Incentives play a crucial role in driving DeFi growth and adoption.
In recent years, we've not only seen a wider range of behaviors being incentivized (swap crypto, supply assets, follow on social,…) but also a surge in different reward distribution methods.
So, you’ve got an incentive budget and you know what actions you want to encourage — now, how do you spend it to maximize ROI on every dollar invested?
What’s the best incentive distribution method?
The 3 incentive distribution models
1. Linear split with variable APR
This is the most common system you'll see.
Let’s say you have 10,000 tokens to distribute over 100 days — which means 100 tokens per day. In this variable APR model, the amount each participant gets is proportional to the liquidity they contributed that day, with the 100 tokens being split accordingly.
For example, if the incentive program targets liquidity in a pool, with two liquidity providers (LPs) each contributing $100 at the start of the day (50%/50%), and a third LP adding $200 midday (25%/25%/50%):
- The first two LPs each get 50 tokens for their contribution in the first half of the day, then 25 tokens each for the second half.
- The third LP, who contributed $200 in the second half, receives 50% of the rewards for that period, which is 50 tokens.
This distribution method is based on time-weighted liquidity in the pool. In these campaigns, every new participant dilutes the yield for others—like dividing a pizza of the same size into more slices.
2. Fixed APR campaigns
This distribution method is straightforward, as users know exactly how much they earn. For each $1 of liquidity provided per day, users earn a fixed amount of rewards, regardless of what others contribute.
The key limitation here is the budget allocated by the campaign creator, which impacts the campaign’s duration.
For example, if you offer $1 in rewards per $100 in the pool per day, and the pool has $100, it costs you $1 daily. If $100 million are deposited into the pool, the cost jumps to $1 million per day!
Thus, in fixed APR campaigns, new entrants don’t impact the reward earned per user’s liquidity but shorten the overall earning duration.
This distribution method is widely used in point systems. Users earn X points for completing a specific action, regardless of how many others are doing the same.
However, when distributing points, your budget is effectively unlimited; you can allocate as many points as you want, allowing the campaign to last indefinitely.
That said, when dealing with points, since they may convert into a token allocation for an airdrop, each new point awarded can dilute users' final airdrop share. Thus, even with a fixed APR, the value is often diluted among all participants.
All in all, when launching fixed APR campaigns, it’s key to monitor the spending pace of your campaigns!
3. Event-based rewards
This distribution method is used by quest platforms like Galxe, Layer3, and Intract, where users complete specific actions to unlock rewards, such as following an account, joining a Discord, or visiting a website.
In DeFi, this would look like campaigns targeting trading volume, such as swapping 10 USDC to earn 1 token reward.
The difference with fixed APR campaigns is that there’s no time component; there’s no need to deposit liquidity for a certain period to receive rewards. You simply need to complete an event.
Quest platforms have innovated by offering a mix of events to unlock rewards. The problem with these campaigns is they’re often vulnerable to Sybil attacks and fake accounts engaging in wash trading, especially when there's high volume.
These campaigns typically have a predefined budget, and each new participant reduces the available funds.
Benefits and drawbacks
The goal of any incentive program for the campaign creator is to attract as much capital or as many users as possible, with minimal cost. On the other hand, users aim to maximize the return on their assets.
It’s all about finding the right balance.
Benefits and drawbacks of fixed APR campaigns
Fixed APR campaigns have drawbacks, as they don’t allow for 'price discovery', meaning it’s hard for campaign creators to determine the lowest APR at which users will still participate.
However, these campaigns provide a high level of predictability, allowing users to clearly anticipate how much they can earn over a given period.
Benefits and drawbacks of variable APR campaigns
Variable APR campaigns can be highly effective for protocols as they enable APR tolerance discovery.
However, during the discovery phase, protocols often end up overpaying.
For example, if a protocol starts distributing $1000 in daily incentives to a pool with only $10 in liquidity because the opportunity isn’t noticed in the early days, the APR can skyrocket to millions of percent. This is what happened during the early days of DeFi Summer in 2020, when APRs soared above 1000%!
Benefits and drawbacks of event-based campaigns
Finally, as we've seen above, event-based rewards are the simplest since they remove the time factor — users only need to perform an action to earn rewards. However, they are vulnerable to Sybil attacks.
What’s next?
Going forward, the next iterations of distribution methods should focus on optimizing the cost of attracting capital, user returns, and the anticipation of future returns. Idea can be to combine different methods, like capping variable APR campaigns or creating fixed APR campaigns with dynamic daily adjustments for better discovery.
Imagine a campaign with a variable APR that guarantees the campaign creator will never reward liquidity at more than a 30% rate!