This article is partially based on Taiki Maeda’s “Humble Farmers Thesis”:

Ethereum alternatives, also called Layer 1s, have outperformed the crypto market by a lot this past bull market. The explosive rise of many of them has drawn a lot of hype and money into the altcoin sector. Much of that capital came from yield farming, often financially incentivized by VC firms and early investors. In this article, I will attempt to explain my L1 investment strategy for the coming bull market.

Ethereum alternatives, also called Layer 1s, have outperformed the crypto market by a lot this past bull market. The explosive rise of many of them has drawn a lot of hype and money into the altcoin sector. Much of that capital came from yield farming, often financially incentivized by VC firms and early investors. In this article, I will attempt to explain my L1 investment strategy for the coming bull market.

If you are not sure what liquidity mining and yield farming is, here is a quick reminder on what AMMs are and how they work:

Automated market makers (AMMs) are one of the most important components of the DeFi ecosystem. AMMs are a type of DEX (decentralized exchange) that use a liquidity pool model instead of a traditional order book model which centralized exchanges use in order to facilitate trades. AMMs have the benefit of allowing users to trade tokens permissionlessly, meaning there is no admin that first has to list a token on an exchange. Instead, anyone can trade literally any ERC-20 token on an AMM. Another benefit is the liquidity pool model, which lets users trade tokens with very low liquidity.

Liquidity providers deposit liquidity of a token pair (for example ETH & USDC) into a liquidity pool. The ratio between those two tokens determines the price of a token in relation to the other one. For example, there is much less ETH in a liquidity pool than USDC, which makes ETH more valuable compared to USDC. When somebody makes a trade they deposit one asset into the liquidity pool and receive another asset from that liquidity pool. When making a swap the user pays a fee to the liquidity providers. In order to attract liquidity on an AMM or a blockchain, companies often add a financial incentive to provide liquidity by adding a bonus to the transaction fee. Yield farming is a strategy, where you chase the highest yields in DeFi. You will see later why this is important

Unlike Ethereum, most alternative L1s have extremely low gas fees. For example, a simple transaction on the Polygon PoS network costs 0.00007664$ at the time of writing. Unlike what most people think gas fees can’t be the main driving factor in driving up the price of the gas token, otherwise, we would be looking at much smaller returns — and not the 1540% that Matic has appreciated from January 2021 to the all time high.

Staking can’t be the reason either for the dramatic price action either, because the return is too small. For example, the annualized reward rate of Matic is roughly 4.5% per year (source: stakingrewards.com).

The main factors driving the price action in my opinion are speculation and most importantly the liquidity incentives on the blockchain.

Let's look at the biggest liquidity pools on Polygon’s main AMM:

As you can see 4/10 of the top 10 liquidity pools have Matic as one half of the trading pair.

High volume of a trading pair creates high revenue for the liquidity providers, incentivizing more liquidity to flow into the liquidity pool, which creates demand for those assets in the LP. As you can see half of the biggest liquidity pools have Matic as one half of the trading pair:

The first catalyst for a rise in the usage and price of an L1 is a sustained increase in Ethereum gas fees. When Ethereum becomes too expensive to use users will start using cheaper alternative L1s. Let's look at the price of BNB since the Binance Smart Chain is the first L1 to take major market share from Ethereum

As you can see there is a high correlation between the average Ethereum transaction fee and the price of BNB. You can also see that the rise in gas fees in January preceded the rise of the price of BNB in February.

The Humble Farmers thesis looks at the probability of an ecosystem’s success. According to the Humble Farmers Thesis, there are two main factors that enable a good liquidity farming ecosystem:

In order to achieve this firms and AMMs often offer financial incentives for liquidity providers, sometimes using the AMM’s own, usually highly inflationary token. Another type of financial incentive which drives liquidity into the ecosystem more generally are developer grants and incentives. This capital is used for developers to create high-quality dapps, such as a new, trusted AMM and other interesting dapps. Often developers will use some of that money to incentivize liquidity providers as previously stated.

Polygon TVL started dramatically going up around the 14th of April, source: Defillama.com

Why is a trusted, reliable money market essential for an ecosystem? By borrowing against assets like Bitcoin or Ether using a money market you can unlock additional liquidity, without having to sell those assets. There are several reasons why one might not want to sell those assets, such as the tax implications, or because you believe in the success of the asset and you don’t want to miss out on the potential gains.

In addition, money markets allow you to short assets, enabling you to hedge against a position in a trustless, permissionless way. While this might not be very popular with the average retail investor, this is often a prerequisite for smart money to enter the ecosystem.

There are several pieces of infrastructure that have to be integrated into a blockchain in order for a money market to be considered safe. First of all, there has to be a trusted money market dapp. Those dapps are usually audited, rely on reputable oracle price feeds such as Chainlink, and sport an original and well-designed website. These money markets can be already well-established money markets or newly built money markets, exclusive to this ecosystem. New money markets have the added benefit of bringing more hype to the ecosystem because of their own new token that those money markets usually have. Often these new money markets incentivize usage by subsidizing borrowing or lending by distributing their own, often highly inflationary token.

