Does Farming Represent Progress in Token Distribution?
In late 2019, Smith + Crown published a report on issues of fairness related to token distribution mechanisms. A key takeaway identified in this research was the significant extent to which a project’s choice of token distribution mechanism reflected its priorities regarding incentivizing certain initial contributions and ongoing user behaviors. In the two years since, we have observed that this assertion remains true, though the number of token distribution mechanisms to which it now must be applied has expanded substantially. Referencing CoinList’s “Evolution of Token Distribution Models,” this commentary analyzes past and emerging trends in token distribution, with a particular focus on the progress potentially represented by the rapidly proliferating practice of farming-based distribution.
CoinList, a non-exchange token distribution platform, characterizes token distribution mechanisms as undergoing five distinct phases of adaptation, upon which we have expanded with our own interpretations below:
- 2009: The launch of the world’s first blockchain-based digital currency, Bitcoin, also brought the first token distribution mechanism. Unlike later sale-based distributions, early BTC was distributed in technically the same manner as it has been throughout its twelve-year history: mining. Referred to as “fair mining,” initial Bitcoin distribution rewarded early network participants, whose mining activities catalyzed the formation of the now-extensive network of nodes ensuring Bitcoin’s security. A defining trait of this “fair” distribution model was the lack of fundraising for development by a centralized team as well as the absence of direct founder rewards; theoretically, any participant was able to mine BTC alongside Satoshi.
- 2013-2017: Following the launch of Ethereum, which introduced smart contract-based token functionality, initial coin offerings, or ICOs, became the primary model for token distribution, with their ubiquity peaking during the so-called ICO Boom of 2017. Though alternative networks such as Polkadot and Filecoin also conducted token sales during this period, the space was dominated by projects, blockchain-related or otherwise, developing and selling ERC-20 tokens directly through smart contracts or project websites as a means of fundraising. In addition to the immaturity of the space, it was perhaps the presence of projects otherwise unrelated to distributed ledger technology that supported ICOs’ emphasis on fundraising over cryptoeconomic-based behavior incentivization. Another key driver of the shift away from fair mining was the ubiquitous desire amongst projects to raise funds prior to any meaningful development efforts.
- 2018: In response to mounting criticism over the lack of transparency and absence of any vetting of projects, many teams looking to raise funds shifted shifted to exchange-hosted sales, referred to as Initial Exchange Offerings or IEOs. While there indeed existed a certain degree of vetting withIEOs when compared with ICOs, these efforts were seen retrospectively as overstated by many. Also during this time, airdrops, wherein tokens were distributed to Ethereum wallets for free based on factors such as ETH holdings, began to emerge as a means of initial token distribution for projects perhaps not in need of funding at the time, but desirous of targeting adoption to particular user-bases.
- 2019: In this phase, the blockchain industry began to see the complexity of token distribution mechanisms increasing, with auction-style sales becoming a prominent model. Dutch auctions and bonding curves, hosted by both exchanges and projects directly, emerged as a popular distribution model during this period. The extent to which these shifts represented truly novel approaches, whether in terms of addressing long-standing regulatory issues, or concerns about the wide range of quality of projects that were associated with the ICO boom of 2017, remains an open question.
- 2020: In the last year, public token distribution mechanisms have notably shifted from those intended primarily to directly raise funds to those also used as a means of incentivizing user behavior beneficial to the network. Smart contract platforms conducted stakedrops and lockdrops, which involved users depositing refundable cryptoassets in smart contracts for a defined period of time in exchange for newly minted tokens native to a given project. Likewise, farming-based distribution mechanisms, namely yield farming and liquidity mining, grew ubiquitous in the DeFi sector.
Arguably, the increasing individualization of token distribution mechanisms are largely superficial innovations upon a largely unsupervised arena where ambitious and innovative, but also untested, projects are able to directly access an investing public often unqualified to assess the prospects of opportunities presented to it. One important shift throughout this period is that, while early ICOs conducted by projects directly were a novel yet blunt instrument for token distribution, later iterations experimented with more nuanced approaches that in many cases were more cognizant of long-term objectives. As a result of such experimentation, recent projects now have a growing stable of existing token distribution mechanisms from which bespoke models can be developed.
A related trend is that, as projects move towards more tailored models, token distribution mechanisms are being increasingly designed around incentivizing beneficial behavior rather than direct fundraising. Spearheaded by the rapidly expanding DeFi sector, projects are increasingly bifurcating fundraising and public issuances. For instance,private placements can fund early-stage development, often by selling equity in a project, while forks generally limit initial development costs and allow iterative projects to be brought to market quickly and inexpensively. Both approaches allow for non-revenue-generating public distribution mechanisms to be subsequently used. The latter is now most frequently instantiated as farming-based mechanisms, which represent perhaps the most significant innovation in token distribution to date. Such mechanisms theoretically support longer-term growth for both platforms and their native assets, as tokens are distributed based not on monetary investment but rather ongoing use of the platforms themselves. For example, Compound distributes newly-minted COMP tokens to users that generate loans, and prominent decentralized exchanges such as Uniswap (UNI) distribute tokens to users contributing liquidity to their pools.
However, it is quite possible that the progress supposedly represented by farming mechanisms is overstated, particularly in regards to those claiming these represent innovations on the regulatory front While these models do not directly sell tokens, farming implementations have been demonstrably causal of substantial price appreciation, indirectly raising capital for project teams through the distribution tokens with dubious utility. While COMP and UNI are considered DeFi blue chips, memecoins such as PICKLE and HOTDOG indicate that there still exists the same spectrum of project legitimacy present during the ICO boom. Further, private placements prior to implementation of farming programs still leave these assets vulnerable to classification as securities to an extent. Nonetheless, novel farming mechanisms are contributions to the growing repository of token distribution models from which projects can derive increasingly bespoke mechanisms, and Smith + Crown will be monitoring their use closely in coming months.