer the question of value accrual and the associated regulatory risks, instead focusing on the value of governance participation in these networks.

The Compound user dashboard at the time of the COMP launch

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The second novel concept introduced by Compound was liquidity mining, linking the usage of a product with token incentives, helping to bootstrap liquidity and usage of the product while distributing tokens to the community. In every block, COMP tokens would be distributed to users of the protocol split 50/50 between borrowers and lenders, with close to $1m of token emissions being distributed daily.

As liquidity miners were being compensated for both lending and borrowing, the optimal strategy was for farmers to lend the highest interest rate asset, borrow as much as they could against their collateral, and recycle the borrowed funds back into Compound. Some farmers also realized that borrowing non-stablecoin assets could move the interest rate higher, allowing them to earn a higher proportion of the COMP rewards. The aggressive token incentives combined with the resulting rise in the price of COMP led to huge APYs for farmers, further driving a reflexive cycle of growth for the platform.

The introduction of liquidity mining was a key inflection point in using token incentives as it incentivized protocol users to provide capital into the protocol to earn token incentives, helping the platform bootstrap the supply and demand side of the network. This powerful new idea inspired the creation of a generation of new DeFi projects, all seeking to utilize token incentives to target new and existing markets to various degrees of success.

The SushiSwap Vampire Attack

Sushiswap Original LP Dashboard

Later that year, in August 2020, saw another major token launch with SUSHI, the governance token of Sushiswap, pioneering the concept of a vampire attack on another protocol. Uniswap was the leading DEX by market share at the time, did not have a token, and offered liquidity providers (LPs) trading fees for providing liquidity on the platform. Sushiswap, which began as a Uniswap v2 fork, was formed on the premise that by launching with a token, it could drain the liquidity and users of Uniswap by utilizing token incentives to deliver a superior service for liquidity providers and enabling LPs on the platform to become owners of the network. Following the launch of Sushiswap, Uniswap saw significant capital flight from Uniswap pools to Sushi pools due to the high liquidity incentives being offered, reaching over $1.2b in liquidity in the days that followed the launch of Sushi rewards.

The Uniswap Retroactive Airdrop

The UNI Claim Dashboard

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One of the most notable and prominent token launches of DeFi Summer was, by no doubt, the launch of Uniswap’s governance token UNI and the beginning of the retroactive airdrop. Due to the pressure from Sushiswap’s token launch and the associated vampire attack, a few months after the launch of Sushiswap, Uniswap announced the launch of their governance token UNI. Unlike previous token launches that required users to earn tokens by providing liquidity in the protocol, Uniswap retroactively assigned a portion of the initial supply to historical user addresses and liquidity providers. Given the scope and size of the UNI airdrop, as the most used application on Ethereum, the Uniswap airdrop reshaped the community perception of token launches, with airdrops playing a key role in token launches after the launch of Uniswap.

The Blur Care Package Campaign

Blur Care packages

Blur, one of the more recent and notorious airdrop campaigns, took the NFT market by storm, transforming the NFT landscape, securing its place as the leading NFT marketplace and reshaping the way many think about the purpose of an airdrop campaign. Blur is today the leading NFT marketplace by volume, starting as an NFT aggregator that built an NFT exchange designed for traders, allowing users to trade NFTs on any venue, which made the controversial decision to allow traders to pay no royalties to creators. Unlike most airdrops before it, Blur used a 3 phase airdrop in which traders could earn points for specific behaviors using the exchange, with the points representing care packages that could be opened at the end of the season for variable token amounts based on their rarity rating of the boxes.

The behaviors that Blur was incentivizing changed with each phase, with Airdrop 1 being a more traditional retroactive airdrop for previous users of the exchange, Airdrop 2 being for traders who were actively listing NFTs on Blur and Airdrop 3 being for bidding on NFTs, for sale on Blur and rewarding loyalty for those exclusively bidding on collections on Blur.

By iterating on what they were incentivizing of users and airdrop farmers, Blur was able to rapidly rise from a small new aggregator to becoming one of the market leaders in the NFT exchange market by using economic incentives to bootstrap the supply and demand side of its marketplace.

Conclusions

Over time, token airdrops have evolved from simple marketing giveaways to iterative incentivization games rewarding active participants in new emerging networks. Similar to how some of the earliest crypto networks enabled anyone to build a stake through proof of work mining, new networks allow early users to build a stake in their emerging network by providing value in various forms through iterative airdrop campaigns. Lowering the barriers to participation and providing a path for early users to earn a stake in the network can create an early engaged cohort of super users with an economic incentive to see the network succeed.

Diagram illustrating the Cold Start Problem by Andrew Chen in his book “The Cold Start Problem”

It's also important for teams to take the time to deeply understand their network and what is required to win the market. While for some networks, the supply side may be the harder side of the network to bootstrap, for others, it may be the demand side, and there may be novel ways to utilize incentives to help overcome this hurdle. Which side of the market to incentivize may change over time as the networks mature and expand into new market segments. As an iterative process, teams must monitor and measure if the incentives are working and adjust incentives where necessary.

While iterative airdrops have advantages, they are not a panacea and cannot compensate for a lack of product market fit. A clear value proposition and unique differentiation in the market are still essential for a product's success. Incentivizing usage for a product that lacks product market fit or has a leaky bucket will lead to high churn and create mixed signals, which may give the illusion of product market fit but fade as economic incentives are removed. Networks need a clear long-term strategy to win the market and provide a clear vision the community can rally behind.

In conclusion, well-designed iterative airdrops are a tool that new token-based networks can deploy to help overcome the cold start problem in an emerging network. By incentivizing either the supply or demand side of a new network, structurally disadvantaged new entrants can deploy economic incentives to bootstrap a new network, allowing them to cross the tipping point where the network can provide a better service than alternatives to hit escape velocity.