There are several pieces of infrastructure that have to be integrated into a blockchain in order for this to be the case. First of all, there has to be a trusted money market dapp. Those dapps are usually audited, rely on trusted oracle price feeds such as Chainlink, and sport an original and well-designed website. These money markets can be already well-established money markets or new money markets, exclusive to this ecosystem. New money markets have the added benefit of bringing more hype to the ecosystem because of their own new token that those money markets usually have. Often these new money markets incentivize usage by subsidizing borrowing or lending by distributing their own, often highly inflationary token.

Another factor in the safety of an ecosystem’s safety is the integration of native stablecoins. The native support of stablecoins, such as USDC, USDT, BUSD and DAI, make the ecosystem much safer because bridged assets are a major point of failure for the ecosystem. Bridged assets work by locking one token on its native blockchain and giving you a “placeholder token” on the blockchain you want to bridge over to. If a side gets compromised in a way that enables the fraudulent minting of new assets (which are now unbacked), the attackers can now mint as many “placeholder tokens” as they want and bridge them to the other blockchain until there is no backing left, leaving everyone else holding the now worthless “placeholder tokens” that they can’t bridge back. This makes non-native, bridged stablecoins extremely risky to hold because they are one bug in the bridge away from becoming worthless.

For the same reason, the native currency of a blockchain will increase with a surge in volume and TVL the AMM token will also increase with a surge in the usage of this AMM. AMM developers often pair most of the most traded tokens with the AMM token and offer financial incentives to supply liquidity. Often these AMM tokens are very inflationary, allowing the AMM to offer much higher interest compared with the other liquidity pools. Due to the very low market cap that these AMM tokens have before the hype, these have the most potential to grow in terms of market cap.

As you can see, during the first big wave of hype, the AMM token outperforms the native currency of the underlying blockchain by a lot. After the first big wave of hype the token underperforms the native currency of the underlying blockchain due to the inflationary nature of these AMM tokens.

To wrap things up here is everything summarized in a checklist.

1. Is the ecosystem in the early stages of its hype cycle (is it already well known, or does it still have a lot of potential for growth)?

2. Are Ethereum gas fees high?

3. Is there a new, exciting AMM created specifically for this ecosystem?

4. Is there a reliable, trusted money market?

5. Are the money market audited? Do they use chainlink price feeds? Is there native support for reputable stablecoins?

6. Are there Liquidity Mining incentives or other financial incentives to be launched in the ecosystem?

7. Are there developer incentives?

This article is partially based on Taiki Maeda’s “Humble Farmers Thesis”:

Ethereum alternatives, also called Layer 1s, have outperformed the crypto market by a lot this past bull market. The explosive rise of many of them has drawn a lot of hype and money into the altcoin sector. Much of that capital came from yield farming, often financially incentivized by VC firms and early investors. In this article, I will attempt to explain my L1 investment strategy for the coming bull market.

Ethereum alternatives, also called Layer 1s, have outperformed the crypto market by a lot this past bull market. The explosive rise of many of them has drawn a lot of hype and money into the altcoin sector. Much of that capital came from yield farming, often financially incentivized by VC firms and early investors. In this article, I will attempt to explain my L1 investment strategy for the coming bull market.

If you are not sure what liquidity mining and yield farming is, here is a quick reminder on what AMMs are and how they work:

Automated market makers (AMMs) are one of the most important components of the DeFi ecosystem. AMMs are a type of DEX (decentralized exchange) that use a liquidity pool model instead of a traditional order book model which centralized exchanges use in order to facilitate trades. AMMs have the benefit of allowing users to trade tokens permissionlessly, meaning there is no admin that first has to list a token on an exchange. Instead, anyone can trade literally any ERC-20 token on an AMM. Another benefit is the liquidity pool model, which lets users trade tokens with very low liquidity.

Liquidity providers deposit liquidity of a token pair (for example ETH & USDC) into a liquidity pool. The ratio between those two tokens determines the price of a token in relation to the other one. For example, there is much less ETH in a liquidity pool than USDC, which makes ETH more valuable compared to USDC. When somebody makes a trade they deposit one asset into the liquidity pool and receive another asset from that liquidity pool. When making a swap the user pays a fee to the liquidity providers. In order to attract liquidity on an AMM or a blockchain, companies often add a financial incentive to provide liquidity by adding a bonus to the transaction fee. Yield farming is a strategy, where you chase the highest yields in DeFi. You will see later why this is important

Unlike Ethereum, most alternative L1s have extremely low gas fees. For example, a simple transaction on the Polygon PoS network costs 0.00007664$ at the time of writing. Unlike what most people think gas fees can’t be the main driving factor in driving up the price of the gas token, otherwise, we would be looking at much smaller returns — and not the 1540% that Matic has appreciated from January 2021 to the all time high.

Staking can’t be the reason either for the dramatic price action either, because the return is too small. For example, the annualized reward rate of Matic is roughly 4.5% per year (source: stakingrewards.com).

