The Second Wave of Node Protocols
The Buy/Sell Gap and the Trade-off of High Return and Sustainability
In this thread, I want to talk a little bit about the fate of node protocols. It’s clear that many node protocols are struggling, the sell pressure at some point is too big, and the token price completely crashes. This makes some people want to move away from nodes altogether, they go to the next thing. That’s fine and understandable.
But some also understand that what caused so much of the struggle in these old protocols is not necessarily inevitable. And therefore, many people have dedicated a lot of time and money to creating protocols that try to fix those problems.
Many call this the second node wave, node season 2.0, or what have you. The point is to learn from what caused so many problems for the first node protocols and avoid them in the future.
It’s not entirely agreed on what the second wave constitutes, but I’d argue it’s mostly based on 3 factors:
- 1. Lower rewards.
The space has been shifting in its standards, and 5%, 4% and 3% daily APY have been recognized as doomed no matter what. The new standard seems to have settled around 1% per day.
- 2. Professionalism and transparency
At unprecedented levels compared to before. This isn’t a technical point, but still important. It leads to higher trust and less panic selling from those who are afraid of rugs. It’s common getting now common to see doxxed teams while before this was very rare.
- 3. Reward tapers.
It is now (almost) common knowledge that part of what makes the protocol struggle is the investors who are long past ROI and selling their rewards forever.
Unfortunately, tapers are still not very common and there are only a handful of protocols implementing it, but it’s getting more popular. But as I’ve been arguing for a long time, this will 100% become the norm.
- 4. Utility
The project has to provide some service that is useful. This is a huge topic and discussing the specific ways a protocol can provide utility is out of the scope of this thread, but I will cover the most important aspect of utility later.
The overall reward rate is the most important because the whole problem of nodes is that the sell pressure is so huge. But that sell pressure is directly tied to the reward rate. If you’re getting less, you will sell less. This is especially important because as everyone in investing and crypto knows, compounding is exponential. And when people compound with higher rewards, you’re making the exponential *more* exponential. Therefore, also exponential sell pressure as consequence.
That’s why nodes got so popular at the end of 2021, people loved their spreadsheets and seeing how much they could get per day after compounding for X time. Yes, in some ways that was very misguided because of the price action. But in other ways, it wasn’t for those who got early enough. Even if the price has dropped a lot, some people that compounded are now getting huge rewards per day. They are now selling those rewards, and they will keep doing that *forever* until the protocol is drained dry.
This is particularly problematic for old protocols because the longer they run, the bigger this gap becomes: the difference between the buy pressure and sell pressure of any given investor. Let’s call this the buy/sell gap. This is specific to nodes because of the reward system. If you buy BTC and then sell it, you sell it once. You can’t profit from the investment you made, and then also sell it and profit again every day for the rest of your life.
Because of this, the trend over time is down. This led to many protocols lowering rewards in order to slow this down. However, this only helps to some degree. In a way, it’s too late. Even if you decrease the rewards, people who compounded early enough will still make a good profit, and they will cause massive sell pressure. A 50% reward reduction is not a big deal if you compounded from 3 nodes to 30.
STRONG’s rewards are not very high, and yet just because they have been running for a long time, some people have compounded massively. The best way to think about it is that the more “ROI” cycles a protocol have gone through, the higher the risk.
Therefore, almost every node protocol from the “second wave” has lower rewards from the very beginning. It will help this problem to a massive degree. Although it doesn’t magically make protocols completely sustainable. The buy/sell gap still applies. However, the intensity of it will be way lower, and it will give the protocol way more time to implement utility before it starts becoming a huge issue.
Some people have argued that even though lowering rewards makes it more sustainable, it makes the project not appealing. Especially because the ROI is much longer. For example here is how typical rewards look in terms of ROI:
3% rewards: 33 days ROI
2% rewards: 50 days ROI
1% rewards: 100 days ROI
0.5% rewards: 200 days ROI
Is it really worth it to invest in something and have to wait 200 days just to get your ROI back? Depends on your view. Are you looking in the short-term, or long-term? To me, I don’t really care about short-term gains. If you want to play a short game, then by all means go to projects with high rewards, as long as you accept the trade-off.
Another point that can be made, and it’s a good one, is that if the ROI gets very long, then you could do something else with that money and be gaining profit in that time. For instance, you could stake stables and get a very safe return. This is a great point.
