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By Shahmeer Chaudhry, Co-Founder and CEO of Fluidity
In the years since Bitcoin first emerged, many other cryptocurrencies and tokens have arisen, each attempting to solve a different problem or address a different use case. But just like building a beautiful solution for a problem that doesn’t exist, crypto still suffers from a use problem despite its astounding degree of innovation.
While blockchain technology offers a tantalizing set of incentives and the possibility of inclusivity that other systems cannot replicate, many promises, like banking services for unbanked populations, have yet to materialize. Even stablecoins, which are cryptocurrencies pegged to a stable asset such as the US dollar or Euros, haven’t realized their full potential outside of the speculative trading environment.
While perfect tools for commerce and transfers of value without the volatility characteristic of most other cryptocurrencies, people who currently own stablecoins are more attracted to depositing them in savings-like vehicles, in a process called staking, instead of spending them. In this context, staking is the process of holding a certain amount of cryptocurrency in a wallet to participate in the maintenance and validation of a blockchain network in return for a reward.
One significant reason stablecoin holders gravitate to staking is that staking ensures a definitive way to earn a return on one’s stablecoin holdings without having to sell them. Besides, staking becomes more attractive if the yield generated is higher than what is available through other alternatives, such as traditional interest-bearing accounts or loans.
The question that arises is how to encourage use, and what does it take to transform the current habits of traders, so that incentivized utilization becomes the driving force of their actions?
The Current State of the Market
A protocol, in the context of blockchain and cryptocurrency, is a set of rules and standards that govern how a particular ecosystem operates.
For a protocol to achieve widespread adoption and establish itself within an ecosystem, it typically needs to offer some sort of unique value proposition or solve a problem that existing protocols are unable to address effectively. In addition to the value proposition, a thriving protocol demands token velocity, or the movement of a token through its ecosystem, usually the byproduct of an accompanying product, service, or functionality.
However, many protocols end-up attracting users through short-term incentives like airdrops (free tokens) and promises of high yields (in the form of APY) for depositors, leading to a lack of long-term sustainability. This has resulted in a phenomenon whereby users are more content to buy cryptos, stake them, and generate returns instead of encouraging their use in transactions.
Users who hold large amounts of cryptocurrencies rush to stake their coins in these protocols because they are only interested in the short-term rewards and high yields they can generate from their assets. Users are, therefore, reluctant to spend cryptocurrencies because they believe depositing their cryptos will yield higher returns by sharing in the protocol’s transaction fees. As the returns diminish over time, and users have no incentive to maintain their deposits, they eventually switch protocols.
Meanwhile, retailers are hesitant to accept these tokens as payment, especially stablecoins, because they are not widely used in commerce. To accept crypto, retailers would have to invest in the infrastructure needed to process digital currency payments without any guarantee that customers would actually use the system. This is a risky proposition many retailers and service providers are hesitant to take on.
Together these issues form the crux of crypto’s utility problem: if people have no actual reason to use the protocols beyond their incentive schemes, platforms die when incentives disappear. This extends to use in commerce as well. Without willing spenders and willing recipients, the utility of stablecoins as a medium of exchange becomes even more limited.
Utility Mining Extends a Potent Response
Incentive mechanisms need to be reworked so that the utility of protocols becomes the main value proposition, ensuring protocols can attract capital and promote utility equitably and sustainably.
While the central idea of Web3 has been to ensure a fair system of rewards for genuine users by aligning incentives with certain activities, yield generation isn’t always aligned with the protocol’s goals, namely because it doesn’t encourage protocol use. Utility mining can change the stakes by embracing a network model that stimulates token velocity through the ecosystem.
Unlike directly depositing tokens into a staking mechanism to generate yields, utility mining involves swapping a crypto asset for another crypto asset at a 1:1 ratio. The swapped assets are known as “wrapped tokens,” and the process is known as “wrapping.”
One of the main benefits of wrapping assets is that it offers a dual-use path for a single token: depositing the unwrapped token and transacting in the wrapped token simultaneously. By following this model, protocols can deposit users’ original “unwrapped” tokens into staking pools to generate yields. Meanwhile, users can take the “wrapped” tokens and use them in on-chain transactions.
When transacting in the wrapped token, the sender and receiver split on-chain transaction fees. Moreover, there can be a fluctuating amount of rewards distributed to these users based on the staked, unwrapped token. Yields can fluctuate based on various factors, like gas fees, platform fees, transaction volumes, and APY, but this model grants token holders a dual-sided yield generation mechanism: yield from transacting and yield from staking.
Together, these utility mining features address the on-chain activity dilemma and, by extension, the velocity quandary by closing the gaps in existing incentive programs. By sustainably encouraging participation in on-chain transactions through a reward mechanism, the utility mining model effectively creates a circular economy, ensuring more equitable and sustainable yield distribution that inspires usage.
About the author
Shahmeer Chaudhry is the Co-Founder and CEO of Fluidity, a blockchain incentive layer. Shahmeer was first introduced to Bitcoin in 2013 and later became active in arbitrage trading. A recent graduate of the University of Adelaide with an advanced Computer Science degree, Shahmeer is highly active within the blockchain space, directing the long-term strategic vision for Fluidity while navigating and engaging with key players and partners. He previously served as a Board Member at the Blockchain Acceleration Foundation, helping sculpt the organization’s roadmap.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
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