The main factors driving the price action in my opinion are speculation and most importantly the liquidity incentives on the blockchain.

Let's look at the biggest liquidity pools on Polygon’s main AMM:

As you can see 4/10 of the top 10 liquidity pools have Matic as one half of the trading pair.

High volume of a trading pair creates high revenue for the liquidity providers, incentivizing more liquidity to flow into the liquidity pool, which creates demand for those assets in the LP. As you can see half of the biggest liquidity pools have Matic as one half of the trading pair:

The first catalyst for a rise in the usage and price of an L1 is a sustained increase in Ethereum gas fees. When Ethereum becomes too expensive to use users will start using cheaper alternative L1s. Let's look at the price of BNB since the Binance Smart Chain is the first L1 to take major market share from Ethereum

As you can see there is a high correlation between the average Ethereum transaction fee and the price of BNB. You can also see that the rise in gas fees in January preceded the rise of the price of BNB in February.

The Humble Farmers thesis looks at the probability of an ecosystem’s success. According to the Humble Farmers Thesis, there are two main factors that enable a good liquidity farming ecosystem:

In order to achieve this firms and AMMs often offer financial incentives for liquidity providers, sometimes using the AMM’s own, usually highly inflationary token. Another type of financial incentive which drives liquidity into the ecosystem more generally are developer grants and incentives. This capital is used for developers to create high-quality dapps, such as a new, trusted AMM and other interesting dapps. Often developers will use some of that money to incentivize liquidity providers as previously stated.

Polygon TVL started dramatically going up around the 14th of April, source: Defillama.com

Why is a trusted, reliable money market essential for an ecosystem? By borrowing against assets like Bitcoin or Ether using a money market you can unlock additional liquidity, without having to sell those assets. There are several reasons why one might not want to sell those assets, such as the tax implications, or because you believe in the success of the asset and you don’t want to miss out on the potential gains.

In addition, money markets allow you to short assets, enabling you to hedge against a position in a trustless, permissionless way. While this might not be very popular with the average retail investor, this is often a prerequisite for smart money to enter the ecosystem.

There are several pieces of infrastructure that have to be integrated into a blockchain in order for a money market to be considered safe. First of all, there has to be a trusted money market dapp. Those dapps are usually audited, rely on reputable oracle price feeds such as Chainlink, and sport an original and well-designed website. These money markets can be already well-established money markets or newly built money markets, exclusive to this ecosystem. New money markets have the added benefit of bringing more hype to the ecosystem because of their own new token that those money markets usually have. Often these new money markets incentivize usage by subsidizing borrowing or lending by distributing their own, often highly inflationary token.

There are several pieces of infrastructure that have to be integrated into a blockchain in order for this to be the case. First of all, there has to be a trusted money market dapp. Those dapps are usually audited, rely on trusted oracle price feeds such as Chainlink, and sport an original and well-designed website. These money markets can be already well-established money markets or new money markets, exclusive to this ecosystem. New money markets have the added benefit of bringing more hype to the ecosystem because of their own new token that those money markets usually have. Often these new money markets incentivize usage by subsidizing borrowing or lending by distributing their own, often highly inflationary token.

Another factor in the safety of an ecosystem’s safety is the integration of native stablecoins. The native support of stablecoins, such as USDC, USDT, BUSD and DAI, make the ecosystem much safer because bridged assets are a major point of failure for the ecosystem. Bridged assets work by locking one token on its native blockchain and giving you a “placeholder token” on the blockchain you want to bridge over to. If a side gets compromised in a way that enables the fraudulent minting of new assets (which are now unbacked), the attackers can now mint as many “placeholder tokens” as they want and bridge them to the other blockchain until there is no backing left, leaving everyone else holding the now worthless “placeholder tokens” that they can’t bridge back. This makes non-native, bridged stablecoins extremely risky to hold because they are one bug in the bridge away from becoming worthless.

For the same reason, the native currency of a blockchain will increase with a surge in volume and TVL the AMM token will also increase with a surge in the usage of this AMM. AMM developers often pair most of the most traded tokens with the AMM token and offer financial incentives to supply liquidity. Often these AMM tokens are very inflationary, allowing the AMM to offer much higher interest compared with the other liquidity pools. Due to the very low market cap that these AMM tokens have before the hype, these have the most potential to grow in terms of market cap.

As you can see, during the first big wave of hype, the AMM token outperforms the native currency of the underlying blockchain by a lot. After the first big wave of hype the token underperforms the native currency of the underlying blockchain due to the inflationary nature of these AMM tokens.

To wrap things up here is everything summarized in a checklist.

1. Is the ecosystem in the early stages of its hype cycle (is it already well known, or does it still have a lot of potential for growth)?

2. Are Ethereum gas fees high?

3. Is there a new, exciting AMM created specifically for this ecosystem?

4. Is there a reliable, trusted money market?

5. Are the money market audited? Do they use chainlink price feeds? Is there native support for reputable stablecoins?

6. Are there Liquidity Mining incentives or other financial incentives to be launched in the ecosystem?

7. Are there developer incentives?