Incentive mechanisms are commonly applied to bootstrap network and dApp growth, as well as to attract early users. These incentives can impact the token supply and must be carefully considered.
Incentivizing network participants usually serves the following purposes:
- Bootstrap early user adoption
- Attract developers to build certain features or applications on your chain
- Attract users to buy and/or hold your token
Ecosystem incentives can serve various functions, depending on the objectives of your network. Incentivization typically rewards network participants with the native network token for certain behaviors that are beneficial to the network. This should be closely tied to your go-to-market strategy and may be crucial for bootstrapping your network.
The questions that should be answered are:
Where do the incentives come from?
Ecosystem incentives usually take the form of:
- Newly minted tokens according to the networks Emission schedule
- Releasing minted tokens through the release schedule
- Protocol Revenue / Usage fees that is accrued by the network
To determine this, take the following points into account:
Token Supply The supply schedule that defines the inflation and deflation of the network and how it will affect ecosystem incentives over time
Token Distribution defines what amount of tokens will be distributed as ecosystem incentives according to:
- Genesis Supply
- Token release or emission schedule
- Fully Diluted Supply
- Your tokens inflation and deflation model
What behavior should be incentivized?
The desired behavior that is to be incentivized depends on the purpose and goal of your network, and how to drive adoption and usage of the protocol or dApp.
Incentive allocation is a powerful tool for accelerating user onboarding, but if not allocated strategically, it can attract non-optimal protocol users and risk creating unnecessary sell pressure for the token.
Aligning incentives to drive the desired behavior should ideally lead to protocol usage that eventually generates protocol revenue such as fees paid by the users.
Some examples in are:
- Providing Liquidity (e.g. Osmosis)
- Common for DEXes is the incentivization to provide liquidity. It is based on the assumption that deeper liquidity attracts more traders which in return generates more revenue via trading fees. However the cost of liquidity which is paid in incentives and therefore does have a $ value has to be strongly considered for it to not overpay LPs and therefore creating more sell pressure than needed. Example: OsmosisOsmosis incentivises users to provide liquidity into the LPs by attracting them with high APYs if they do so. The higher the lock up time, the higher the APY. The APY users get originate from the newly minted tokens that are distributed as “Ecosystem Incentives”.Osmosis’ being highly inflationary in the first 3-4 years makes the “Ecosystem Incentives” proportionally high in order to generate high APYs for users which resulted in driving early user adoption.The downside to such a model is that you should ask yourself what happens to these users (and essentially the liquidity in the pool) once the incentives decline or don’t exist anymore. Additionally you need to keep in mind that by paying users incentives, this is actually a cost as it can be translated to a $ value that is given to users.
- Developers Incentives to build smart contracts on a protocol (e.g. Evmos Fee split module)
- Rewarding lenders on a lending protocol for providing liquidity (e.g. Incentives for Borrowers & Suppliers on Kava)
- Network security (most Cosmos L1s, e.g. Cosmos Hub, Osmosis, etc.)
- “Gamified” mechanisms such as:
- Rewarding user for playing a game
- Rewarding users for desired protocol actions
- Rewarding users for real world behavior (e.g. using eco friendly transportation. collect waste, etc.)
- Reward service providers for using the network as their platform
- For providing data (e.g. Oracles, Relayers)
- Building apps (e.g. via Grants programs)
How are the incentives being paid to the users and participants?
Some common examples are:
- Bounties and grants (including governance proposals)
- Staking rewards from newly minted tokens
- APYs for providing liquidity
- Airdrops for user onboarding
If & how to use disincentivization?
At the same time certain behavior that would be counterproductive for the network can be punished.
The most common example is staking with emission based staking rewards. By not staking the token and therefore not helping to secure the network, a user's network share will get diluted through inflation of the token over time.
Example: Cosmos Hub
Users are incentivised to stake their ATOM through receiving staking rewards. On the other hand, if users don’t stake their ATOM, they don’t get rewarded but they also get diluted at the same time through the Atom being inflationary.
However, this should be treated with care, as a very high staking APY can lead to bigger opportunity costs for non-stakers which may prevent users from using other parts of the protocol.