By Mason Nystrom
Compiled by: TechFlow
It has been proven that when tokens (or token promises) are combined with new innovative products, they can effectively alleviate the cold start problem. But while speculation brings benefits to network activity, it also brings negative effects of short-term liquidity and non-organic users.
Marketplaces and networks that launch tokens from the outset (or before sufficient organic demand has been built) must find product-market fit (PMF) within a shortened window or they will run out of precious token resources.
My friend and investor Tina calls this the “hot start problem,” where the existence of a token limits the window of time a startup has to find a PMF and gain enough organic traction to retain users and liquidity when token rewards are reduced.
Apps launched with a points system will also suffer from the hot start problem because users now have an implicit expectation of the token.
I really like the term “hot start problem” because one of the core differences of Crypto compared to Web2 is the ability to use tokens as financial incentives to launch new networks.
This strategy has proven to be effective, especially in DeFi protocols such as MakerDAO, DyDx, Lido, GMX, etc. Token launch has also proven to be effective for other Crypto networks, from decentralized IoT networks such as Helium to infrastructure such as Layer 1 blockchains and certain middleware such as oracles. However, those networks that choose to scale quickly through tokens and face the hot start problem face several trade-offs, including blurring natural traction and PMF, running out of token resources prematurely, and increasing the complexity of operational tasks due to DAO governance (such as fundraising, governance decisions, etc.).
Why choose the hot start problem?
There are two situations where the warm start problem is more favorable than the cold start problem:
Startups competing in a highly competitive, red ocean market with known demand
Products and networks with passive supply-side participation
Red Sea Market
The core disadvantage of the hot start problem is that it is difficult to judge natural demand, but this problem is alleviated in categories with strong product-market fit (PMF). In this case, latecomers have the potential to successfully challenge early movers by launching tokens early. The DeFi space provides many examples of latecomers overcoming the hot start problem by effectively using tokens to launch new protocols. While Bitmex and Perpetual Protocol were the first centralized and decentralized exchanges to offer perpetual contracts, later GMX and dYdX quickly increased liquidity through tokens and became leaders in the perpetual contract market. Newer DeFi protocols such as Morpho and Spark have successfully launched billions of dollars in total locked volume (TVL) in lending, although early movers such as Compound still dominate, and Aave (formerly ETHlend) still dominates. Today, tokens (and points) have become the default choice for liquidity launch when the demand for new protocols is clear. For example, liquidity staking protocols actively use points and tokens to increase liquidity in a competitive market.
In the crypto consumer space, Blur has demonstrated a strategy to compete in a red ocean market, with its market-defining points system and token launch making Blur the dominant Ethereum NFT trading venue by trading volume.
Passive and active supply involvement
The hot start problem is much easier to overcome in passive supply networks than in active supply networks. A brief history of token economics shows that tokens are useful in launching networks when there are passive tasks to be done, such as staking, providing liquidity, listing assets (like NFTs), or hardware that can be set and forgotten (like DePIN).
Conversely, while tokens have also been successful in launching active networks such as Axie, Braintrust, Prime, YGG, and Stepn, the premature appearance of tokens often obscures true product-market fit. Therefore, the hot start problem is more challenging in active networks than in passive networks.
The lesson here is not that tokens are ineffective in active networks, but that applications and marketplaces that launch token rewards for completing active tasks (such as usage, games, gigs, services, etc.) must take additional measures to ensure that token rewards are used for organic usage and drive important metrics such as engagement and retention. For example, the data annotation network Sapien gamifies the annotation task and lets users stake points to earn more points. In this case, users passively staking when performing certain actions may serve as a loss aversion mechanism to ensure that participants provide higher quality data annotations.
Speculation: Feature or Bug?
Speculation is a double-edged sword. If integrated early in the product lifecycle, it can be a flaw, but if done strategically, it can also be a powerful feature and growth tool for attracting user attention.
Rather than solving the cold start problem, startups that choose to launch tokens before gaining organic traction choose the hot start problem. They accept the tradeoff of using tokens as an external incentive to attract user attention while betting on their ability to discover or create organic product utility amidst the increased speculative noise.
