DeFi 2.0 Wave of New Projects Test Liquidity Mining Alternatives

Things aren’t getting easier for those struggling to stay current with the lightning quick DeFi space. Just when you think you’re up to speed with the latest token or protocol along comes something new. Brace yourselves because here comes DeFi 2.0. What that term actually means is still in flux.

While DeFi 2.0’s meaning is still congealing, a core component of DeFi’s next evolution includes alternatives to a mainstay of DeFi 1.0: liquidity mining. Projects like OlympusDAO, Fei Protocol, and Alchemix, are all experimenting with new ways of capturing users with the new challenge of getting them to stay.

The new crop of DeFi projects centers around the idea called protocol controlled liquidity (PCV). This entails projects acquiring funds to support their financial applications, rather than tapping users’ funds by enticing them with liquidity mining rewards.

“DeFi 2.0 is mostly about DAOs changing the relationship between capital providers and the protocol itself.

Tyler Reynolds

“Profit taking is expected, but when a giant player comes in and exclusively dumps the governance token, it creates a dynamic where all price appreciation is nullified,” Scoopy Trooples, the founder of Alchemix, the auto-paying loan app and critic of excessive liquidity mining, told The Defiant. “This depresses the community and convinces them to do the same or else they won’t ever be able to realize their gains.”

In a nutshell, liquidity mining involves protocols giving their native token to users in exchange for depositing assets that other users can borrow or trade. 

The problem is that protocols are watering down their token’s supply in exchange for capital deposits, which are often temporary. So people come in, lend their assets to the protocol while milking its rewards, then leave with both the assets and rewards, leaving the protocol high and dry. 

There are countless examples of this phenomenon — a project called Big Data Protocol attracted over $6B in total value locked during a six-day stretch of liquidity mining rewards only to fall to a current level of only $3.1M, according to DeBank.

Sometimes liquidity mining programs aren’t so short lived. Compound Finance, a lender and pioneer of the liquidity mining model, was net negative when subtracting liquidity mining from protocol revenue as of July 15, according to a graph posted by Andrew Kang of Mechanism Capital. Compound has a long term and ongoing liquidity mining program going with its COMP token.

Regardless of duration, liquidity mining is a questionable choice that dilutes a project’s supply and attracts mercenary capital as Big Data Protocol’s program exemplifies.

So what’s this got to do with DeFi 2.0? Well there’s a swath of projects eschewing liquidity mining and experimenting with alternatives. OlympusDAO, a project aiming to offer what the project calls on its website a “decentralized reserve currency,” in its OHM token.

OlympusDAO sells its token at a discount in exchange for tokens like DAI, but also liquidity provider (LP) tokens which include OHM. So for example, a user could trade their OHM-DAI LP token, which represents a liquidity position in the decentralized exchange Sushiswap, for OHM. Olympus calls this mechanism a bond, because the discount is paid out over five days.

The new crop of DeFi projects centers around the idea called protocol controlled liquidity (PCV). This entails projects acquiring funds to support their financial applications, rather than tapping users’ funds by enticing them with liquidity mining rewards.

This system has allowed Olympus to own its own liquidity, a major difference from projects which watch liquidity fade away as rewards run out. OlympusDAO’s stats page says the protocol owns over 99% of the OHM-DAI liquidity. And that liquidity isn’t going anywhere because Olympus itself owns it (and is earning LP fees with the LP tokens). 

Olympus has another innovative mechanism — a staking function which pays users in additional OHM tokens in exchange for locking the token up. This counteracts the sell pressure which comes from users’ ability to get OHM at a discount with bonds. Staking is working — over 90% of OHM is staked today according to the project’s primary dashboard.

So, without liquidity mining and exemplifying the DeFi 2.0 movement, OHM has reached the 55th slot in market cap terms among all digital assets at over $2.9B. 

Olympus recently launched Olympus Pro, which aims to become “the new industry standard platform to help protocols acquire their own liquidity,” as the project’s docs say. Olympus Pro does this by offering a bonding service, similar to the one it uses to acquire its own liquidity tokens. 

Other projects, you could consider to be part of  DeFi 2.0, are hopping on board — Alchemix, Abracadabra, the stablecoin issuer gunning for MakerDAO, and others have elected to use Olympus Pro in efforts to control their own liquidity as a part of DeFi’s new wave.

Rented Liquidity

Achemix’s ALCX token is up over 30% in the past week and Abracadabra’s SPELL is up over 150% in the same span.

“Protocol controlled value brings sustainability so you can maintain the growth you had without hollowing out the community,” Trooples said. The founder thinks of protocol controlled value as another knob projects can use, in addition to liquidity mining.

There are other projects implementing the protocol controlled value model — the Fei protocol, which issues the FEI stablecoin, was one of the early pioneers, and just launched a v2. Fei’s native TRIBE token is up over 40% in the last week according to CoinGecko.

“DeFi 2.0 is mostly about DAOs changing the relationship between capital providers and the protocol itself. The move in DeFi 2.0 is for protocols to own their own liquidity,” Tyler Reynolds, an angel investor and crypto advisor, told The Defiant. “This contrasts to ‘DeFi 1.0’ where protocols earned TVL by providing the best user experience or rented liquidity via liquidity incentives.”

Other projects like Pod Finance, an options protocol which launched on Oct. 11, is offering NFTs to liquidity providers, as an alternative to liquidity mining with fungible ERC-20 rewards. 

While seeking liquidity mining alternatives is one of DeFi 2.0 characteristics, it’s not the only one. Another part of the emerging movement includes forks, or iterations of the OG DeFi protocols. 

Rari Capital, which offers isolated lending pools and recently unveiled a permissionless function allowing anyone to create said pools, crossed the $1B mark in TVL on Oct. 12. Rari is iterating on what Compound Finance did, essentially allowing users to fork the OG protocol’s pools and customize them, instead of limiting users to one pool.

Abracadabra is experimenting with allowing users to deposit interest-bearing assets as collateral and to lend against those assets. This contrasts with MakerDAO, which accepts some interest-bearing assets as collateral, namely LP tokens for popular Uniswap trading pairs.

These rapid developers are happening, while DeFi Pulse Index, which contains the tokens of open finance’s pioneers like Aave, Uniswap, Compound, and Maker, is down more than 10% in the last 30 days according to the project’s website, new projects are shunning liquidity mining and shaping what’s becoming DeFi 2.0 with their design decisions.

Crypto is the land of FOMO, where disruptors get disrupted, almost daily. But with the model of protocol-controlled value leaving liquidity mining behind, there is real change afoot in DeFi.