But as long as you have a long-term vision in mind, I still think it’s worth it. Let’s say we have project A that has 2% rewards: 50 day ROI. And then we have project B with 0.5% rewards: 200 day ROI.
If you invest $1000, in project A you get those $1000 in 50 days, and 200 days in project B. To make sure that they are on equal footing, let’s say that the project goes badly after 1x ROI time. I think this is an unfair equalization since that’s more likely with project A, but let’s say it isn’t as long as the time is equated.
That means by investing your project A compared to project B, you have a difference of 150 days. So on day 50, you could just get that ROI and put it into a stable coin protocol and get 20% yearly safe returns. So how much would that give you? With $1000, that’s $200. But that’s assuming 1 year, it isn’t. So for 150 days, you get an extra $82.
From my point of view, that’s not a lot. Of course, you can also argue that you could have put the money into a riskier project and gotten a higher return, that’s fine. It depends on your investment strategy and how you conceptualize these newer projects. It’s not the major point as I will later explain.
While those $82 aren’t insignificant, we are assuming that both projects stop at the same time. But the crucial issue is: what makes them stop, precisely? Again we go back to the buy/sell gap. How do we stop it? You can’t. By definition, node protocols are giving more money than what they initially received.
Despite that, if utility is implemented, that gap can be sustained. Utility here means that you can do something with the token that investors find worthwhile. However, this is topic is very misunderstood.
Even if you build something great, people will only use the token instead of selling it if they are willing to pay the price they are missing from that sale. As a basic example, if I can use X service for 1 token for your platform, but I can sell that token for $100, that means the service is worth $100. This is a bit oversimplified and assumes that investors are rational actors (they’re not), but it’s a good overall framework.
COMB is a perfect example of this, and it can be easily seen why its price has tanked so much after its node cap. People say that it’s because they eliminated buy pressure. This is not true. They have a buy pressure incentive, just not from nodes.
You can get zcomb and invest in the protocol, which is getting returns. So why is the price tanking? Because people who have nodes make more money selling the token than putting it into the protocol. Thus increasing sell pressure and making the price go down.
This will keep going down until an equilibrium is reached. People will stop selling COMB when not selling COMB has better or equal pay than selling it. If that’s $50 per COMB, then it will go to $50. If it’s $20, it will go to that. Although once again, this problem would have been reduced if tapers were implemented.
This isn’t attacking COMB, they have a great system and they are in many ways pioneers of the 2nd wave. I’m just outlining the logic behind these processes. I think COMB is great and I fully believe that will still be around for many years. That’s a claim very hard to make for almost any other protocol.
Long story short, what people call utility is simply making money. And this is where the second wave protocols shine. The whole problem of node protocols is the buy/sell gap, and therefore the higher the rewards, the higher that gap. So if you want to close it, that means that the money you need to create is much lower.
This is why I’m not very confident in the utility solutions that many node protocols are doing. Even if they are good services and products, the revenue they have to provide is gigantic, and I really don’t see it working. Even huge companies like Apple or Amazon, providing the best products and services in the world, can’t expect to produce infinite revenue. If what they have to pay (expenses) is higher than what they generate (profit), they fail. Investors are the expense.
Imagine creating a business, and you can have the same type of business, getting a similar amount of money, but in business A you have to create 1M to stay afloat, while in business B you have to create 5M. Everything else is equal. In which business do you bet to still be alive years from now?
Here is another analogy. You’re starting a business and you need money. You go to a bank and ask for a loan. This is basically the position that node protocols are in. They ask for a loan from you, the investor. The rewards are paying the loan back, plus interest (after the ROI).
In the beginning, it’s great because they get a loan so they are swimming in money and they have to give back very little. But over time they have to pay it all back AND more. The only way to survive is to do something with that money to pay the difference.
This is what brings perspective to those extra $82. This is assuming both protocols are on equal footing and they last the same amount of time. They don’t because of the buy/sell gap difference. And if one just has a slightly better chance of doing well long term, then those $82 will become absolutely irrelevant. If instead of ROI the project can survive just 25% extra time beyond ROI, then that’s an extra $250.
And this is pretty conservative in my book. There is a huge psychological element in these protocols. While the fundamental issue is the buy/sell gap, the lifecycle of a protocol is significantly reduced if people no longer believe in the protocol, decreasing the number of people keeping the money inside the protocol. These increases sell pressure, the protocol looks even worse, and it snowballs.
