One-year anniversary of DeFi explosion triggered by liquidity mining! How has DeFi grown?

This article is authorized and reposted from ChainNews, titled "One Year Anniversary of Liquidity Mining Explosion, How DeFi Growth Has Been." The original article can be found here.

An interesting fact: The term "liquidity mining" was invented by one project, first adopted by another project, and popularized by a third project.

By: Pan Zhixiong

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A year ago, decentralized finance (DeFi) began to attract widespread attention from the cryptocurrency community. However, without the impact of "liquidity mining" and "yield farming" concepts, the DeFi ecosystem might not have developed so rapidly in the past year, and the subsequent "DeFi Summer" may not have occurred.

Looking back at the achievements of this year, the development speed of the DeFi ecosystem has been beyond imagination. Just a few examples reveal growth in the hundreds, such as a 170-fold increase in loan funds, a 140-fold increase in the number of trading users, and a 140-fold increase in the total assets locked in DeFi smart contracts, and so on.

Although the term "liquidity mining" was neither invented by Compound nor the mechanism they first adopted, Compound played a crucial role in driving this concept. Almost all information about liquidity mining that can be found on the internet emerged after Compound introduced "borrowing equals mining." From that point in time, it has been exactly one year until now.

Since then, liquidity mining has become the most valuable mechanism for new DeFi protocols upon launch and has even become a standard "template." Many projects will adjust this template based on their own characteristics.

Participants in liquidity mining are divided into two categories:

• One type includes "whales" or "gun pools" who immediately sell the token rewards they receive for cash;
• The other type consists of users who hope to participate in primary market token distribution through this method and grow with the project.

On the flip side, critics argue that the risks brought by this mechanism, such as "rug pulling" (where protocols combine mining activities), may increase systemic risks in the entire DeFi ecosystem. If the distribution method is not precisely designed, it could prematurely exhaust the growth potential of protocols. For example, Uniswap halted liquidity mining activities after a few attempts until the release of V3, possibly to design a more reasonable solution.

Regardless, this mechanism effectively motivates the cryptocurrency community and users to actively participate in DeFi protocols and has become an essential component for all new projects.

As we celebrate the one-year anniversary of liquidity mining prevalence, we hope to review the achievements and impacts of the DeFi ecosystem over the past year through data. It must be noted that the rise of DeFi was not solely caused by liquidity mining, but it is undoubtedly one of the most critical factors.

Who Coined the Term Liquidity Mining?

Exploring the origins of the term Liquidity Mining, the earliest source can be traced back to the open-source automated trading tool Hummingbot. The term began to be used in June 2020, with the Hummingbot team adopting it over half a year prior.

Hummingbot is a tool geared towards professional users, so it may not be well-known among ordinary users.

The team first announced the "launch of Liquidity Mining feature" in a blog post on November 1, 2019, and subsequently integrated related functions in the 0.20.0 version in December, followed by opening Beta testing in the 0.23.0 version in February 2020, initially supporting centralized exchanges like Binance and decentralized exchanges like 0x Mesh.

Reference: "Introducing Liquidity Mining"

In Hummingbot's original definition, "liquidity mining" specifically referred to providing liquidity to exchanges. The DeFi industry later expanded this concept further, applying it to lending or other financial applications, as these services also require a party to provide liquidity. This evolution eventually gave rise to another new term: "Yield Farming."

Hummingbot's definition of "liquidity mining" is very precise and comprehensive. Here is their explanation:

"We call this 'liquidity mining' because the concept is similar to mining in PoW. Instead of using mining rigs and electricity, liquidity mining uses computational resources and token inventory to operate Hummingbot's market-making client. By competing with other participants to receive economic incentives, their collective efforts can achieve a common goal of providing liquidity for specific tokens and exchanges. In return, they are compensated commensurately with their work according to the algorithmically defined model."

The Hummingbot team also released a whitepaper titled "Liquidity Mining," which provides more specific details, with the whitepaper completed on October 30, 2019.

