By Mason Nystrom
Compiled by: Tia, Techub News
When it comes to innovative products, tokens (or token promises) have proven to be effective in alleviating the cold start problem. While speculation increases network activity, it can also lead to short-term liquidity and loss of non-native users.
Products that launch a market by issuing tokens from the outset (or before building enough organic demand) must find PMF (Product-Market Fit) in a shortened time frame, otherwise they will waste the bullet in their growth arsenal known as “tokenization.”
My friend and fellow investor Tina calls this the “hot start problem”, but launching a market by issuing tokens actually sets a time window for startups to find PMF and gain enough organic traction within a certain period of time, that is, they need to retain users/liquidity when token rewards are reduced.
Applications launched through a points system will also encounter hot start problems because users will expect the project to issue tokens.
I really like the framework of the "hot start problem" because the core difference between cryptocurrency and Web2 is that crypto is able to use tokens (financial incentives) to attract traffic.
This strategy has proven to be effective, especially for some DeFi protocols, such as MakerDAO, dydx, Lido, GMX, etc. Token bootstrapping has also been proven to be effective for other cryptocurrency networks, which has been verified in DePIN (such as Helium), infrastructure (such as L1), and some middleware (such as oracles). However, solving the hot start problem by using tokens as a lightning expansion method also faces some trade-offs, such as how to find hybrid native attraction (aka PMF), how to deal with the problem of running out of bullets in the "growth gun" too early, and how to deal with the challenges brought by DAO governance (such as fundraising, governance decisions, etc.).
Opt-in for hot start
The hot start problem is better than the cold start problem in two cases:
Startups competing in a red ocean market (a market with high competition and known demand)
Products and networks that passively participate on the supply side
Red Sea Market
The core drawback of the hot start problem is the inability to identify native demand, but this problem is mitigated when strong product-market fit is established. In this case, actors launch tokens early to gain the opportunity to compete with early market entrants. DeFi is full of examples of new protocols being launched through hot starts (i.e., effectively leveraging tokens). While BitMEX and Perpetual Protocol were the first centralized and decentralized exchanges to offer perps, latecomers such as GMX and dYdX leveraged tokens to quickly increase liquidity and become leaders in the perp track. Newer DeFi lending protocols such as Morpho and Spark have also successfully captured billions of TVL through this approach, even in the face of competition from first movers such as Compound and Aave (although first mover Aave (formerly ETHlend) still dominates). Today, tokens (and points) have become the default option for liquidity bootstrapping game plans when demand for new protocols emerges. For example, liquidity staking protocols actively leverage points and tokens to increase liquidity in a highly competitive market.
Elsewhere in the cryptocurrency space, protocols like Blur have also demonstrated strategies to compete in the red ocean market through its points system and token issuance. Blur has become the leading venue for Ethereum NFT trading by trading volume.
Passive and active supply participants
Passive supply networks are more likely to overcome the hot start problem than active supply networks. A brief history of token economics shows that tokens play a big role in guiding the formation of network effects when passive work needs to be done, such as staking, providing liquidity, and DePIN.
In contrast, while tokens have also successfully launched active networks such as Axie, Braintrust, Prime, YGG, and STEPN, the premature appearance of tokens often obfuscates true product-market fit. As a result, the hot start problem is more difficult to overcome in active networks than in passive networks.
The lesson to be learned from these cases is not that simple tokens are ineffective in active networks. If token incentives are introduced for activity, applications and markets must take additional measures to ensure that token rewards are used organically and can truly drive important metrics such as engagement and retention. A good example is the data labeling network Sapien, which gamifies the labeling task and allows users to stake points to earn more points. In this case, passive staking has the potential to act as a loss aversion mechanism to ensure that participants provide higher quality data labels.
Speculation: Feature or Bug?
Speculation is a double-edged sword. If incorporated too early into the product lifecycle, it can be a flaw, but if done strategically, it can also be a powerful feature and catalyst for capturing user attention.
Startups that choose to issue tokens before organic traffic is gaining traction are not solving the cold start problem, but rather the hot start problem. They are gambling by using tokens as an external incentive to attract user attention, hoping that their product will continue to grow organically despite increasing speculative noise.
