The U.S. Treasury now forecasts that the stablecoin market could grow to $2 trillion by 2028, assuming legislative clarity and increased adoption across payments, reserves, and settlement use cases.

Stablecoins are providing a critical lifeline in regions with limited financial access by enabling reliable, digital access to the U.S. dollar. Indeed, a recent report from Castle Island Ventures found that among non-trading stablecoin users, nearly half (47%) primarily value this stable, dollar-denominated savings option. Beyond dollar access, stablecoins also power cross-border transfers and serve as a sophisticated treasury management tool for corporations in developed markets. According to the same study, other popular real-world stablecoin use cases include yield generation (39%) and transactional activities such as currency conversion, cross-border payments, and paying or receiving salaries. For an interactive view of this fast-evolving stablecoin market, visit Stablewatch.io, where stablecoins already account for over 1% of the global M1 money supply.

In 2024 alone, stablecoins processed over $7 trillion in transaction volume in total—a scale easily surpassing the annual remittance flows of many mid-sized countries. Visa data reinforces this rapid growth, with monthly stablecoin volumes nearly doubling from around $355 billion in December 2021 to approximately $710 billion by May 2025, accompanied by similarly impressive growth in transaction counts. According to RWA.xyz, the stablecoin market cap has surged from roughly $28 billion at the end of 2020 to nearly $230 billion today (a 69% CAGR), while the number of holders has climbed from around 25 million to more than 165 million (around 60% CAGR).

There’s been no shortage of buzz in traditional finance either. In just the last year, major players like BlackRock (through its BUIDL fund), Fidelity (which is planning to launch its own stablecoin), and Custodia/Vantage Bank with its Avit Stablecoin have signaled their intent. PayPal has already entered the fray with PYUSD, marking one of the most significant mainstream stablecoin launches to date. Even central banks are joining in—Nigeria’s CBN is developing a cNGN stablecoin, while institutions like Standard Chartered and Robinhood are actively experimenting with stablecoin reserve management and products such as USDG.

But it’s not just about the raw numbers. Stablecoins are beginning to capture value by eliminating the multiple layers of rent-seeking intermediaries that have long burdened traditional card networks and the correspondent banking chains behind SWIFT. While SWIFT is merely a messaging tool, the real friction stems from the chain of intermediary banks, each adding fees, delays, and compliance checks. This legacy infrastructure is especially slow, opaque, and failure-prone in emerging markets. Eytan, founder of Nilos, draws an insightful parallel here, noting how the global payments stack—especially in remittances—is rapidly being restructured around stablecoins, mirroring the transformation Stripe drove in merchant payments by “growing the GDP of the Internet.”

The momentum extends into the infrastructure layer, where players like Codex, 1Money, Plasma, and SphereNet have raised millions to build stablecoin ecosystems tailored for real-world business use. Their goal: eliminate the UX friction, workflow incompatibility, and regulatory ambiguity that have long stunted stablecoin adoption beyond crypto-native circles. Meanwhile, Tether - whose USDT has dominated crypto trading and boosted financial inclusion in emerging markets - is exploring a new U.S.-based stablecoin targeted at large, regulated institutions. This push coincides with increasing calls for regulatory clarity in the U.S., with legislative efforts such as the STABLE Act and the GENIUS Act currently moving through Congress. While these bills could significantly accelerate institutional adoption by establishing clear compliance standards, they are not without controversy. Critics argue the new regulations might sharply increase compliance costs or even risk “regulating stablecoins to death,” mirroring the stringent reforms applied to money market funds following the financial crises of 2008 and 2010.

Lastly, stablecoin adoption isn’t just confined to crypto-native circles. In nations such as Brazil, India, Indonesia, Nigeria, and Turkey, surveys show that 69% of respondents who have used cryptocurrency in the past year have converted their local currency to stablecoins - with 39% using stables to pay for goods and services, 30% employing them in business, and 23% even processing salaries in stablecoins.

All these metrics, adoption events, and new initiatives point to one thing: stablecoins are no longer a fringe experiment. They represent a seismic shift in the way money moves - a shift that’s already unlocking massive economic potential and a new branch of the “money tree”, i.e. the next logical iteration similar to that of coins to notes, gold standard to fiat, paper instruments to electronic payments (the thesis behind the acquisition of Bridge by Stripe, as per John and Patrick).

This piece provides an overview of innovation in the stablecoin segment. The market map below provides a bird’s eye view of different categories and relevant projects within them. We then provide a deep dive into the last mile of stablecoin adoption across key categories. To conclude, we offer thoughts about where we see this wave of innovation going next.

Market Map

The Last Mile of Stablecoin Adoption

Are we already living in the future of finance? Not quite. Seeing 191 dollar-pegged stablecoins on DeFiLlama might look like an endless choice, but it really exposes how fragmented the market remains. That one data point underlines a bigger truth: despite soaring market caps and high-profile launches, stablecoins still struggle to deliver on their everyday promise. In jurisdictions around the globe, patchy regulations, clunky user experiences and ever-present compliance hurdles keep mainstream businesses on the sidelines. The result is a yawning disconnect - an ecosystem that’s growing by the numbers but hasn’t yet bridged into the real-world economy.

This gap is exactly where innovative infrastructure providers - from on-/off-ramps, to custody solutions, and stablecoin orchestration platforms - step in to bridge the divide. They are tasked with building the rails necessary for widespread stablecoin adoption, ensuring that the potential of these digital assets isn’t confined to niche crypto applications but extends to genuine, everyday use.

To truly appreciate the potential of stablecoins, Matt Brown suggests to view them through two complementary lenses: On one hand, stablecoins traditionally serve as a bridge between the traditional fiat world and the fast-paced crypto world - providing a stable on-chain asset for those lacking access to a reliable local currency. On the other, they are evolving into parallel infrastructure within fiat systems themselves, enabling cheaper, faster, globally open-access (or permissionless), and programmable money movement (“room-temp superconductors for financial services” as Stripe dubs it). But beyond that duality, it also helps to consider a second axis: End-User Proximity. Some projects operate deep in the infrastructure stack - laying the rails that others will build on. Others are shipping polished, user-facing products designed to abstract away the complexity and deliver programmable money directly into people’s hands. Together, these layers form a full-stack financial system that’s only now beginning to surface.

At first glance, stablecoins within fiat systems deliver first-order benefits - for example, cheaper and faster money movement means lower costs and reduced friction in everyday transactions. But as these benefits compound, they produce second- and even third-order effects: the open-access nature of decentralized networks expands the market dramatically, while programmability unlocks entirely new business models through automation and integration of financial services. These dynamics also set the stage for significant value accrual by displacing the rent-seeking intermediaries that have long dominated legacy payment systems - think of decades-old card networks or the SWIFT network, burdened by antiquated infrastructure and multiple fee layers. As stablecoin infrastructure reduces friction and enables seamless automation, it not only shifts costs but also reallocates value toward digital-native platforms that can capture efficiencies traditionally locked up by entrenched incumbents. And depending on where in the value chain a given startup sits, whether it’s providing the rails or packaging the final product, the business model, go-to-market strategy, and UX will look very different.

We can broadly categorize stablecoin-related companies into three buckets, with each category reflecting not just different orders of impact, but also a distinct level of proximity to the end user. Some focus on infrastructure, others on asset creation and yield, and a third group on full-stack end-user experiences. These layers aren’t mutually exclusive. But understanding where value is created, captured, and surfaced is key to mapping this new financial system.

Payments

Here, the first-order effects - namely, cheaper and faster transactions - are most evident. These frictions aren’t just theoretical: BVNK estimates that some $11.6 billion of working capital sits idle across four major B2B corridors because banks must pre‑fund float for days. That’s the kind of locked‑up liquidity stablecoin rails can free. Take Bridge, for example, whose acquisition by Stripe for $1.1 billion underscores the value of near‑instant, low‑cost cross‑border rails. Companies like these leverage cost reduction and speed to build platforms for remittances, everyday payments, and cross-border transfers. Our research suggests the clearest 10X opportunity isn’t consumer remittance but cross‑border B2B - where stablecoins can collapse a 2-5‑day, 4-6% fee cycle into sub‑minute, sub‑0.5% rails.

Layered on top of that universal rail, a growing tier of specialist infrastructure providers is tackling the remaining frictions in specific verticals: cash collection networks solving last-mile liquidity, integrated banking stacks for seamless on-/off-ramps, embedded wallet and custody layers to secure keys, orchestration engines that automate routing and compliance, and bespoke FX pools for local-currency payouts. Together, these elements form a complete, end-to-end payments ecosystem built on programmable money.

A distinct subcluster within payments focuses solely on cross-border transfers. While some generalist platforms like Bridge handle both domestic and international flows, others specialize in FX optimization and corridor-specific liquidity, carving out a niche where regulatory clarity and regional partnerships become key strategic moats.

A growing segment within the payments pillar focuses on merchants and billing infrastructure, where the pain is especially acute in emerging markets. Gaston from Grateful points out that in Uruguay, one restaurant paid $35,000 in processing fees on $1 million of summer revenue, nearly a third of its total EBITDA. That’s 3.5% of top-line revenue lost just to accept digital payments. Across the region, providers like M.Pago and PayWay reportedly charge anywhere from 1.5% to over 4% per transaction. Stablecoin rails, by contrast, offer near-zero fees and instant settlement. It’s a vivid reminder that stablecoins aren’t just about remittances or cross-border B2B. They can sustainably rewire the economics of everyday commerce.

A growing subsegment within infrastructure focuses on stablecoin-native L1s, optimized for real-world payments and compliance. Projects like 1Money, Codex, Plasma, and SphereNet not only routing value but also rebuilding the roads beneath it.

RWA Yield

If Payments is the low-hanging fruit of stablecoins, RWA Yield is the next branch on the money tree - where programmability and cost efficiency combine to deliver real, predictable returns. At the forefront sits Ondo Finance, which has tokenized over $1 billion of short-term U.S. Treasuries into on-chain funds (OUSG for accredited investors, USDY for non-U.S. users). Treasury analysis suggests that stablecoin growth could trigger a reallocation of deposits away from banks - especially non-interest-bearing transactional accounts - and into yield-bearing or operationally superior digital instruments. By minting directly against T-bills and money-market funds from the likes of BlackRock, Fidelity and WisdomTree, Ondo proves you can earn 4-5% yield with daily NAV accrual, instant mint and redeem, and the full composability of a DeFi token.

Beneath Ondo’s flagship products, established DeFi money markets like Aave and Morpho continue to set the benchmark for yield on USDC and other major stablecoins, offering deep liquidity, permissionless access and integration with borrowing, leverage and automated strategies. Building on that base, a host of protocols is pushing the model further into new asset classes: fixed-term stablecoin notes that feel like programmable Certificates of Deposit; decentralized credit marketplaces matching borrowers and lenders at agreed rates without banks in the middle; and multi-chain “corporate cash desks” that wrap insured stablecoin accounts into treasury management suites.

Together, these approaches are transforming stablecoins into institutional-grade yield engines - automating middle- and back-office workflows, disintermediating custodian fees and marrying proven TradFi assets with DeFi rails. The result is a new suite of programmable primitives for corporate treasuries, high-yield savings and institutional cash management across both mature and emerging markets.

Neobanks

While a number of consumer-facing apps stop short of full-stack banking and focus on modular financial services like savings, yield optimization, and on-chain credit (Stablecoin Fintechs), there is a growing number of neobank-style applications that aim to rebuild financial services from the ground up.