Which DeFi Project First Adopted Liquidity Mining?

The first DeFi protocol to adopt the liquidity mining mechanism may have been the synthetic asset protocol Synthetix, which launched liquidity incentives in February 2020, almost 4 months before the DeFi boom that began in June 2020.

Reference: "New Uniswap sETH LP reward system"

At that time, Synthetix did not use the term "liquidity mining," but referred to it as "LP reward system," with LP standing for liquidity providers. They later used phrases like "liquidity incentive experiment" to describe liquidity mining activities.

Mechanically, the incentive program introduced by Synthetix is similar to liquidity mining, rewarding users who provide liquidity for synthetic assets on Uniswap, with the first supported trading pair being sETH/ETH.

Of course, the complete process to receive rewards is quite lengthy: users first need to stake SNX to obtain sUSD, then exchange it for sETH, and also pair it with an equivalent amount of ETH on Uniswap to provide liquidity and receive "LP tokens." Finally, these LP tokens are staked in Synthetix's smart contract to receive SNX as rewards.

Who Ignited the Liquidity Mining Craze?

Although early liquidity mining was more associated with trading scenarios, the one who truly propelled the prosperity of liquidity mining was the decentralized lending protocol Compound.

During June 2020, Compound officially introduced the distribution method of its governance token COMP, which was the first time other DeFi protocols realized they could promote liquidity growth through their own governance tokens.

The mechanism was relatively straightforward, as users simply had to use Compound's lending protocol regularly to receive a certain amount of COMP tokens based on the borrowed funds. Of course, this mechanism underwent several adjustments later on.

Compound itself was a relatively large and influential project within the DeFi protocol space, and had not previously disclosed plans for its native token, so when the community learned about Compound's introduction of "valueless governance tokens," discussions and research around it surged.

At that time, Compound and the community did not refer to their mechanism as "liquidity mining," but it did pave the way for other projects to adopt liquidity mining mechanisms. Searching for the term "liquidity mining" on Chain News reveals that the term emerged around the time Compound publicly announced their token distribution mechanism, which is likely not a coincidence.

For various reasons, this event by Compound holds significant milestone importance, leading to the DeFi boom in the following months, which overseas communities dubbed "DeFi Summer."

Is Liquidity Mining the Same as FCoin's "Trading Mining"?

Shortly after the concept of liquidity mining was introduced, there were many voices within the Chinese community suggesting that this was essentially the same as FCoin's "Trading Mining" launched in 2018, with some even claiming that FCoin, which introduced "Trading Mining," was the forerunner of "liquidity mining."

However, the core differences between these two concepts are quite evident. Liquidity mining based on transparent blockchain transaction data ensures the entire process is auditable and traceable, while FCoin's inability to sustain itself was largely due to its chaotic centralized management and lack of transparent asset custody status.

Furthermore, while the mechanisms adopted by the aforementioned three projects (Hummingbot, Synthetix, and Compound) are ultimately referred to as "liquidity mining," they are fundamentally different mechanisms. Hummingbot's approach is similar to FCoin's trading mining.

Data Speaks: DeFi Over the Past Year

Total Value Locked (TVL): 140x

Total Value Locked (TVL) is a key indicator for evaluating liquidity and capacity within the DeFi ecosystem, representing the total real assets invested in DeFi smart contracts to scale the entire system.

According to DeBank's data, as of June 1, 2020, the total TVL of all DeFi projects was $940 million, with the peak reaching $131.4 billion on May 11, 2021, nearly a 140x increase within a year.

Total Borrowed Amount: 170x

Within DeFi, there are protocols specifically offering over-collateralized lending services, and the total borrowed amount can reflect the collateral and lending scale of these protocols.

As of June 1, 2020, the total borrowed amount across all DeFi was $150 million, which peaked at $26.7 billion on May 9, 2021, showing a 170x increase within a year.

Number of Trading Users: 140x

Trading protocols are crucial facilities within the DeFi ecosystem, and the number of users (counted by unique addresses) using these trading protocols can indicate the user scale of the entire DeFi ecosystem.

