By the end of 2018, many cryptoskeptics had the “I told you” moment when many initial coin offers or ICOs failed to deliver on their promises. Between 2017 and 2018, 3,250 projects were started via ICO and $ 21.4 billion was raised from investors. In early 2018, however, a study found that almost half of the 2017 ICOs had failed – another 13% were considered “half-fail” – and dealt financial blows to coin buyers who expected profits. Many projects initially achieved very high returns, only that the coin values fell steeply afterwards.
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It’s important to note that many other ICOs have succeeded and launched projects that continue to flourish to this day (Chainlink is one such example). Despite the successes, however, investors were reluctant to forget about the less fortunate stories – in recent years ICOs have slowed down to a trickle.
Perhaps skeptics celebrated something prematurely. While ICOs may not have proven to be the optimal funding mechanism for decentralized projects, the fundamental promise behind these innovations remains. Innovations continue and a new method of bootstrapping – liquidity mining – has been introduced to fill the void.
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In liquidity mining, a project offers its tokens to anyone who is willing to deposit their money into a smart contract. Let’s look at a hypothetical example: “Cranberry Finance” offers every user who deposits Cranberry and Ether (ETH) with Uniswap the liquidity provider token “Cranberry Coins”. In addition to the fees charged on every trade between Cranberry and ETH on Uniswap, anyone who puts their liquidity provider tokens into a smart contract can earn more coins from the project. Depending on the price of the cranberry coins, the rate of the cranberry rewards, and the amount of liquidity provided, the annualized returns from liquidity mining programs can range from double-digit returns at the low end to annual percentage returns in excess of 10,000% for higher-risk projects.
The spread of liquidity mining and decentralized finance (DeFi) has surprised even industry optimists (myself included). Today, the market cap for DeFi is over $ 80 billion, with the total value being over $ 67 billion (compared to $ 5.4 billion raised by ICOs throughout 2017). While the liquidity runoff wasn’t implemented on a large scale for the first time until mid-2020, it is clear that a new boom was born.
For many, however, questions remain unanswered: Will this boom break at some point? Will investors looking for high returns stay in their pockets again?
ICOs and liquidity mining have some things in common: as always, the investor needs to know what they’re investing in and take the risks (and the risks are real). However, I believe the answer to the above questions is that there are fundamental differences between ICOs and liquidity mining. These differences make liquidity mining a more sustainable financing model for long-term value creation, both for the project developers and their investors. Let’s examine how ICOs and liquidity mining differ.
Comparison of the native elements: ICOs vs. Liquidity Mining
ICOs provided a mechanism for distributing tokens, raising funds, and building a coin user base. However, some of the shortcomings inherent in the system became apparent. Investors tended to see high returns immediately after the ICO, but values often fell afterwards. Since the tokens themselves confer no legal rights, income opportunities beyond the market value of the coin and no control over the project, there was little incentive for many to continue holding tokens. Many investors took early profits and paid out, which did little to help coin growth. Some ICO projects turned out to be fraud affected by hacks or poorly designed projects with inadequate management teams spending invested capital on extravagance.
Liquidity mining works on a fundamentally different principle. Since the trading volume on decentralized exchanges exceeds that on central exchanges, the marketability of a token depends on sufficient liquidity on a decentralized exchange. However, generating liquidity to support an exchange, derivatives contract, credit platform, etc. can be challenging. The distribution of tokens to liquidity providers is the main mechanism to initially invite the required liquidity. The tokens are worth more than the coin’s face value by offering returns – and often governance rights – that encourage both a sense of ownership of the project and longer-term retention. More liquidity attracts more users and more users pay back more money to liquidity providers, creating a continuous positive feedback loop.
It is also important to note that the characteristics of the growth of DeFi and the ICO bubble are very different. While often non-savvy retail investors plunged headlong into the ICO boom cycle, we see fewer investors with more specialized industry knowledge of the market that includes DeFi. That said, FOMO – the fear of missing out – is human nature. There will always be those who are so tempted by the potential gains that they cannot resist the urge to become “apes”.
Not everything that glitters is gold: Thorough research projects
While I believe Liquidity Mining and DeFi in general are built on solid foundations, not all projects are created equal. I am neither an investment advisor nor a tax attorney and I cannot tell you which projects are more advisable than others.
However, I will encourage every investor to understand exactly what they are getting into. Each project has different leadership skills, governance structures, marketing plans, innovations, security frameworks, and plans to build and encourage community engagement. All of these factors are important to be considered in any investment decision.
Gold, silver, crypto, DeFi: change is inevitable, but rarely linear
The history of what we consider currency – and the staccato pace of innovation – teaches us that change will continue, but not always in predictable ways. While the methods of attracting investment for blockchain projects have gone through quite a few starts and stops, I believe that the runoff will stay here.
That’s not to say that some other mechanism will eventually fail to take its place if it proves to be even better for the community – after all, that’s the essence of innovation.
This article does not contain any investment recommendations or recommendations. Every step of investing and trading involves risk and readers should do their own research in making their decision.
The views, thoughts, and opinions expressed here are the sole rights of the author and do not necessarily reflect or represent the views and opinions of Cointelegraph.
Willy Ogorzaly is the senior product manager at ShapeShift, an international market leader in non-custody cryptocurrencies. He is responsible for further developing the product strategy, defining new functions and solutions and ensuring that new products meet the requirements of an evolving, innovative and dynamic crypto and DeFi landscape. Before joining ShapeShift, Willy was the co-founder of Bitfract (acquired by ShapeShift in 2018), the first tool that enables Bitcoin to be traded in multiple cryptocurrencies in a single transaction.