This is the most nascent pillar, where instead of bolting stablecoins onto old rails, founders are rebuilding every layer of finance on programmable money. We haven’t seen a runaway success yet, but the field is alive with innovation: platforms that automate invoicing, compliance and real-time payouts; white-label “banking stacks” you can spin up with a few API calls; and consumer apps in emerging markets that let anyone buy stocks, earn yield and move money.

These teams are weaving programmable rails into payroll, bookkeeping, lending, treasury and investing. Their work proves a simple truth: once money really is code, you can rethink the entire financial stack from first principles.

End-User Proximity as a lens offers a helpful way to compare how projects position themselves, both in terms of product design and market reach. The table below summarizes this spectrum across Web2 analogues, Web3 implementations, and strategic implications:

The road ahead

Stablecoins have already rewritten the rules of money movement—compressing settlement from days to seconds, unlocking billions in trapped liquidity, and layering real-world assets onto programmable rails. But this transformation is only just beginning. As we look into the future, three subtle yet powerful developments will reshape stablecoin markets in ways that aren't immediately obvious but could profoundly alter the global financial landscape.

1. Institutional-grade infrastructure and custody

The current narrative around regulation often focuses on compliance costs and potential constraints, yet a less obvious upside is quietly emerging: regulatory clarity will enable true institutional-grade infrastructure for custody, settlement, and compliance. As legislative frameworks like the U.S. STABLE Act, GENIUS Act, and Europe’s MiCA fully roll out, we will see major financial institutions—not just fintech startups—confidently enter the stablecoin space. Custody giants such as BNY Mellon, State Street, and Fidelity will provide trusted on-ramps, custodial services, and regulatory-compliant settlement platforms. At the same time, specialized DeFi compliance platforms like Predicate are emerging to offer neutral and decentralized infrastructure that empowers ecosystem participants to define and enforce compliance rules in a permissionless manner. Predicate’s approach, focused on enabling “values expression,” is pivotal for managing transaction compliance without undermining Ethereum’s foundational neutrality. These frameworks, combined with advanced compliance solutions, could actually unlock institutional-scale adoption, dramatically improving liquidity, reducing systemic risk, and boosting confidence for enterprise and governmental users.

2. Localized and non-USD stablecoins

The U.S. Treasury notes that demand for USD-backed stablecoins could draw non-USD liquidity into the dollar system, reinforcing its role in global capital markets - even as non-USD coins gain localized traction. Indeed, Euro-backed stablecoins are already gaining traction in Europe, with supply nearing half a billion USD - more than double the level at the end of 2023. Zug-based Schuman Financial, for example, recently raised €7 million to scale EURØP, a fully MiCA-compliant euro stablecoin. Meanwhile, BRICS nations are experimenting with stablecoins pegged to local currencies like the BRL, INR, CNY, while pilots in Asia-Pacific markets, including the SGD and JPY, are also underway. Local issuers will tailor stablecoins to regional rails and regulations, reducing reliance on the dollar and aligning with domestic monetary policy - further broadening the market beyond the current 1-2% of global M1.

3. Phase-2 tokenization

Beyond stablecoins themselves, programmable money infrastructure is quietly catalyzing a "phase-2" tokenization wave that extends to equities, bonds, real estate, and private credit. Rather than mere digital wrappers of traditional assets, this new generation of tokenization will fundamentally change the market structure, trading dynamics, and accessibility of global capital markets. Imagine automated, near-instantaneous settlement for tokenized bonds; fractionalized real estate equity available globally with minimal friction; and fully transparent, programmable equities traded 24/7. This shift isn’t just a technological upgrade; it's a structural revolution that will dismantle entrenched intermediaries, democratize market access, and trigger new business models built on programmable liquidity.

We are still very early

We stand at an inflection point in financial history. What began as a crypto experiment has evolved into the backbone of a new monetary system—one where dollars flow as seamlessly as data, where a merchant in Lagos can receive instant, near-zero-fee payments from New York, and where corporate treasuries can earn yield on programmable money that settles in seconds rather than days.

As regulatory frameworks crystallize and institutional infrastructure matures, we're approaching a world where the distinction between "traditional" and "digital" finance will seem quaint. The next phase—where localized stablecoins serve regional needs, where tokenized assets trade 24/7 with programmable settlement, and where compliance itself becomes a composable, automated layer—will make today's financial system appear as antiquated as sending faxes.

Perhaps most remarkably, this transformation is still in its infancy. When dollars become natively digital and programmable—when money truly becomes code—we can scarcely imagine the innovative applications that entrepreneurs will build. Just as the internet spawned business models unthinkable in the pre-digital era, programmable money will enable financial services we haven't yet conceived. The only certainty is that the future of finance won't just be faster or cheaper—it will be fundamentally different, and more accessible to everyone, everywhere.

How can a decentralized protocol accrue value and pay its participants? Blockchain-based native tokens are the answer to this question. Native tokens of crypto protocols can be categorized into two main clusters of use-cases:

1. Incentivization & Distribution

2. Capital formation

This article will elaborate on these use-cases to equip readers to determine whether a specific protocol or product should launch a token or not. Note that we are considering native tokens and excluding tokenization or memecoins. Tokenization describes the issuance of existing assets on-chain, e.g., stablecoins (tokenizing USD) or other “real-world assets” (RWAs) like tokenized equity or bonds. Memecoins are tokens that are not tied to any protocol or external asset but represent an idea only.

The historic evolution of crypto tokens can be described as a balancing act between the two clusters of use cases around incentives and capital, usually providing both but focusing strongly on one side of the spectrum:

1. 2008: Bitcoin used BTC to incentivize and pay miners to secure its network and distribute tokens early to drive distribution of ownership

2. 2017: Initial Coin Offerings (ICOs) emerged to capitalize early projects

3. 2020: During the Decentralized Finance (DeFi) boom, governance tokens and yield farming were used to incentivize usage and distribute governance

4. 2021+: Token incentives (similar to those in DeFi protocols) were used to implement new crypto-economic protocols  and incentivize network participants. Mechanisms are implemented to give value accrual to these tokens and manage supply that would otherwise be inflationary

5. 2025 and onwards: As the regulatory climate around tokens shifts, we suggest that more capital-like properties like accruing actual cash flows become increasingly prevalent

There is still confusion around the nature and use of tokens because of their complex history, the different emphases of different stakeholders, and overlapping definitions. Tokens are being criticized for all kinds of different reasons: not being useful, not being valuable, being issued too much or too little.

This debate continues to evolve with market cycles. During bear markets, founders face skepticism with questions like "Does your protocol really need a token?". While in bull markets, the conversation shifts to an eager "Wen token?". Regardless of market conditions, founders must carefully consider whether and how a token can genuinely benefit their protocol's ecosystem. This article provides a guide to help determine whether launching a token makes sense for a given protocol, elaborating on the trade-offs between incentivization & distribution and capital formation.

The relationship between protocols and tokens

The relationship between protocols and tokens can be structured in two different ways.

1. First of all, there are indeed cases where a token is needed to make the protocol work in the first place.

2. Much more common are cases where the protocol can benefit from a token, but doesn’t strictly need a token to function.

We will now go through both of these cases and illustrate with examples of existing projects in each category. There are also potential pitfalls of tokens that founders need to be aware of for making an informed decision, which we will address before summarizing our considerations with a decision flow chart.

Staking/slashing games require tokens

In reality, there are only a handful of protocols that strictly need a token, meaning that they could not provide their core functionality without it. For these, incentivization and distribution is crucial, especially in early phases.

Most notably, they include Layer 1 blockchains (L1s): In order to secure the blockchain, a native monetary asset is needed for all types of consensus algorithms in order to incentivise stakers/miners and to ensure their incentive alignment. Usually, the token is also required as a means of payment for transaction fees for using the blockchain. This was the original use case for native tokens with blockchains such as Bitcoin and Ethereum, and is still best practice for more recent sovereign chains such as Sui or Monad. Note that with the advent of Eigenlayer and other restaking protocols, it is now also possible to launch a chain without its own native token.

However, Eigenlayer would only work in a much more limited way without its native token EIGEN that is needed for “intersubjective consensus”, adjudicating slashing conditions that are not objective/on-chain. We can generalize that a subset of crypto-economic protocols, most importantly staking/slashing mechanisms, require native tokens to work. In these mechanisms, participants need to put capital in the native token at risk for the right to perform work on behalf of the protocol. If this work is performed correctly (e.g. participating in consensus of a blockchain), participants earn more of the native token, often as an annual percentage return (APR) on the provided capital. A native token is required to issue those rewards to participants.

One could also argue that DePin (Decentralized Physical Infrastructure) networks that provide infrastructure from storage to connectivity in a decentralized manner realistically need their own token to work. While such a network could theoretically run without its own token at maturity, the cold-start problem (see the chapter below) is so significant that they would be unlikely to get there without first launching a token. Examples for DePin include IPFS/Filecoin or Impossible Cloud for storage and Helium for connectivity.

Tokens can improve protocols by setting incentives

More frequently, certain types of protocols can be improved significantly with the addition of a token, even though they could also be built without. The benefits of adding a token are mostly around incentivization and distribution: either for initial adoption, to improve performance, or to reward loyalty.

Even when it is not strictly required, the addition of a staking/slashing mechanism can increase the quality of services provided by external stakeholders. For example, services such as injecting off-chain data or curation can be improved if there is capital at stake for the providers. Chainlink uses a staking mechanism to improve the quality of its oracles.

Potentially the largest category of protocols that can significantly benefit from tokens are any protocols that rely on a network effect to provide their service and need to overcome a “cold-start” problem in order to be useful. The cold-start problem describes a situation where both supply and demand sides are needed for a protocol to work, and neither wants to join without the other one already being there. By issuing its own native token, a protocol can pay the supply side without the demand being there to pay yet and, therefore, overcome this problem. For example, the Filecoin token successfully bootstrapped the supply side of IPFS. Similarly, “X-to-earn projects” from games like Axie Infinity or health data protocols like Sweatcoin use token incentives to bootstrap an initial user base. Other examples include L2s like Blast and Zircuit, which have successfully scaled their total value locked (TVL) to billions of dollars by using this strategy (starting as points programs).

A third category of protocol improvements through tokens can be broadly summarized as loyalty programs. Whether by locking tokens upfront (as originally proposed by Curve and still practiced by many DeFi protocols) to receive benefits or by accruing boosts over time (for example, as with Kamino Finance), tokens can incentivize long-term participation. Loyalty mechanisms can often be effectively combined with staking mechanisms.

There are other ways that tokens can improve protocols, and innovation in this area will continue. The most common ways that tokens can improve protocols include:

1. Improving services with staking

2. Overcoming the cold-start problem with rewards

3. Incentivizing long-term participation and loyalty

Potential pitfalls of introducing tokens

It is important to consider that, in some cases, introducing a token closely tied to the protocol can harm prospects of success. There are recurring pitfalls that founders of crypto protocols should be aware of and avoid wherever possible.

First of all, using a native token as the only admissible means of payment generally only makes sense in the case of L1s or DePins (“Protocols that need a token” above). In most other cases, requiring tokens for payment causes significant friction, especially if the target audience is not crypto-native or even includes enterprise customers. Payment utility also does not help sustain long term token value (see the “velocity problem”). These in fact create neither incentivization & distribution advantages nor do they foster capital formation (the velocity of tokens has been discussed repeatedly since the advent of utility tokens)

Another pitfall is using the token exclusively for user rewards, without providing reasons for users to hold on to or even lock up the token (e.g. through staking). The introduction of financial incentives may “crowd-out” the intrinsic motivation of users, and if the only thing they can do with the token is sell it for cash, the token will have a hard time sustaining its value. Elevated token emissions to incentivize user activity can also lead to negative feedback loops when token price starts declining, as the case of Axie Infinity and other “x-to-earn” tokens have illustrated. Here, lacking capital formation ultimately destroys incentivization.