As of June 1, 2020, there were over 6,200 users using DeFi trading protocols, with the peak reaching 850,000 users on May 11, 2021, showing an almost 140x increase within a year.

Trading Volume: 1000x

For trading protocols, trading volume is a very intuitive metric. Particularly since the launch of Binance Smart Chain (BSC) this year, trading volume within its network has seen a significant surge.

As of May 31, 2020, the daily trading volume across all protocols was $22.3 million, with the peak reaching $23 billion on May 29, 2021, showing over a 1000x increase within a year.

Gas Price: 18x Peak

Prior to DeFi Summer, Ethereum's network price indicator Gas Price had already shown a significant increase, rising from single-digit Gwei levels to tens of Gwei levels. However, after the launch of liquidity mining, Gas Price continued to rise rapidly until recently showing a downward trend.

According to Blockchair's data, on June 1, 2020, the median Gas Price was 30 Gwei, peaking at an average of 544 Gwei on September 17, 2020, an 18x increase in three months.

Interestingly, on September 17, 2020, Uniswap announced the issuance of governance tokens and conducted an airdrop, resulting in a significant number of on-chain transactions for UNI token claims that day.

Block Capacity: Triple Increase, Cumulative 50% Growth

Unlike Bitcoin, Ethereum's block capacity can be adjusted by miners' votes, allowing miners to continuously increase the network's capacity and throughput as physical network, computational, and storage resources improve.

Prior to June 2020, Ethereum's block capacity (Gas Limit) was 10 million Gwei per block, increasing to 12 million Gwei in July, and further to 12.5 million Gwei by the end of July.

Until April this year, block capacity was further increased to 15 million Gwei, a 50% growth compared to the same period last year.

Stablecoin Issuance: 10x Growth

The demand for stablecoins has seen significant growth, with the stablecoin issuance increasing from $7.3 billion on June 1, 2020, to $705 billion currently, almost a 10x increase in a year.

BTC Cross-chain Coin Issuance: 48x Growth

With the development of DeFi, the demand for BTC on the Ethereum network has grown rapidly, as it is a native digital asset with a large user base and market value.

The issuance of BTC-anchored coins increased from 5,200 BTC on June 1, 2020, to 250,000 BTC currently, a 48x growth in a year.

Oracle Call Frequency: 500x Increase

Before the rapid development of DeFi, oracles had not seen widespread application, but since DeFi Summer last year, the demand for oracles has dramatically increased.

As of June 1, 2020, the daily number of oracle calls was 72, peaking close to 40,000 calls on December 18, 2020, over a 500x increase in six months.

How Will DeFi Continue to Grow?

Recently, we have seen a downturn in the cryptocurrency market, with a significant indicator being the decrease in Gas Price, among other data showing varying degrees of decline. Does this mean Ethereum's DeFi ecosystem has hit a ceiling?

From a data perspective, the current DeFi ecosystem is still in its infancy, with Ethereum's TVL now down to $56 billion, but more assets have yet to enter the DeFi ecosystem.

With a simple calculation, if we combine the "market value of Ethereum + the market value of Ethereum-based stablecoins and BTC + the market value of the top 5 projects on Ethereum (UNI, LINK, MATIC, AMP, AAVE)," this scale amounts to around $400 billion. In this light, $56 billion accounts for only 14% of $400 billion, and this doesn't even include the thousands of long-tail tokens on the Ethereum network.

Aside from asset scale, Ethereum's current limitations due to throughput constraints have hindered the growth of many transaction-based applications, as they face challenges of being "too expensive" and "too slow." While block capacity has increased by 50% over the past year, there is still a long way to go before achieving cost-effective usability.

Fortunately, various new-generation Layer2 protocols have recently been launched or are about to go live, which will become the core foundation for the next phase of DeFi growth. With this new infrastructure, we can expect to see more interesting mechanisms beyond "liquidity mining," making it worth keeping an eye on.