While I’ve mentioned this many times and I don’t want to cover it in-depth here, there is also the issue that compounding in 2nd wave nodes actually helps the protocol, because it gives the protocol more time but without compromising it. For protocols with higher rewards, while it also gives time, it does so by snowballing into a huge amount of sell pressure later. This does not happen if the rewards are more prudent and tapers are implemented.
Because of all the points I’ve mentioned previously, conservative protocols have a much higher probability of actually making it long-term. Meaning that not only can they survive longer, but because the revenue they have to generate from that utility is much lower, it actually has a good stance to survive long-term. Not as much money needs to be made, and there is much more time for protocols to pivot as needed. And if the protocol survives long-term, obviously it will always pay off in the end.
Rewards aside, some people are also critical of node protocols, even new ones, because they dislike the whole concept of DeFi as a Service. They think that it’s more productive to invest in DeFi themselves, instead of relying on another protocol and adding extra risk. This is a very good point, and it’s a personal choice.
The most obvious benefit is that your money is being managed by someone a lot more experienced than you (in most cases), and therefore making good returns is obviously easier. It also has the benefit of getting into investments that are hard to make for the average joe, especially more towards the launchpad route. But let’s set both those points aside.
I think the most pragmatic aspect is simplicity. While I love DeFi, I’m not particularly thrilled about spending hours and hours researching projects just so I can make money. I do it because I have to. If I could not do it and still have great profit, then I would. I have ETFs because I know that in 20 and 30 years I will have a significant amount of profit, and my effort throughout those decades was zero. This is what DaaS can provide.
It’s not everyone’s cup of tea, but there is definitely a great interest in it. In fact, in theory, that’s what nodes were supposed to be from the very beginning. The whole problem was precisely the high rewards because the payout is so high that there isn’t anything reliable on DeFi to match it. If the rewards are more conservative, this becomes more doable.
I’m not telling you what to invest in. I get it that many people were burned by nodes, especially if you were late. But we can analyze what went wrong and come up with a better system. For those that like the system that nodes promised, but tweaked in a way in order to make it more sustainable and you want long-term investing, then look into the second wave protocols.
I built @defo_app as the protocol that I’d want to invest in, using my entire experience in the space, and carefully analyzing the pitfalls of older projects. But of course, it’s not guaranteed it will succeed. Nothing is, and this space remains very experimental.
I’m not shilling and asking you to invest in DEFO, but just letting you know of an option within this realm if you’re so inclined. But there are other great protocols too, and if they follow the 4 key factors of the second node wave I mentioned, I think they are promising.
Some people still won’t be interested in this new wave. As I mentioned, a few find the long ROI unbearable, and they will keep chasing protocols with higher rewards. That’s fine, I respect everyone’s investment decisions. However, it’s worth considering the ethics of doing so.
While every single protocol has ponzinomics at its core, to me that’s only justifiable if you have a plan on how to get out of it. Otherwise, the only way to make money is if you’re lucky in getting in early enough. If you are, you can take your ROI out ASAP and then happily get whatever returns afterwards.
This can definitely work (if you’re not rugged), but I’d invite everyone to think about the ethics of doing so. Yes, you’re making money, but at the expense of other people. In a very literal sense.
New wave node protocols still have this feature, but they are trying to actually build something long-term. It feels more like true start-up investing. Of course, still a high-risk high-reward strategy. But if these plans are never implemented, to me that’s just a scam.
What every node protocol with high rewards will say to that is of course that they do plan to have utility, and they will indeed succeed long-term. But anyone can say that. It costs nothing to say you will build a metaverse and whatever buzz words are popular at the moment.
But truly think about what I presented here, and don’t take their word for granted. The greater the buy/sell gap, the higher the need for an absurd amount of revenue generation, which at some point is nothing but wishful thinking.
Some people will also prefer not to invest in nodes at all, that’s ok too! I think this experience has moved a lot of people towards blue chips, which as far as I’m concerned it’s definitely a good move. Especially if you’re just starting and you don’t have a solid foundation in crypto.
I just wanted to share my thoughts about this key transitional period in this space, and wish you good luck no matter what path everyone is taking. Thank you for reading and I hope this provided some insight.