Finally, if the project has raised capital on an equity basis before, care is needed to avoid conflicts of interests and adverse incentives between token holders and equity owners. Conflicts of interest often occur in cases where a part of the protocol revenues goes to an incorporated company and another part goes to token holders (usually indirectly).

To summarize, major pitfalls to avoid when adding tokens to protocols include:

1. Adding friction for users when requiring payments in tokens

2. Creating vulnerability to negative feedback loops through excessive rewards

3. Generating conflicts of interest between token holders and equity owners

To token or not to token?

If the protocol does not fall into the categories described above, the answer to the question “Does the protocol need a token?” is likely a clear “No”. However, there may still be good reasons to launch a token nevertheless.

Most notably, if the project wants to decentralize control and distribute ownership widely, whether for legal or ideological reasons, a (governance) token may still make sense. As long as the pitfalls described above can be avoided and the relevant jurisdictions allow it, a governance token can be used effectively to incentivise team members and raise funds for the project. Airdrops and other distribution mechanisms can be used to distribute the token to early users and contributors. This line of reasoning becomes more relevant if the project has contributors distributed all over the world or is hoping to raise a crowdsale from many small contributors. As regulatory clarity increases, other capital-like mechanisms like distributing protocol cash flows to token holders are also likely to become more prevalent.

However, it is also important to note that projects in that situation should carefully consider the decision and not feel pressured to launch their own token just because they are building a blockchain-related protocol. If there is no protocol-level justification for a token, introducing a governance token may conflict with certain regulations. In addition, there are other ways of incentivizing users and collaborators that may be more adequate, for example revenue sharing or reputation systems.

The flowchart above summarizes the decision tree for considering the addition of a token to a protocol. We hope that it provides initial guidance to founders on the decision on whether or not to launch their own token.

The decision to launch a token remains one of the most consequential choices crypto founders face today. True protocol-token fit exists when tokens either enable core functionality (as with L1s and DePin) or meaningfully enhance protocol operations through staking, bootstrapping, or loyalty mechanisms.

However, the pressure to "tokenize everything" should be resisted – a lesson hard-learned through multiple market cycles. The most successful token implementations will be those that arise from genuine protocol requirements rather than market pressures, avoid common pitfalls like excessive rewards or payment friction, and align with the project's long-term vision for decentralization and community ownership. As the blockchain ecosystem matures, a thoughtful approach to token design will distinguish sustainable protocols from short-lived experiments.

This post explores daily price performance of public Web3 tokens compared to Ethereum (ETH). We estimate and analyze the Alpha and Beta of around 150 assets over four years, leading to some key insights:

• Most tokens have negative Alpha.

  • This isn't necessarily bad. In high-funding environments, trading into high Beta assets with negative Alpha can be cost-effective.

• However, most of these assets also have a Beta lower than 1.

  • 57% have a Beta lower than 1.

  • Only 30% of assets have positive Alpha.

  • Just 13% have positive Alpha and a Beta above 1.

• 2023 saw the most Beta dispersion, while 2021 had the widest Alpha variation. The current period closely resembles 2022.

• Beta estimates fluctuate significantly over time. No asset consistently acts as "Beta on ETH."

• Some notable observations:

  • Popular Layer 2 solutions  like ARB and OP, contrary to popular belief, don't reliably act as Beta on ETH. Same for the liquid staking pioneer LDO. Despite high Beta in some periods, these assets tend to underperform ETH and have negative Alpha.

  • ENS is a rare exception, currently showing high Beta with positive Alpha. Other than that, high Betas with positive Alpha are mostly captured by some memecoins.

  • MKR is a safe haven and usually performs like that (i.e. has a Beta below 1 and moves less than ETH). Recently though, it shows characteristics of a high Beta asset.

  • Check our interactive dashboard to explore other assets.

Introduction

Alpha and Beta

The Greek letters Alpha and Beta are two important metrics that occupy a central place in financial markets. Investors typically hunt for positive Alpha, which indicates an asset that consistently outperforms the market over time - independent of how the market itself iswas behaving.

On the other hand, Beta is more relevant to those looking for exposure to volatility or the broader market. A Beta higher than 1 means the asset is more volatile than the market, acting as a form of natural leverage. Conversely, assets with a Beta lower than 1 are considered safer, more conservative investments. Assets with negative Beta are rare and thus not relevant to this discussion.

Defining the market

To calculate Alpha and Beta, the first step is defining the market portfolio — an index representing the overall market. In emerging markets like Web3, this is tricky. Deciding which tokens to include in a market index, and how to weight them, can lead to different answers at different times. As a result, investors often look for assets that act as Beta to a specific asset, usually Bitcoin or Ethereum, rather than the market as a whole. The idea is that certain projects act as Beta on an ecosystem, and investors seek out these assets for two main reasons: to gain leverage or to efficiently gain exposure across multiple ecosystems. For example, if you find an asset with a Beta of 2 relative to Ether, you could achieve the same ecosystem exposure with only half the capital required to buy Ether directly. This would then allow you to cover more ecosystems.

The main analysis

Single-Year estimates

The chart below shows a scatterplot of all Beta and Alpha pairs for 2024. Four out of the five assets with the highest Beta (and positive Alpha) during this period were memecoins. The only non-memecoin in this group is ENS, which has surged about 60% compared to Ether in 2024.

Currently, most assets in our dataset have a Beta lower than 1. Only about 43% have a Beta higher than 1, meaning they move more strongly than Ether. Roughly 30% of assets have a positive Alpha overall, and just 12.7% boasting both positive Alpha and a Beta higher than 1. Interestingly, most high Beta assets—30.7% of the total sample and about 70% of those with a Beta above 1—actually have a negative Alpha, consistently underperforming Ether. This isn’t necessarily as bad as it sounds. In times of high funding, it can actually be more cost-effective to trade into high Beta assets with negative Alpha then to pay funding on ETH futures. Meanwhile, 38.7% of all assets show both negative Alpha and a Beta lower than 1. The “dinosaur coins” XRP, LTC, and XMR are examples of such tokens (though their estimates might look better relative to Bitcoin). Aside from XMR, these assets and their respective networks don’t offer much functional purpose, and as these results indicate, neither do the tokens from an asset allocation perspective.

Dispersion is often seen as a sign of a maturing market. Contrary to popular belief, Beta dispersion was highest in 2023, not in the current period. Today, most Beta estimates are more centered around 1 or lower, while 2023 saw a broader distribution. As for Alpha, the 2023 period had little variance, with values centered around a slightly positive mean. In contrast, the current 2024 period is most similar to 2022, with Alpha values centered around a negative mean. Both periods are characterized by weaker price performance following an initial frenzy in Web3 token prices. In 2021, a year often remembered as a raging bull market, there was the most dispersion in Alpha and most tokens not keeping pace when ETH was on the move—proving that even in a rising market, what you hold still matters.

Rolling estimates

Examining individual calendar years reveals that the overall distribution of Alpha and Beta estimates can vary widely. To capture this variability, we subsequently focus on rolling estimates (60-day) of Alpha and Beta. This approach helps analyze how stable these estimates are and how much they change over time. It also allows us to better evaluate how well certain assets act as "Beta on Ether."

L2s and LSTs - native leverage?

Layer 2 solutions like ARB and OP are often considered "Beta on Ether." However, when looking at rolling Beta estimates, it’s clear these values are quite volatile. In the past months, Beta estimates have ranged from 0.5 to 1.5. While these assets began the year with high Beta, they failed to consistently outpace Ether, meaning they didn’t provide the expected native leverage they were supposed to. Only recently have they regained a Beta higher than 1. Additionally, their Alpha estimates have been negative since about March, leading to poor price performance and failing to deliver leverage within the Ethereum ecosystem. As a result, from a portfolio construction perspective, they have underperformed Ether significantly. The reasons for this underperformance are not immediately clear, but one could speculate that investor unlocks and supply inflation are factors.

LDO, often viewed as leverage on ETH due to its role as the leading liquid staking protocol on Ethereum, has also shown negative Alpha for most of the trading period. While LDO’s Beta estimates are also volatile, it has generally maintained a higher Beta. However, periods of very low and negative Alpha combined with a Beta that fluctuates greatly over short periods mean that LDO doesn’t exhibit the characteristics of efficient Beta. It appears at most suitable for active portfolio managers. The LDO/ETH price reflects much of this behavior.

Other noteworthy observations

Below we show rolling estimates for a few other interesting tokens and briefly discuss these results. Feel free to play around with the dashboard, or fork the repository and explore yourself.

MKR: Often seen as the central bank of DeFi and generally considered a safe-haven asset, MKR usually exhibits a Beta lower than 1, meaning it moves less than ETH. However, this trend has recently shifted, possibly due to its "endgame" strategy and anticipation of a token revamp. Or because of Grayscale’s new MKR ETF. Interestingly, MKR had positive Alpha throughout most of 2023, potentially benefiting from the higher interest rate environment, which allowed it to capture more value compared to your average "degen" coin.

RBN: After recently converting to AEVO, RBN initially showed a high Beta and impressive Alpha, growing strongly and independently of ETH. This trend reversed dramatically around late April/early May, just a few weeks before the token conversion. This event could be considered a classic case of "sell the news," although it happened a few weeks too early. During its migration to AEVO (with a simple 1:1 conversion), RBN exhibited significant negative funding on centralized exchanges. Ultimately, hedging through these Futures could have been very profitable.

GNO: As an asset from the 2017 ICO era, GNO is free from the usual low float/high FDV issues, and investor vesting isn’t a significant concern. Closely integrated with the Ethereum ecosystem, GNO moved in tandem with ETH for most of 2023, albeit slightly underperforming. However, in late 2023, GNO started outperforming ETH, showing substantial positive Alpha independent of the market, while its Beta remained stable around 1. Recently, it seems to be giving back some of that outperformance, with negative Alpha in the past few weeks.

ENS: Not as old as GNO (at least the token). No investors, just a team, a treasury and the community. Pretty consistent (absolute) inflation through treasury vesting, which in fact is not low. A recent appchain announcement might have triggered a repricing. As of now, ENS is the standout performer of the past few months and the only non-memecoin among the top 5 Beta assets of 2024. With a positive Alpha, ENS could be primed to outperform further in the coming weeks and months.

Conclusion

As we move forward, the landscape for Web3 tokens will likely continue to evolve, driven by both market dynamics and technological advancements. The ongoing fluctuations in Alpha and Beta suggest that investors need to stay agile, closely monitoring these metrics to optimize their strategies. With the potential for regulatory developments, increased institutional interest, and the growing impact of factors like token unlocks and ETF flows, the correlation between ETH and other assets could shift in unexpected ways. Investors might find new opportunities in assets that were previously overlooked or undervalued. As the market matures, those who can adapt quickly and anticipate changes in Alpha and Beta will be better positioned to capitalize on emerging trends. Whether seeking leverage through high Beta assets or searching for hidden Alpha, the key will be in staying informed and ready to pivot as the Web3 space continues to redefine itself. Personally, we believe that an asset allocation strategy based on the notion of something acting as “Beta on ETH” is flawed and as such will disappoint. Finding value independently of Ether’s price fluctuations might be harder but more rewarding in the end.

