How to prevent sudden death of DeFi under the wave of liquidity mining

4 min readSep 1, 2020


Many DeFi protocols are trying to channel their network effects by motivating users with governance tokens. Known as liquidity mining, compound is one of the most famous examples of which came out with the governance token comp at the end of June. As long as the borrower borrows from the compound platform, he can get 50% of comp token distribution every day. As long as the value of comp obtained can cover the repayment interest rate, he can carry out no loss arbitrage, which is also the main reason for the rapid rise of loan amount with the rise of comp price.

Take YFI project as an example It belongs to the aggregation platform of liquidity mining. On July 17, 2020, year’s TVL on curve was about $8 million. Three days later, as of Monday, July 20, 2020, that figure had risen to $147 million. TVL’s rise drove the price of its governance token YFI, which soared to $13616 from its original valuation price of $30.

The Westerners of liquidity mining have seen something new, and they have a name called “yield farming”. However, after our analysis, we find that the model seems very familiar. Isn’t this the fcoin model?

Fcoin launched the liquidity incentive policy at that time and used its own platform currency to reward the users who traded on the platform. The trading volume of the platform exploded rapidly within a month. However, such a rapid growth of trading volume was not the real trading demand, but a lot of investors with brush volume robots speculated in it. Eventually, the Fcoin platform was shut down in February this year, failing to pay users $67 million to $125 million.

Let’s go back to the example in the previous section. As long as the borrower borrows from the compound platform, he can get 50% of the comp token distribution of the platform every day. As long as the value of comp obtained can cover the repayment interest rate, he can carry out no loss arbitrage. This is also the main reason why the amount of borrowing rises rapidly with the rise of comp price.

We quickly discovered the root of this pattern. Whose money are speculators making? Speculators pass on the risk to the people who buy the reward tokens by circulating the reward tokens in the secondary market. However, as a speculator, they have no real borrowing demand or trading demand. They just sell the reward tokens in the trading market to gain profits.

Obviously, the incentive model itself does not stimulate real borrowing or trading demand, nor does it really solve the mismatch between supply and demand. Most traders come to stimulate themselves rather than trade demand.

The risk point of this stimulus model is that speculators rush in because of the positive growth cycle. The proportion of speculators in the system is much higher than that of real trading demand. Once the cost (Commission or borrowing cost) exceeds the income distribution for speculators at a certain time, speculators will withdraw from trading, leaving only a small number of real traders 。

As a result, with the scenery how the positive circulation influx, the end will be what kind of death spiral ending. Once the situation is reversed, the system has not yet had time to establish the support of negative feedback (or because of the explosive growth of release, it is impossible to carry out any effective negative feedback management), accelerate the price drop, accelerate the exit of speculators, and cause the system to collapse.

Liquidity mining is now exposed to security risks and systemic risks. The lightning loan attack against BZX is a typical one. The attacker arbitrage more than one million US dollars in ten seconds according to the rules without stealing the token. Defi products with the spirit of cross chain agreement have become more and more close to the leverage game of traditional finance. With the popularity of liquidity mining and aggregation platform, the interaction between mainstream projects is increasingly intensified, which may cause certain systemic risks.

In the project of liquidity mining, the price of project token tends to increase with the increase of participating funds. In this case, the number of participants and the funds locked in the platform will increase the price of project tokens, which in turn will continue to stimulate more funds to participate in the liquidity mining of the platform, and the participation of high liquidity funds will further increase the token price, thus forming a cycle, and even giving birth to a kind of “false prosperity” Pang’s spiral “.

How to prevent DeFi from being like a greedy snake and eventually dying from the rapid expansion of its greedy body is a problem that all DeFi projects need to take seriously and consider, because under the avalanche, no snowflake is innocent.

the DATT project provides an exploration path of its own. DeFi can’t promote prosperity only through fund circulation. It needs to introduce the Internet outside of DeFi, as well as the traffic and assets in the longer-term real world, so as to get rid of the rapid expansion and sudden death caused by short-term arbitrage and wealth effect.

Welcome to discuss and jointly promote the healthy development of DeFi.