Bootstrapping Web3 Networks: The Limitations of Token Incentives

Bootstrapping Web3 Networks: The Limitations of Token Incentives

In the world of Web3 networks, token incentives have become a popular tool for attracting users and increasing network participation. However, there are limitations to this approach that need to be considered. NFX has proposed a concept called network bonding theory, which explores the idea of passive participation in decentralized networks. This concept is exemplified by networks like Helium, Arweave, and Compound, which require minimal engagement from users to benefit from financial upside.

Helium, for example, is a decentralized network that provides internet access to IoT devices in the wild. Users passively participate by providing coverage through their devices and earn Helium tokens in return. Similarly, Arweave is a decentralized storage network that rewards users for contributing their storage space to the network. Compound, on the other hand, is a lending network where lenders deposit their crypto assets into a pool for borrowers to access.

These examples demonstrate that passive participation can be an effective way to incentivize users and increase the utility of a network. However, networks with passive participation tend to be rare. In most cases, active participation is necessary to achieve the desired network effects.

One of the key principles of bootstrapping a network is to start with the most underserved users. These are the users who feel the problem most deeply and are willing to put up with any amount of friction to engage with the network. Token incentives can be a blunt instrument for targeting this underserved niche, as they can attract users who are primarily drawn to financial incentives rather than the near-term utility of the network.

When token incentives are misaligned with network utility, it becomes difficult to reach the required density of the right kind of users. This can lead to instant growth followed by a painful decline, as we've seen in the case of Looksrare and Sushiswap. Looksrare executed a "vampire attack" on Opensea by distributing LOOKS tokens for free to high-volume Opensea users. While this approach should have helped Looksrare scale its network, it instead led to user behaviors that weren't aligned with network utility, resulting in a collapse of genuine trade volumes.

Sushiswap also executed a vampire attack on Uniswap, with similar results. These examples highlight the importance of linking token incentives to network utility. Rewards should be restricted to specific, desirable actions that add value to the network, rather than simply incentivizing adoption.

To address this problem, networks need to focus on active participation and engagement from their user base. Scaling tactics should resemble those of active web2 networks like Roblox, rather than passive web3 networks like Helium. This requires careful consideration of the kind of network being built and how token incentives interact with network utility.

In conclusion, while token incentives can be an effective tool for bootstrapping a Web3 network, they have limitations that need to be understood and addressed. Three actionable pieces of advice to overcome these limitations are:

• 1. Start with the most underserved users: Identify the users who feel the problem most deeply and are willing to engage with the network despite any friction. These users are more likely to contribute to the network's utility and long-term success.

• 2. Align token incentives with network utility: Ensure that token rewards are tied to specific, desirable actions that add value to the network. This will attract users who are interested in the network's utility rather than just financial incentives.

• 3. Encourage active participation and engagement: Design strategies that encourage users to actively participate in the network and engage with other users. This can be achieved through features like chat rooms, collaborations, and shared experiences.

By incorporating these tactics, networks can overcome the limitations of token incentives and create sustainable growth and engagement within their communities.