From a research standpoint, a few interesting questions have come up during this work that remain unanswered.

• What is driving Alpha or Beta decay? Could it be token unlocks, or is it simply a natural process leading to both Alpha and Beta decay, driven by constant market rotations?

• How do Alpha estimates correlate with funding rates for ETH?

• Why should any token fundamentally serve as Beta on ETH? Many tokens don’t have intrinsic value capture tied directly to the Ethereum network and its usage.

• How will ETF flows impact these assets? Can any asset have meaningful Beta in an environment in which Ether is deflationary due to EIP-1559, while also attracting traditional investors through ETFs?

If any curious reader wants to explore these questions together, or can think of other relevant questions, we would be happy if you reached out to us.

This article aims to provide a balanced overview of airdrops in 2024, helping founders decide if an airdrop is right for them and how to design it well.

Introduction: the good, the bad, and the ugly of airdrops

The Good: Why airdrops are a persistent strategy

Airdrops are not new. Stellar launched an airdrop as early as 2014, but the mechanism only truly became popular in 2020, notably with Uniswap's retroactive airdrop. Ever since, airdrops have been a key distribution mechanism for tokens.

Airdrops are popular in Web3 due to the unique dynamics of decentralized protocol networks compared to traditional startups:

1. Decentralization: Crucial for protocol safety and regulatory compliance.

2. Open source: Most code is open source, reducing proprietary advantages.

3. Low switching costs: Users can easily switch protocols.

4. Community and liquidity: Some of the strongest network effects in Web3.

Airdrops create a widely distributed base of token holders, reducing legal risks if launched post-protocol functionality. They build strong, committed communities, turning users into co-owners and advocates fuelling organic growth, known as the "network ownership effect."

As airdrops became more common, users now expect them from protocols they use, boosting adoption and engagement. On the upside, adoption of new protocols is accelerated and usage numbers are pushed higher by this expectation. Clear points programs can enhance this effect by making valuable actions transparent and the overall process more engaging.

The Bad: Common pitfalls of airdrops

There are also downsides to this dynamic. First and foremost: adverse selection. If an airdrop is expected, organic users can be overrun by airdrop farmers who don’t have any intrinsic motivation to use the product but are merely speculating on the value of the airdrop they expect to receive. This dynamic is harmful for a project in multiple ways:

• Fake product market fit: Usage metrics become unreliable.

• User dilution: Genuine users get diluted by speculators.

• Sell pressure: Speculators often sell tokens immediately.

For airdrops to be effective, tokens should reach long-term users and community members. If speculators dominate, the benefits of retention and organic growth diminish. Speculators selling immediately causes negative market impact.

Distinguishing genuine users from speculators is challenging. Criteria meant to filter out speculators can exacerbate the problem if not set correctly. Missteps lead to frustrated users and negative perceptions, turning a potential marketing win into a PR disaster. For instance, the Starknet airdrop faced backlash due to exclusion criteria, large allocations to developers, and perceived fake activity. Users were frustrated by these issues, evidenced by the spike in activity on the airdrop claim day being followed by a sharp decline.

To avoid these pitfalls, projects must target genuine users over speculators and determine the right allocation sizes. Too much can lead to sell-offs, while too little can frustrate users. The amount received also depends on the token’s initial valuation, which adds complexity.

The Ugly: will bad incentives break airdrops?

The current points and airdrop paradigm has faced increasing criticism as of Q2 2024. Airdrops can seem like zero-sum games rather than community catalysts. Users complain that allocations are too small for average users and only whales can profit meaningfully. Projects face tough trade-offs, highlighting structural misaligned incentives and conflicts of interest.

For the projects, structural incentives include:

• Maximizing user participation (TVL, etc.) with points and airdrop campaigns.

• Maximizing dollar value of airdrop per users by launching at a high valuation.

Meanwhile, projects need to navigate the trade-offs between linear and tiered distributions to minimize criticism and avoid regulatory risk by selling tokens to users or even allowing claims from users in risky jurisdictions (e.g. the US).

These incentives drive towards inflated protocol usage due to speculation, resulting in high launch valuations and substantial airdrops. However, this strategy can backfire as high valuations leave little room for growth, especially as speculative usage wanes and more tokens enter the market, leading to declining token values. This undermines the community-building purpose of airdrops. The initial airdrop allocation makes users less likely to invest in the project, as they tend to value tokens bought more than those received for free. Without many buyers, downward price pressure is more likely. Launching at a lower valuation might disappoint users with smaller airdrop amounts. Distributing tokens fairly is challenging. Linear distributions may be to the benefit of whales, while higher minimum amounts favour Sybil attacks from industrial airdrop farming operations.

A similar set of incentives drive behavior from users:

• De-facto investment decision: Thinking about using Web3 projects in investment terms, parking capital wherever they expect the most return in airdrops.

• Sybil attacks: Using several wallets to interact with a project or even launch an automated Sybil attack maximizes airdrop value.

• Never be satisfied: Complaining on social media after the airdrop could lead to the project giving away more tokens, so this becomes a winning strategy.

• Mercenary attention: Selling tokens after the airdrop and moving on to the next project to farm maximizes expected value.

These user behaviors are driven by a regulatory climate that makes selling tokens to retail rare. If users could invest directly at lower valuations, incentives would shift. Currently, airdrops are the only way to gain exposure pre-launch, encouraging Sybil attacks for meaningful allocations. Even believers in a project may sell their tokens post-launch due to high valuations and low circulating supply.

Under the current market conditions, airdrops have lost much of their initial appeal as fair, community-oriented distribution mechanisms. The benefits of fostering a community of passionate token holders are significantly undermined. In the following part, we will explore how best practices in airdrop mechanisms can help solve for adverse incentives.

A mechanism design guide to airdrops

The following is a guide for founders to support the process of designing an airdrop.

Since Uniswap’s seminal retroactive airdrop in 2020 that simply distributed the same amount to all swap users and a linear distribution to LPs, there has been a lot of experimentation and innovation in airdrop design. We will first look at the most important parameters to consider when designing an airdrop before exploring best practices and recent innovations. Note that we are focusing on the distribution strategy when it comes to airdrops and assuming that the utility (and total supply) of the token has already been decided at this point.

Parameters of an airdrop

Even though the design space of token distributions is large, all airdrops share fundamental parameters. When designing an airdrop, it is helpful to start at this very top level analysis and then gradually increase the level of detail.

The following are the most high-level parameters:

• Percentage of total supply reserved for airdrop campaign(s)

• Timeline

• Target audiences

Projects should consider their long-term strategy when deciding these high-level parameters. What level of decentralization and initial liquidity is required? Who are the most important target audiences for the protocol? When is the right timing for the token to launch?

When it comes to the timeline, it is recommended to only allow token claiming (and trading) once the protocol is fully functional and the reliance on the team has decreased significantly to reduce legal risk. If the token includes governance functionality, it is recommended to launch these in parallel with the first airdrop campaign.

Target audiences may distinguish between different user groups and could even include groups of potential future users. Each of these high-level parameters needs to be further elaborated. The total airdrop allocation needs to be broken down over different campaigns. The timeline can be further broken down into snapshot, announcement, eligibility, and claims. Once target audiences are set, the token allocation per campaign needs to be allocated to each audience. Additionally, inclusion criteria and the distribution formula need to be defined for each audience.

The table above includes tactical parameters for each of the high-level parameters. We now turn to recent best practices, following the outline of this table.

Innovation and recent best practices

While each project should think about their distribution strategy from first principles, it is helpful to know what benchmarks and best practices are. We looked at 7 major airdrops of this year as case studies to survey the most recent market standards for the parameters above.

Amount and Campaign Structure: In terms of the percentage of supply reserved for airdrops, initial airdrop campaigns of the selected case studies have ranged between 5-12.5%. There are of course outliers on either side, the most extreme being Friend.tech who chose to drop 100% of tokens to their users.

It is notable that the vast majority of projects decided to do several airdrop campaigns (2 most often) instead of just one, which used to be more common a few years ago. Allocations per campaign tend to be roughly equal. Projects often choose to not yet define the allocations for future campaigns.

Other innovations include:

• Non-transferrable tokens: Safe and Eigenlayer both launched claims of their tokens before they became transferable, presumably for legal and/or operational reasons.

• Vesting: Ethena and Renzo included linear vesting for 6 and 3 months, for the top 2% and 1% of wallets, respectively. Both used the platform Liquifi for vesting.

Especially splitting up an airdrop into several campaigns has emerged as a clear best practice. It makes sense to draw out the positive momentum of an airdrop over longer and also allow later users to get an allocation. While not yet used widely, vesting for top wallets is a promising mechanism to align larger holders.

Timeline: Snapshot and announcement are usually coupled together, and it is best practice to announce the airdrop shortly after the snapshot (to avoid frustrated users that have entered between the snapshot date and the announcement). As an exception, Kamino has announced their token before the snapshot, and even disclosed the snapshot date upfront. While announcing before the snapshot could generate additional marketing momentum, it may also attract short-term speculators so we wouldn’t recommend this.

Most often, projects provide an eligibility checker before claims are available. We recommend explaining the eligibility criteria in a blog post at this time to help users understand (especially if their claimable amount deviates from their expectations). See Eigenlayer’s post as an example.

Pioneered by earlier projects like ENS in 2022, the airdrop claiming experience is a key communication opportunity to users. Some best practices include:

• Retrospective: Summarize the history of the project, its mission, as well as the user’s engagement with the project (EtherFi’s claims are a great example).

• T&Cs: Have users sign the terms and conditions of the tokens and potentially even the constitution of the DAO in the case of governance tokens.

• Token actions: Direct users towards any actions they can take with their claimed tokens, e.g. delegation or staking.

The final parameter is the claiming window (during which airdrops can be claimed). It is best practice to redistribute unclaimed tokens to future reward campaigns. There is a large span in the case studies we looked at from 1 month to 8.5 months. While the typical claiming window has become shorter over time, we don’t recommend going below 3 months to give also less online users a fair chance to claim.

Target audiences and distribution formula

When it comes to target audiences for the airdrop, there are three different categories to consider:

• User groups

• Contributors and partners

• Potential future users

Most of the total airdrop allocation should go to users of the protocol. There may be different user groups depending on the protocol that receive a different total allocation. In the case of Parcl, both traders and LPs were different relevant user groups. If there was a points program before the airdrop, the token allocation should reflect the distribution of points and differences between user groups should already be evident at that level. For example, Ethena granted different multipliers in their points program to users who either staked, held, or locked USDe.

The second category concerns stakeholders who contributed in other ways than using the protocol. Most common examples include:

• Holders of protocol-native NFTs like (e.g. EtherFi’s Ether.fan or Tensor’s Tensorians)

• Developers (e.g. Github contributions)

• Holders/stakers of partner protocols (e.g. both Altlayer and Dymension dropped to Celestia stakers)

Finally, a protocol may target external communities to acquire as future users. This could include users of competitive protocols (“vampire attacks”) or NFT communities. For example, both Ethena and Renzo included the Schizo Poster NFT community in their airdrop allocation.

When it comes to the distribution between these groups, 90-100% of tokens tend to be allocated to protocol users, in proportion to the points earned (if there was a points program beforehand). Allocations of other target audiences need to be determined case-by-case and depend on both the number of wallets in these categories and their perceived value to the protocol.

