Author: Mason Nystrom, former investment partner of Variant Fund; Translation: Golden Finance xiaozou
Tokens (or token promises) have proven to be effective in mitigating the cold start problem when combined with new and innovative products. However, while speculation brings the benefits of network activity, it also comes with the challenges of short-term liquidity and inorganic users.
Marketplaces and networks that choose to launch tokens at the outset (or before building enough organic demand) must achieve product-market fit in a shorter time frame or they’ll run out of tokenized bullets in their growth guns.
My friend and investor Tina calls this the “hot start problem”, where the existence of a token limits the window of time in which a startup can build PMF and gain enough organic traction to retain users/liquidity even as token rewards decrease.
Apps launched with a points system also suffer from a warm start problem because users now have some implicit expectation of the token.
I really like the description of the “hot start problem” because the core difference in the crypto world compared to web2 is the ability to use tokens (financial incentives) as a tool to launch new networks.
This strategy has proven to be effective, especially for DeFi protocols like MakerDAO, DyDx, Lido, GMX, etc. The token launch approach has also proven to be effective for other crypto networks, from DePIN (e.g. Helium) to infrastructure (e.g. L1) and certain middleware (e.g. oracle). However, networks that respond to the hot start problem by flash scaling their tokens face some trade-offs, including unclear organic traction/PMF, premature consumption of bullets in the growth gun, and greater friction in completing operational tasks due to DAO governance (e.g. fundraising, governance decisions, etc.).
1. Select hot start
Compared with the cold start problem, people prefer the hot start problem in two cases:
Startups competing in a red ocean market (a market with high competition and clear demand)
· Products and networks including passive supply side
(1) Red Ocean Market
The core disadvantage of the hot start problem is the inability to identify organic demand, but this problem is mitigated when a category with strong product-market fit is established. It is in situations like this that latecomers have the potential to successfully compete with those who entered the market earlier by issuing tokens early. The DeFi space is full of 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 perp (perpetual contracts) trading, respectively, latecomers such as GMX and dYdX used tokens to quickly increase liquidity and become leaders in the perp category. Compared to first movers such as Compound, emerging DeFi protocols in the lending space such as Morpho and Spark have successfully achieved billions of dollars in TVL, although first mover Aave (formerly ETHlend) still dominates. Today, there are clear signs of demand for emerging protocols, and tokens (and points) are the default choice for liquidity launch strategies. For example, liquidity staking protocols actively use points and tokens to increase liquidity in a highly competitive market.
Elsewhere in the crypto consumer space, Blur has demonstrated a red ocean market competition strategy, with its market point system and token issuance making Blur the dominant Ethereum NFT trading venue by trading volume.
(2) Passive vs. Active Supply-Side Participation
The hot start problem is easier to overcome for passive supply networks than for active supply networks. Looking at the history of token economics, we can see that tokens are useful when bootstrapping passive supply networks - staking, providing liquidity, listing assets (such as NFTs), or set-it and forget-it hardware (such as DePIN).
In contrast, while tokens have also successfully launched active supply networks, such as Axie, Braintrust, Prime, YGG, and Stepn, the premature launch of tokens often makes true product-market fit difficult to detect. Therefore, the hot start problem in active supply networks is more challenging than that in passive supply networks.
The lesson here is not that tokens are ineffective in active networks, but that when applications and markets introduce token incentives for active networks (usage, gameplay, services, etc.), they must take additional steps to ensure that token rewards are driven in the direction of organic usage and drive growth in important metrics such as stickiness and retention. For example, the data annotation network Sapien gamifies the annotation task and allows users to earn more points by staking points. In this case, passive staking when performing certain actions has the potential to play a role of loss aversion, ensuring that participants submit higher quality data labels.
2. Speculation: Features vs Bugs
Speculation is a double-edged sword. If integrated into the product lifecycle too early, it can become a bug, but if used strategically, it can also be a powerful feature and growth tool for capturing user attention.
Startups that launch tokens before they gain organic traction choose to deal with the hot start problem. They accept the pros and cons of using tokens as an extrinsic incentive to attract user attention while betting on their ability to find or create organic utility for their products amidst the growing speculative noise.