There are ongoing controversies and trade-offs around the allocation formula. The most common options are either linear (as a function to points or usage metrics e.g. TVL or volume) or tiered (whereas usage translates into different tiers which each receive the same amount of tokens). At the heart of these controversies is the notion of fairness: In a linear distribution, users with the most capital (“whales”) have an advantage. On the other hand, a high minimum tier not just benefits smaller users, but Sybil attackers who own multiple wallets. Out of the 7 case studies, 3 went for a linear distribution and 4 combined a linear distribution with tiers (either just a minimum tier or also a maximum cap).

This combination of linear distribution with a minimum tier seems like a robust compromise. Especially if it’s combined with anti-Sybil measures. Both Tensor and Parcl removed wallets identified as a Sybil cluster (by a third-party agency) from their allocation. Layer0 has launched an anti-Sybil campaign before their airdrop, where Sybils and users are incentivised to report Sybil activity. While the reception of Layer0’s campaign has been mixed, it seems clear that minimizing Sybil attacks is crucial for the viability of airdrops.

The table below shows parameters for the 7 case studies we looked at for this article. We chose projects across both Ethereum and Solana and focused on the application layer to be most relevant for most founders. Note that while they provide an illustration of recent best practices, this is not an exhaustive survey and the design space is vast.

Conclusion: Recommendations for new airdrops

In order to benefit fully from the positive impact of airdrops, projects must adapt their strategies to current realities and avoid adverse incentives. Recommendations include:

• Minimize speculators: Design incentives to attract long-term users.

• Launch after product-market-fit: Launch points programs only after achieving product-market fit.

• Prevent Sybil attacks: Implement measures to disqualify Sybil attacks for the airdrop.

• Resist high FDV temptation: Avoid launching at a high Fully Diluted Valuation (FDV) and low float.

• Include public sales: Consider public sales or platforms like Coinlist for retail investors to acquire tokens.

A comeback of token sales could improve the situation by providing retail investors a more direct way to gain exposure, fostering skin-in-the-game. This shift would be more feasible with clearer regulatory guidelines, which are currently a barrier.

Being less aggressive with incentives and launch valuations might seem like a disadvantage, but it can lead to better long-term outcomes. High Total Value Locked (TVL) and FDV may look impressive initially, but they don't benefit a project if they decline post-launch. Sustainable growth through a committed community of token holders is the true power of airdrops.

Final thoughts

Even if airdrops have come under critique recently and there are a number of adverse incentives at play, we are convinced that they will remain a key mechanism for protocols to distribute their tokens. However, strategies and parameters will continue to evolve. The most notable changes to airdrop mechanisms over the last year include:

• The emergence of points programs as a preliminary stage to airdrops (see this article) and generally more transparency and granular targeting

• Best practices around timelines, communication, and claiming experience

• Generally shorter claiming windows

• Innovations in mechanisms such as multiple airdrop campaigns and token vesting

In addition to mechanisms, airdrops will continue to be shaped by behavior and expectation of market participants. The cat-and-mouse dynamic between Sybil attackers and protocols will likely continue and anti-Sybil measures will become increasingly important. We advise projects to actively try to decrease adversarial dynamics with users by incentivizing intrinsic users over airdrop farmers. More conservative approaches on marketing and launch valuations could also support this.

Finally, we expect that airdrops will increasingly be complemented by other distribution mechanisms that allow users to buy tokens. Increasing regulatory clarity and innovations in mechanism design could both bring back token sales of various flavors.

Points programs are the new meta in crypto. Points were pioneered by the NFT marketplace Blur and used by major projects from Friend.tech to Eigenlayer. In a nutshell, points are loyalty scores designed to encourage usage, usually stored off-chain. Points are non-transferrable and are issued entirely at the discretion of the project. On a first glance, they seem similar to traditional loyalty schemes from airline miles to retailer loyalty points.

“What is the big deal about points, then?”, some might ask. Idealists might criticize how “centralized” they are and lament that this is a step back from tokens. This critique is valid if points are the final stage of an incentive program.

However, points are often just used as a stepping stone towards a token launch, like in the case of Blur or more recently, Jito, Solana’s leading liquid staking protocol. It is in this case that points become a powerful mechanism design primitive. Points can be thought of as non-binding promises for future tokens. It is important to note that points are generally issued by another entity than a subsequent token would be. The entity issuing the token has no obligation to follow the points accounting exactly.   Issuing points before launching a token has a range of benefits and has become increasingly popular. We outline the major benefits of points programs before surveying the most common mechanisms, and ending with recommendations.

The benefits of launching points before tokens

There are 3 key benefits of launching points programs before tokens:

1. Bootstrapping adoption

2. Flexibility & experimentation

3. Speed

Bootstrapping adoption

Fundamentally, points are issued for the same reasons that airdrops and token reward campaigns (e.g. liquidity mining or staking) have become dominant strategies in crypto: They help bootstrap adoption and a decentralized community. Mechanisms and learnings from various token reward campaigns can be applied directly to the design space of points programs.

Even though projects usually don’t explicitly promise to later award tokens to holders of points, there is an implicit expectation from the crypto community. Once a points program is launched, the community assigns a higher probability to an airdrop and also gets assurances on what actions will be rewarded. A sense of urgency tends to set in once points are live.

Ultimately, it is still the ownership effect and liquidity of tokens that create strong adoption incentives. If a later token launch wasn’t expected, points would indeed be equivalent to airline miles. They might still retain some of their function as an incentive, but would not nearly be as strong. In the case without a later token launch, points also do not help to distribute ownership and governance to a community.

We’ve seen successful points programs create large shifts in user behavior in the crypto space. For example, Blur’s cometic rise to overtake Open Sea as the leading NFT marketplace started with their points program. Blur still dominates NFT trading volumes with 75+% of market share. Margin.fi introduced points in July of 2023, which caused its TVL to grow 7x within 2 months - in the depths of the Solana bear market.

Especially for projects in very competitive spaces, the introduction of a points program might provide a critical advantage. For instance, the wallet space is not just competitive, but users are also notoriously sticky. While the jury is still out on the ultimate impact, the wallets Rainbow and Rabby both launched points programs that could enable them to convert a substantial number of users from the much more entrenched Metamask.

Flexibility & experimentation

A major advantage over token-based reward programs is that there is much more flexibility with points. Points may raise expectations for a token launch, but are not an explicit commitment to launch a token. The project retains all the flexibility on if and when a token will be launched but already gets the benefits of boosting adoption. Once tokens are distributed, it is extremely hard to create more of them or replace them with another token altogether.

Points, on the other hand, are entirely controlled by the project and could be changed at any time. This includes revoking past points (even though less common), changing the issuance rate, and modifying the actions which are rewarded. The ability to experiment is a key benefit of points: They function as a “test run” for later token incentive programs that can more easily be iterated on. The project can try out different incentives and see how users react (including trying to game the system). The data generated from user behavior is extremely valuable for later translating points into token rewards. Additionally, it is also easier to include off-chain actions into the calculations of points.

Speed

Finally, a substantial advantage of points are the speed at which they can be deployed. Launching a token is a complicated endeavor and requires the following processes:

1. Token design and engineering

2. Implementation and product integration

3. Supply considerations and modeling

4. Distribution strategy

5. Liquidity management

6. Legal structuring and compliance

Points only require a much simpler design process and product integration, without any on-chain elements. Most of the elements required for designing a points program are necessary for token reward programs and airdrops anyway, so there is no duplication of work. Points are legally unproblematic since they are non-transferable and don’t have any explicit value tied to them. Especially since incentives and design can be adjusted over time, there isn’t as much pressure for getting everything right from the get go. Whereas planning and executing a well-designed token launch takes 6 months to a year, a points program can be launched in a single month. This allows a project to kickstart adoption incentives while working on a more lengthy token launch process in parallel.

Mechanism design for points

In the last few months, many projects have launched points with a variety of different mechanisms. Although it is still early days, we can observe which mechanisms are most commonly used and seem to have the greatest impact. We cluster these mechanisms into three major categories:

1. Usage: Incentives for using the product or protocol, designed for the specific usage patterns the project wants to incentivise.

2. Timing: Incentives for using the product or protocol sooner rather than later. This class of incentives is especially impactful for getting to a critical mass of usage.

3. Virality: Incentives designed to onboard more users and stimulate organic growth.These mechanisms can facilitate a go-to-market driven by virality.

The table below summarizes the three most common mechanisms for each class of incentives.

We will now go through each category and describe the leading mechanisms in more detail.

Usage mechanisms

Incentivising usage should be at the center of every points program. We can distinguish between incentives for core usage patterns, secondary usage patterns, and loyalty. Core usage patterns are the way the largest user group most frequently interacts, secondary usage patterns are everything else.

Core usage patterns

Most points should be allocated to users engaging in the core usage patterns. These patterns are different from case to case, but often fall into two categories: TVL (total value locked) or volume.

Usage patterns based on TVL apply for a range of DeFi and L2 ecosystems. Examples include Swell, EtherFi, KelpDAO, Eigenlayer, Manta, and Gravita. The base mechanisms for TVL-based points take into account two factors - the amount of capital (often measured in major assets like ETH, BTC, or SOL) and the length of time at which it was deployed. For example, Eigenlayer gives out 1 point per ETH locked per hour (see formula below

Another frequent core usage pattern is volume. This applies to bridges like Orbiter or trading platforms like Drift and Zeta. Usually, volume is measured in USD equivalents, since there tends to be a much wider range of assets used in these applications as opposed to TVL-based mechanisms. Sometimes, different types of volume are distinguished, e.g. Taker (vs. Maker) volume for trading platforms or certain types of routes or assets for bridges.

Projects should consider how these mechanisms could be gamed to farm points without genuine usage, and adjust them to disqualify users trying to take advantage. For example, Blur changed their most recent reward program to prioritize NFT listings near the floor, and EtherFi disqualifies users who unstake and restake their deposits to get extra points in their recent reward week. Izumi Finance doesn’t count the ETH/WETH pair for their points program rewarding DEX volume since this has been the most used pair by airdrop framers. These examples also illustrate how points allow developers to detect the gaming of their incentives and adapt accordingly.

Secondary usage patterns

In addition to core usage patterns, there may also be secondary usage patterns that help the protocol succeed. For example, providing liquidity in trading applications of all kinds. Parcl (real-estate based perpetuals) and Tensor (NFT trading platform) both award points to liquidity providers. Several liquid (re)staking protocols have incentivized the use of their tokens in DeFi, e.g. the recent collaboration of Swell and Etherfi for a liquidity pool on Curve.

Loyalty scores

Loyalty scores are another mechanism to incentivize (exclusive) usage. The mechanism was pioneered by Blur, punishing their users for listing NFTs on other platforms by lowering their chances in their probabilistic airdrop. It is now also used by Tensor, which applies the loyalty score as a factor for points earned through core usage patterns. Loyalty scores usually work as a percentage of incentivised actions taken on the issuing protocol vs. their competitors. 100% loyalty means only the issuing protocol was used. Applying a loyalty score as a factor to points earned seems like a versatile mechanism that could potentially be used by many other protocols than NFT trading platforms.

Timing mechanisms

Early usage that helps getting to critical mass is much more valuable than incremental usage at scale. That’s why timing mechanisms that incentivize early participation are another popular ingredient for points programs. Usually, timing mechanisms are implemented as boosts or multipliers on usage mechanisms.

The following timing-based mechanisms have been used in prominent points programs:

• Boosted periods

• User-triggered boosts

• Seasons

Boosted periods are periods in which users earn more points for usage. These can either be specific time periods or based on milestones. Examples for time-based mechanisms include Zeta offering additional points for a week in December and EtherFi’s similar campaign in February. Milestone-based mechanisms are usually tied to the respective core usage pattern (e.g. TVL or volume). For example, Swell offered 3x the amount of points for deposits in their pre-launch vaults before 10k stETH had been reached.

Pre-launch vaults are ways of bootstrapping activity (especially TVL) prior to launch and often include more point incentives. Examples include Swell and Diva, both of which used Enzyme for pre-launch vaults.

User-triggered boosts are multipliers on points where the timing is not determined by the project, but the user. This mechanism is usually implemented through NFTs, which give their holders a boost on points earned. The multiplier is either constant for the holder of the NFT, such as Tensor’s Tensorians or Parcl’s homeowners association, or they need to be activated by burning them like Zeta’s Cards (in which the boost only lasts for a certain time).

Seasons are a way of structuring points programs over time. Each season typically lasts for a few months and offers different rewards. This is a great mechanism for projects to experiment with different incentives and also has the advantage of offering a marketing moment with each new season. Like many other points mechanisms, this was pioneered by Blur. Seasons are also a great way to showcase new integrations or product features. For example, Orbiter has offered increased points for bridging to and from many layer 2 networks that they have successively integrated.

Virality mechanisms

The final category are virality mechanisms. These mechanisms leverage points in order to grow the product organically by incentivizing users to onboard new users.

We can distinguish between the following three mechanisms:

1. Referrals & invites

2. Social engagement

3. Rewards for on-chain footprint

Referrals are the most common virality mechanism for points programs. Most of the examples previously mentioned have a referral program, including Swell, EtherFi, MarginFi, Parcl, Zeta, and Tensor. Referrals can either be structured to receive a fixed amount of points per user or a variable amount based on the usage of the referred user. The latter has the benefit of being less gamable and incentivising the referrals of active users. For example, MarginFi users earn 10% of the points of users they refer. Sometimes, there is also a nominal amount of points granted to the referred user for signing up with a referral code.

There has also been experimentation with mechanisms that give out referrals points to a team of users connected by chains of referrals. For example, Blast, Manta, and Puffer all used variations of team-based referrals.

Whereas referrals are optional, invite codes are mandatory in order to use a product or protocol. Friend.tech was only accessible through invites in the beginning, and invite codes were also used by Blast and Manta. While the mechanisms basically work the same way, invite codes create more exclusivity (but might obstruct growth with non crypto-native users).

Social engagement mechanisms incentivise (or require) users to interact with their social media accounts (typically on X or Discord). The most common setup is requiring a connection with an X account to participate in a points program (automatically following the project’s account). For example, Manta and Puffer both require linking X accounts for their respective programs. Besides boosting the follower count of the project in question, this also works as a defense against sybil attacks (the same user participating with multiple wallets). However, there is a downside since many crypto users don’t like to associate their wallets to their social profiles.

Sometimes, this mechanism is also executed via third parties, such as Zealy or Galxe. These platforms offer “quests'' on behalf of projects where users can earn points. Some of these quests typically include following the project’s X account, joining the Discord, or even posting about the project on X.

Finally, there are mechanisms that give points to users based on their on-chain footprint. This initial allocation of points incentivises users active on the relevant blockchain network to check out the project to claim their points. Depending on the use case, this includes token holdings and/or usage of specific protocols. These mechanisms increase virality since they lead to awareness and mouth-to-mouth propaganda with users within the broader web3 ecosystem or the targeted applications.

An attractive target is the usage of competitive protocols. Both Rainbow and Rabby award points to Metamask users who have used the in-wallet swap feature. This subset of mechanisms could be called “vampire points” due to the similarity with vampire attacks in an airdrop (like in the original SushiSwap vampire attack).

Recommendations for designing points programs

After having surveyed the most common mechanisms for points programs, we can now highlight emerging best practices and failure modes. Even though it is still very early, we can see the first signs of what seems to work. Note that these are primarily based on our subjective assessment since there isn’t enough data yet to measure the impact of specific mechanisms quantitatively.

Emerging best practices

The following seem to be emerging as best practices:

1. The heart of the reward mechanisms should reflect the core product or protocol logic, e.g. TVL or volume, in a way that cannot easily be gamed.

2. Incentivising early adoption is key and offering a multiplier on points earned either for a certain time period or based on certain milestones seems like a winning mechanism.

3. Seasons are a great way to structure points programs, making explicit space for experimentation and providing several marketing impulses.

4. Referrals are a key tool to enable viral growth. Offering 10% of points of the referred person is a robust mechanism to set the right incentives.

5. Showing total points issued over time is emerging as a best practice.

6. Clarity in communication is extremely important.

When it comes to clarity in communication, it is important to add a disclaimer that points come with no obligation and that the project reserves the right to change them unilaterally. Showing a total of points issued also provides clarity to users on where they stand while not requiring the project to pre-commit on the proportions upfront. Similarly, including a dashboard with points earned by a specific user adds transparency. Adding a leaderboard can motivate users to earn more points.

Depending on the project, other mechanisms can also make sense, of course. However, the best practices above are the ones that we think have the highest impact on actual usage.

Don’t confuse your users: failure modes of points

There are also some failure modes of points programs. The most important one is confusing or overwhelming users. If too many and too complex mechanisms are used, there is a risk that users will not participate because they don’t understand what is going on. Manta’s campaign could potentially have crossed that barrier with just doing too much: Users earned points for bridging ETH, which could be used to open boxes that held random NFTs. These NFTs, in turn, could be combined into new NFTs. Next to the bridging rewards campaign, there was a range of other rewards including for events, treasure hunts, more NFTs, and much more. Instead of applying all possible mechanisms, it seems better to focus on the few mechanisms that will move the needle the most.

The consideration of focusing on impact and simplicity applies not just to points programs as a whole, but mechanisms within them. For example, Blast’s elaborate invite/referral mechanism that features multiple levels of referrals (with different bonuses based on the number of referred users) and referral-teams was criticized for being a pyramid scheme.

Finally, potentially unclear UX patterns like requiring users to explicitly opt-in to points systems (as opposed to automatically accruing points by using the protocol) should be avoided. Both Parcl and Rainbow wallet require users opting into points programs. Users who uses these protocols without opting in will likely be frustrated when they don’t qualify for an eventual airdrop because of that. Ultimately, increasing adoption and creating loyalty with users is the point of points. This should be taken into consideration design and UX decisions throughout a points program.

Final thoughts

We believe points are another crucial step in the evolution of incentives for bootstrapping protocol usage. If an airdrop follows suit, points help distribute protocol ownership and governance early on. Points unbundle retroactive and future usage incentives from potential airdrops and provide more flexibility and faster execution speed. When designing points programs, creating incentives around core usage patterns, encouraging organic growth, and clarity in communication are crucial.

In the Web3 attention economy, points allow to gamify adoption in creative ways and on multiple dimensions. Whether points will become an industry standard or just an intermediate stepping stone towards even more sophisticated mechanisms remains to be seen. The space keeps moving fast, e.g. whales market creating permissionless liquidity for points could impact the landscape significantly. Given the advantages of points programs described above, it seems likely that they will have staying power at least as one of many possible tools in the mechanism design toolkit of Web3.

Web3 Social has the potential to radically expand crypto/Web3’s user base and application space, while fixing some of the major problems with current social media.

With the recent transition from Twitter to X, change seems to be in the air. X is opting for sharing ad revenues with creators and has released its open-source protocol, AT Protocol (the first app being BlueSky). Creator and community tokens have recently returned with Friend.tech. This seems like a great moment to have another look into the Web3 Social ecosystem. We are sharing a market map and reflections on the emerging tech stack in the article below.

The need for Web3 Social

At this point, few people would disagree with the premise that social media is broken. The topic has been discussed sufficiently to just reiterate some of the major problems briefly:

• Innovation is limited due to platform lock-in effects and market power of incumbents

• Controversies around censorship and de-platforming undermined trust

• Creators only get a small part of the value they generate and have limited options

• Curation algorithms are intransparent and optimized for short-term attention capture

• Users don’t own their data, which is often sold to advertisers without explicit consent

Web3 has the potential to solve these problems one by one, promising user-owned content and direct monetization. It could also provide a credibly neutral playing field for composable tech stacks with data portability and user choice (e.g. on what client or algorithm to use).

An updated market map for Web3 Social

The market map below shows an overview of the entire emerging Web3 Social tech stack, including applications and the tech stack they are built on. There are four layers of the stack that build on top of each other and provide different functions.

We segmented the stack into the following sections:

Applications

Applications, or social dApps are the most visible segment: it’s where users interact, create, and consume content. A major difference to traditional social media is that users can choose between different applications while interacting with a shared Web3 Social protocol. Different applications focus on different content types (e.g. video, text, images) or different interaction patterns (from 1-1 to n-n). There are decentralized versions of Discord and X (n to n), Substack (1 to n), and Whatsapp (1 to 1) already working. Traditional social Media from Instagram to X focuses on both n to n and 1 to n interactions. This is also the segment with the most activity in Web3 Social. We divided example applications between the most common Web3 Social Protocols, Farcaster and Lens. We included Engagement apps, used by Web3 projects to incentivize their communities to take certain actions, since they often involve activity on social media.

Social protocols

Applications are built on top of Web3 Social protocols. These protocols usually include social graphs, identifiers, actions, and algorithms. Web3 Social protocols set the parameters of what is possible with applications and aggregate the required technical capabilities. Currently, the different Social protocols have their own ecosystems developing around them. Farcaster and Lens have generated the most activity so far (see the images in the next chapter).

While Farcaster and Lens share similar functions and overall vision, we notice differentiation occurring over time as decisions are made. Lens has focused on creator monetization from the start with features like posts that are collectable as NFTs for a fee, and even referral fees. Farcaster, on the other hand, has focused more strongly on functionality and catering to builders. Interestingly, Farcaster requires users to pay for connecting to other clients, while Lens is subsidizing gas fees for on-chain interactions. The different strategies are reflected in the protocol architectures, for example the design of IDs/profiles, the portability of the social graph, and what processes happen on vs. off-chain.

There are many other social protocols with similar visions, including AT Protocol, Nostr, DeSo, Cyberconnect, and Orbis.

Identity and reputation

Within the larger Web3 ecosystem, a range of protocols for identity and reputation have emerged. We segment these protocols into the following categories:

• Identifiers

• Credentials

• Participation

• Access

Currently, most Web3 Social protocols provide their own native identity and reputation layers. Eventually, we predict this layer of the tech stack to be unbundled even further, which would allow them to become portable and composable between different Web3 Social protocols.

Low-level Infrastructure

Finally, there is low-level infrastructure at the base of the tech stack. Data storage protocols are used to store content and media in a decentralized manner. Messaging protocols make Web3 social protocols more interoperable. Wallet infrastructure abstracts away the complexity of private key management to make Web3 social applications more accessible.  Finally, blockchains and Layer 2 environments provide consensus on ownership of assets (e.g. NFTs and verifiable credentials through private key ownership).

The market map presented here represents how the ecosystem looks from a high level and is not exhaustive.

Reflections on the state of Web3 Social

After establishing that bird’s eye view of the emerging Web3 Social tech stack, we are offering some reflections on the progress achieved so far and the remaining challenges going forward.

The Web3 Social Tech stack is coming together with multiple thriving ecosystems

First, it is exciting to see that Web3 Social has produced a range of functional applications, even if the usage is still small. Lens and Farcaster are successful examples of how a Web3 Social protocol can galvanize an ecosystem with a diverse set of applications. They also illustrate how a composable tech stack can come together to create working consumer products.

For example, Lens uses Polygon to guarantee ownership of accounts (scaled via a custom optimistic rollup) and their associated data, stores data on Arweave, and facilitates messages with XMTP. A range of different applications has been built on Lens (e.g. Hey, Orb, Butterfly, Tape). The Farcaster ecosystem is in a similar state of development and also offers diverse applications to access it. We provide snapshots of the Farcaster and Lens ecosystems below to illustrate the diversity of applications within each ecosystem.

The different protocols across the stack need further integration

While we are excited about these thriving ecosystems, we observed that the full available tech stack is not yet used.

• The existing identity and reputation stack is poorly integrated into Web3 Social protocols. Identifiers, identity, and credentials could be used to enhance user experience, manage access, etc.

• There is still a disconnect between on-chain assets and Web3 Social protocols. For example, NFTs are mostly used as profile pictures or for gated chats in Discord.

• Web3 Social experiences are not yet integrated throughout Web3 at large.

Web3 Social protocols are quite “fat”, containing different parts that could potentially be unbundled. Both Lens and Farcaster initially used their own identifiers instead of relying on existing solutions. Farcaster has since integrated with ENS. Some functions of social protocols like curation algorithms or social graphs could eventually become independent protocols. The recent progress in open source AI models could empower this new segment of open composable algorithms for content curation - an interesting opportunity for entrepreneurs. In general, unbundling will allow for the higher degrees of user ownership and choice that we are hoping for: Users will be able to bring their identity, reputation and social graph wherever they tread online and choose how they want to interact.

A greater degree of integration of existing on-chain assets will enable Web3 Social protocols to tap into existing communities and enable novel experiences. We are seeing the first signs of this, for example, Warpcast has a dedicated Nouns channel that highlights NFT mints. In the future, holders of governance tokens or NFTs might have access to certain channels and be able to vote within social experiences. Mod Protocol is working on this vision of expanding functionality on top of social protocols with mini apps.

Finally, for Web3 Social to reach its full potential, it will also need to be integrated throughout the rest of Web3. We imagine social aspects permeating all kinds of Web3 applications. For example, gated group chats based on NFT ownership or connection requests based on financial interactions are a few examples. And as Web3 starts to merge with the internet at large, we could also imagine social experiences on the equivalents of Google, Notion, Wikipedia, etc.

Fragmentation and duplication below the application layer

Below the application layer, there are competing protocols at each subsequent layer of the tech stack. While we want a diversity of products on the application layer to give users more choice, the protocol level below should be interoperable for maximum impact. In order to avoid similar fragmentation and duplication like we see in legacy social media, these different protocols will either need to become interoperable or the Web3 Social ecosystem will need to converge on a single protocol for each segment. For now, it seems healthy to have similar attempts with different design decisions across the tech stack run in parallel, e.g. Farcaster and Lens on the level of Social Protocols.

Interoperability between protocols seems like the more realistic pathway to avoid fragmentation. Eventually, we expect shared standards to make interoperability easier for applications. There are first examples of applications that have started to aggregate the different Web3 Social protocols: Yup integrates with Lens, Farcaster, and AT Protocol. It even included posts from X before it became inaccessible because of API costs. Backwards-compatibility with and bootstrapping from existing social platforms (“spooning”) is a great strategy for overcoming entrenched network effects, but can easily be stopped by those platforms (just like we saw in the case of X increasing API costs).

Crossing the chasm

What are the remaining challenges for Web3 Social? What needs to happen for these applications to reach critical mass and seriously challenge legacy social media platforms? We see the following major hurdles for adoption:

• Fixing remaining usability issues

• Producing 10x better social experiences

• Overcoming network effects

First of all, there are still some usability hurdles that need to be overcome: Content moderation, authentication, and spam filtering are some areas in which more advanced solutions are needed. However, these challenges seem relatively tractable at this point.

For instance, authentication and abstraction Web3 elements that lead to complicated UX, seem mostly solved at this point. Friend.tech could expand successfully beyond Web3-natives by using Privy to abstract away private key management.

The task for Web3 Social is not only to get on par with existing social media in terms of user experience, but to produce a 10x better experience. There likely won’t be a single bullet to achieve this, but a growing number of small improvements that will eventually cross the critical threshold.

• Interoperability and composability will enable combinatorial innovation to create a range of experiences not possible on legacy platforms. For example, Interface allows users to see the on-chain activity of the people they follow on Farcaster. Lens is experimenting with monetization through making posts collectable NFTs.

• User ownership and choice across all levels of the tech stack will allow for much more customization while still interacting on shared infrastructure. Users can already choose between applications that look more like X, Youtube, Reddit etc. while accessing the same shared social graph on both Lens and Farcaster. In Web3 Social, when you sign up to a new social app, you’ll find all of your friends already there.

• Eventually, users will also be able to choose between different curation algorithms (and even create their own).

The most important challenge for Web3 Social is probably to reach a critical mass of adoption. Social is a child of Metcalfe’s law: Like any communications network, a social platform is valuable proportional to the square of its number of users. This means that the network effects of incumbents are incredibly strong. This is evidenced by the repeatedly failed attempts of many communities to leave X.com for alternative platforms: The network effects of X are so strong that most users eventually come back, as much as they dislike certain product decisions or policies.

Coordinating user migration into a new application fast enough to reach critical mass is one key strategy. Even though this is a tremendous challenge, it is not insurmountable: Onboarding single communities at a time, as well as using tokens as incentives (and rewarding early adopters) are promising strategies, for example.

Backwards-compatibility with existing platforms with hybrid solutions and bootstrapping reputation from legacy social media are also promising approaches. Friend.tech’s use of X accounts for authentication (acting as a pathway for viral growth additionally) or Yup’s integration with X and Threads are good examples. Eventually, the composability and interoperability of Web3 protocols should resolve this need for bootstrapping towards a critical mass, as users can be shared across applications. For example, Lens DMs show up as Converse chats as soon as a new user signs up, since both are using the messaging protocol XMTP.

Eventually, users will be able to bring their entire digital footprint, connections, and preferences with them wherever they go. Without the lock-in effect of legacy social media, it is an open question how the competitive dynamics will play out, where value will accrue, and what a sustainable advantage looks like. In analogy with the rest of Web3, it seems plausible that community ownership and trust will play key roles. Especially for applications, making their users co-owners and building long-term habits could be crucial in the long run. For protocols deeper in the stack, it might be more important to become an interoperable standard for most applications.

Either way, we could be the start of an entirely new paradigm for social media and online communication that puts users back in charge, which we are truly excited about. However, we’re still very early - watch this space.

Liquid staking protocols have emerged as a transformative force in DeFi and Web3 at large, unlocking liquidity for Proof-of-Stake (PoS) tokens used to secure blockchains, such as Ethereum. By depositing PoS tokens into a staking contract through a protocol, users receive Liquid Staking Tokens (LSTs), which represent a claim on the staked and otherwise usually locked tokens. These original tokens can be withdrawn by burning an equivalent amount of LSTs, and the primary advantage of LSTs lies in their liquidity and their ability to be reused or collateralized in other applications. Essentially, LSTs allow for the separation of work (node operators) and capital (liquid stakers) in the Ethereum space and thus allow for more optimal allocation of resources.

In this blog post, we will delve into the utility of native tokens associated with liquid staking protocols and compare existing approaches. We’ll also discuss the relationship of utility and demand, which is important since a more distributed holder base increases the security of the protocol (protection against governance attacks). We will wrap up with some general conclusions on what that means for the DIVA token specifically.

Unlocked Liquidity Based on Secondary Markets

The unlocked liquidity allows LSTs to be used in DeFi applications, for instance as collateral, or to be traded on automated market makers - all while simultaneously accruing staking yield. Furthermore, LSTs provide easier access to staking yields by eliminating the need for minimum deposit amounts and lockup schedules, offering users greater flexibility to participate in staking. As such, LSTs greatly improve the utility of originally locked staking tokens. They do however rely on the presence of a liquid secondary market, usually between the LST and the staked proof-of-stake token. So there is an additional depegging risk for LST holders.

Recent Catalysts: The Shanghai Upgrade & SEC Lawsuits Against Centralized Staking Services

Two major catalysts have amplified discussions around LSTs earlier this year: the Shanghai hard fork of Ethereum and the SEC action against Kraken's staking program, followed by a lawsuit against Coinbase too a few weeks later. The Shanghai hard fork has enabled the highly anticipated withdrawal of staked ETH, derisked staking in general and boosted overall staking penetration rates as stakers do not solely rely on secondary markets but can also withdraw through the protocol native route, thereby opening up ways to arbitrage prices in the event of the LST losing its peg. Additionally, the SEC's fines imposed on Kraken and Coinbase highlight the increasing relevance of trustless staking protocols, as centralized staking programs have been scrutinized regarding regulatory implications.

Comparing Tokens of Liquid Staking Protocols

Governance Token Utility

Comparing the utility of some of the major liquid staking protocols is a great starting point for understanding the landscape. First of all, it is important to note that the native tokens of liquid staking protocols are quite different in their utility. The utility of a token directly influences how different stakeholders interact with it and its supply dynamics as a result.

Project by Project Comparison

The table below compares the major token utilities found in the native tokens of four major liquid staking protocols: Lido, Rocketpool, Stakewise and Stader. We look at governance, necessary access to operate nodes (staking as well as oracle nodes), and rewards. In some cases, there is also a staking mechanism for the native protocol token (as opposed to staking the proof-of-stake assets). We also include information on whether the token supply is fixed or includes inflation.

Lido, the largest and most established protocol, also has the most “vanilla” token utility. The only use of the token is for governance of the protocol. Lido is also giving out LDO as rewards for liquidity providers.

Rocketpool stands out both in terms of its utility as well as its inflationary supply: The protocol uses is native token to decide who can be a node operator. Both staking and oracle nodes need to stake RPL to provide their services. This increases the performance of the overall network through the additional slashing conditions for the native token (in addition to slashing conditions that staking nodes have on the proof-of-stake network they operate on). The native token staking mechanism is also used as a protocol insurance, protecting users against potential failure modes. In order to compensate for the risk they take on, stakers get an APR paid out which is financed from the RPL inflation. The fact that 47% of all RPL is staked shows that the utility of RPL has proven effective so far.

Stader, a more recent protocol, uses staking of their native token for the general community to access governance, which has a similar effect. The yields to stakers are paid from a part of the protocol fee that Stader levies to users who stake their PoS tokens with the protocol. While staking the native token is not required to operate nodes, it is optional and grants preferential delegations.

Stakewise, a smaller contender in the space is similar to Lido in its utility: the main focus is governance and the token is also used as rewards for liquidity mining. In addition, SWISE was distributed to early adopters in a temporary incentive program.

The Big Picture

All of the analyzed liquid staking protocols grant some form of governance for their token holders. Generally, governance tokens are a form of crypto-native capital, as argued by Placeholder VC. Governance makes tokens relevant because it grants influence over a decentralized protocol and the more decentralized and effective the governance is, the stronger that relationship.

All of the protocols we analyze use their own native tokens as a means of governance. Lido is additionally debating a “two-party” type of governance mechanism with additional governance power for the actual LST - mainly a measure to alleviate centralization concerns. While the details of the governance mechanisms differ, it is clear that governance is the primary utility of these protocols, allowing the community to define and adapt mechanisms and parameters, as well as govern over the treasuries.

In the quite unique case of Rocketpool, node operators are required to use their native token as a gating mechanism for nodes to participate. Other staking mechanisms are also thinkable, e.g. native token staking could be used to gate access to governance.

Most protocols also use their token for some reward function, with liquidity mining rewards being most common. Note that rewards for liquidity are often primarily targeted at the liquid staking tokens rather than governance tokens (e.g. stETH rather than LDO in the case of Lido), since liquidity is more important there as a price as close as possible to peg is essential for usage in DeFi applications.

Our Views On the Staking Ecosystem

We can draw some general conclusions from the comparative analysis above, before diving into implications for the design of a new native token of a liquid staking protocol.

First, like in many other DeFi applications, governance is at the core for all of the analyzed tokens. Some critics argue that LSTs essentially cause PoS protocols networks to degrade to generally considered inferior dPoS networks (where the d stands for delegated). However, we believe that 1) a diverse set of liquid staking protocols, with 2) limited market share captured by the leading LST protocol, combined with 3) governance tokens that allow for a liquid democracy type of checks and balances. Ultimately, market capture would be balanced or even set-off by market prices, allowing for PoS systems to preserve their superior robustness as opposed to dPoS ones.

Another observation is that the additional utility on top of governance functionality really matters: Utility of the token drives its relevance and demand for it. Certain kinds of utility mechanisms (so-called “token sinks”), for instance staking mechanisms, are popular and also impact the supply side: The circulating supply is reduced at least temporarily as tokens are locked in a staking mechanism. For instance, the use of the native token as required collateral for node operators in the case of Rocketpool at once increases the security and performance of the protocol, while adding a sustainable source of demand to the token and reducing circulating supply. A staking mechanism connected to governance like Stader has a similar effect. They do however reduce capital efficiency for node operators, as they establish new, additional staking requirements.

However, some mechanisms might also have a negative impact on the supply dynamics: Especially using the native token as rewards for providing liquidity could cause sustained sell pressure on the token. A report on Lido’s liquidity incentives program found that the vast majority of LPs sold all Lido tokens they received almost immediately. Other mechanisms for providing liquidity rather than using the native token as an incentive seem more promising for a sustainable solution. On the other hand, Lido’s adoption in DeFi applications relied heavily on the presence of a liquid and tightly pegged secondary market between ETH and stETH. If it wasn’t for these incentives, Lido might have never gained such a market penetration.

Finally, an indirect observation through the case of Lido compared to the smaller competing liquid staking protocols: decentralization of a protocol also seems to matter in this context. The more decentralized a protocol, the more influence governance tokens actually confer, the more useful those tokens become. Also, decentralized protocols carry less counterparty risk and thus fewer regulatory requirements apply. For those reasons, the tokens of more decentralized protocols may see more demand. We call this a “decentralization premium”. Additionally, due to its leading market position, Lido may have been pressured to share governance power with LST holders, essentially diminishing the governance power of Lido token holders.

Implications for the DIVA Token

A Primer on Diva

Diva Labs is a new entrant to the liquid staking market. The project came up with a significant innovation: providing a Liquid Staking Derivative (divETH) powered by Distributed Validation Technology (DVT). This approach aims to address Ethereum's staking centralization problem. Diva's DVT offers a series of innovations for truly decentralized staking as opposed to centralized delegated pools. Diva introduces a distributed peer-to-peer network of nodes running validators collaboratively, making staking more accessible and resilient. Diva Operators require only 1 ETH to set up and run a validator node, and Diva's decentralized architecture makes it collusion-resistant. Diva aspires to become the leading staking solution in Ethereum, removing barriers to entry for both stakers and operators and promoting decentralization. very early Ventures was among Diva’s early backers alongside Metaweb, Gnosis, A&T Capital, and other prominent supporters. Read more about Diva in their announcement blog post. Diva has recently launched a non-transferrable token to enable decentralized governance over the protocol. As such, the exact use and utility of the token will be decided by the decentralized community.

Recommendations for the Utility of the DIVA Token

The comparative analysis of currently leading liquid staking protocols provides us insights into what token designs are most common and what mechanisms should be considered by the Diva protocol. The following are recommendations based on the analysis:

1. Include a mechanism that has node operators stake DIVA tokens

2. Consider additional rewards for node operators who stake DIVA

3. Ensure node operators staking DIVA can participate in governance

4. Minimize the use of DIVA for liquidity mining rewards

Utility, demand, and security are in a positive feedback relationship. If the utility of the DIVA token is higher, more users will want to hold the token. As a result, the protocol is more resilient against governance attacks. We would therefore recommend to use the DIVA token not just as a means of governance but also as a staking mechanism for node operators. This could add additional security and resilience to the protocol, which in turn might increase its decentralization premium. In addition, the incentives of every node operator to choose Diva as opposed to another liquid staking protocol could be influenced positively by offering boosted yields via native token staking. In addition, there may be other places where staking mechanisms could be eventually implemented for DIVA, for example for governance participants.

As shown by the report on Lido’s program, the negative effects of distributing tokens to mercenary, short-term actors are not negligible and the liquidity gained by such programs often turns out to be temporary only. While this is not an issue for a non-transferrable token, we want to caution against liquidity mining or similar reward programs in the future (in case governance should ever enable transferability). Instead, we would recommend exploring alternative routes, from providing liquidity from the DAO treasury to using another asset (e.g. CRV) for incentives.

The recommendations here are meant as an input to the Diva community, which has started discussing potential token utility. Ultimately, it will be up to the decentralized governance to decide what mechanisms should be introduced at what point. We hope that the analysis of LST native token utility will prove useful not just for this discussion, but for a larger audience interested in liquid staking or token design.

Hello world. Meet very early Ventures. In this post, we want to introduce you to our fund, its guiding principles, and our vision for the future of blockchain technology and the Web3 space.

We are crypto-native builders rooted in Europe

All of our partners have been in crypto since 2015-2016. Our team brings the technical expertise required to understand the complexity and keep up with the speed of Web3. Two of our 3 partners have technical PhDs in relevant fields, and all of us understand the Web3 tech stack deeply. We’ve built protocols, clients, and tokens, and bring experience from projects like MakerDAO, Celo, and Outlier Ventures.

very early Ventures is backed by professional institutions and crypto-native founders. We believe that we serve an important function in bridging these two worlds.

While crypto is global, early-stage teams are often locally anchored. Our team is building communities across major European crypto hubs such as Lisbon, Berlin, Zurich and Paris. Europe is becoming a Schelling point for early-stage founders due to its excellent quality of life and crypto-friendly jurisdictions. We only expect this trend to continue.

We support founders with technical expertise

Like many VCs, we are “helpful” to founders by making connections, whether to other  investors, customers, or partners. However, we go much further than that. The technical experience we outlined above allows us to roll up our sleeves and be involved in critical workflows directly wherever possible.

We can advise on product decisions, architecture trade-offs and the latest tooling from best practices experienced with leading projects. Whether for analyzing on-chain activity, modeling risk in a staking/slashing scenario, or creating scenarios for token supply dynamics - analytics as a value-add is very well-received by founders. Finally, we can support the process of a token launch from token design to distribution. Choosing suitable mechanisms to set the right incentives for stakeholders is key for unlocking the power of tokens. Similarly, setting up an effective and realistic plan for decentralized governance can accelerate a project significantly.

Thesis: Infrastructure and real-world impact

Our thesis for the first fund is centered around two main topics. Building the next layer of decentralized infrastructure, and helping Web3 cross the chasm to real-world impact.

The next wave of infrastructure

The value proposition of blockchains themselves has been sufficiently proven over crypto’s last cycles. However, blockchains are not enough. Additional infrastructure is needed for them to scale, interoperate, and become usable for a broader range of applications and to larger audiences. One of the key advantages of infrastructure investments is that they are not opinionated on specific use cases. By focusing on the foundational layer, we enable value capture through tokens without being constrained by a particular application or industry. Key areas we are interested in include

1. Cryptographic primitives: A wave of innovations in cryptography unlocks new ways of building this infrastructure: These include zero-knowledge proofs, scaling solutions, and abstraction layers.

2. Off-chain middleware: We are also generally very interested in trustless, off-chain protocols that complement blockchains around data, computation, identity, and credentials. All of these are needed for a robust and efficient foundation upon which broader Web3 applications can thrive.

3. Composability: It is essential to understand the critical role that composability plays in the blockchain ecosystem. Fragmentation across various blockchains and layer 2 solutions poses significant challenges to interoperability and UX. We aim to support projects that foster a unified and composable environment for Web3 applications.

In reality, the relationship between applications and infrastructure is cyclical and interactive. As applications innovate and explore new use cases, they push the boundaries of existing infrastructure and create a demand for more advanced solutions. Simultaneously, advancements in infrastructure empower applications to expand their capabilities and reach new heights.

Real-world impact

The second part of our investment thesis revolves around generating real-world impact, with the ultimate goal of crossing the chasm from early adopters to the majority of users. We believe it is crucial to move beyond the self-contained crypto bubble and start making a tangible difference in the lives of everyday people. By supporting projects in areas where we are ripe for that move, we aim to foster widespread adoption and create a more inclusive, empowering digital future for all. Below, we list some areas we are interested in:

1. DeFi for the Masses: Decentralized finance (DeFi) holds the promise of democratizing access to financial services, making them more accessible, efficient, and transparent. The proliferation of stablecoins shows that the time is right for DeFi to fulfill its promise by serving much larger populations. We want to support projects that simplify DeFi for everyday users, removing barriers to entry and providing intuitive, user-friendly interfaces that cater to a broader audience.

2. NFTs and Culture Diffusion: Non-fungible tokens (NFTs) have the potential to revolutionize the way we create, share, and monetize digital art and collectibles. We are already seeing large brands from Reddit to Nike leverage NFTs. We think it will be especially relevant for the long tail of creators, allowing them to create a direct relationship with their fans. We expect NFTs to enable the diffusion of digital culture across various industries, such as art, music, gaming, and more.

3. Real-World Assets and Tokenization: Tokenizing real-world assets, from carbon credits to traditional finance instruments, can help unlock tremendous value and create new opportunities for investment and wealth generation. We are particularly interested in supporting projects that bridge the gap between the physical and digital realms, making it easier for individuals and institutions to tokenize, trade, and manage real-world assets on blockchain platforms.

By focusing on these areas, our real-world impact investment thesis aims to drive the adoption of blockchain technology among the broader public, ultimately creating a more inclusive and equitable digital landscape.

We are still very early

To put things into perspective, in terms of adoption, we are still in the early nineties when compared with the internet. The largest growth is yet to come, and the opportunities we are about to witness are nothing short of extraordinary.

At the core of Web3’s lies the possibility of separating money from state. Creating a new global monetary system that transcends borders, redefines property rights, and empowers individuals like never before. This transformation represents the biggest opportunity of our lifetimes, and we are thrilled to be part of this paradigm shift.

But the potential of blockchain and Web3 goes beyond financial applications. We're looking at re-architecting the internet itself, breaking the current centralized monopolies, and putting users back in control of their data, privacy, and digital lives. We hope to enter a new era of a more decentralized, transparent, and accountable digital world.

Our goal is to contribute to the development of a more equitable, global financial system and a new layer of the internet that prioritizes user autonomy and inclusivity. The future is bright, and we can't wait to see what it holds.