A brief discussion on the “hot start” of Web3 startup projects: How to balance speculation and natural demand?

Original author: Mason Nystrom

Original translation: Luffy, Foresight News

The combination of tokens and innovative products has been proven to effectively alleviate the cold start problem. However, this strategy also raises new challenges: how to achieve sustainable user retention and activity in the face of short-term liquidity waves brought by speculation and those user groups that do not grow organically?

Marketplaces and networks that launch with tokens early on (or before building enough organic demand) must find product-market fit in a tight timeframe, or they will burn through the cash needed for subsequent business growth.

My friend Tina calls this the “hot start problem”, where tokens limit the window of time in which startups can find PMF and gain enough organic traction, making it difficult for startups to retain users and liquidity when token rewards decrease.

Apps launched through a points system also suffer from a warm start problem because of the latent expectations of users for the tokens.

I really like the framing of the “hot start problem” because a core differentiator of cryptocurrency compared to Web2 is the ability to leverage tokens (financial incentives) as a tool to bootstrap new networks.

This strategy has proven to be effective, especially for DeFi protocols such as MakerDAO, dYdX, Lido, GMX, etc. Token bootstrapping has also proven to be effective for other crypto networks, from DePINs (such as Helium) to infrastructure (such as L1) to certain middleware (such as oracles). However, networks that choose to solve the hot start problem by using tokens for lightning expansion face several trade-offs, including confusing organic growth/PMF, premature consumption of chips required for subsequent growth, and operational friction due to DAO governance.

Select Hot Start

A hot start is better than a cold start in two situations:

• Startups competing in a red ocean market (a market with intense competition and known demand);

• Passive network or product.

Red Sea Market

The core disadvantage of a hot launch is the inability to identify organic demand, but this problem is mitigated when building a category with strong product-market fit. In this case, latecomers have the potential to successfully compete with early market entrants by launching tokens early. DeFi is the area where latecomers have overcome the hot launch problem the most and can effectively use tokens to bootstrap users and liquidity into new protocols. While BitMEX and Perpetual Protocol were the first centralized and decentralized exchanges to launch perpetual contracts, later entrants such as GMX and dYdX used token incentives to quickly bootstrap liquidity and become leaders in the perpetual contract space. Compared to first movers such as Compound, newer DeFi lending protocols such as Morpho and Spark have successfully bootstrapped billions of dollars in TVL. Today, when there is a clear market demand for a new protocol, tokens (and points) are the default option for the liquidity bootstrapping game plan. For example, liquidity staking protocols actively use points and tokens to increase liquidity in a competitive market.

In the consumer cryptocurrency space, Blur has demonstrated a strategy to compete in a crowded market through its market-defining points system and token launch, which has catapulted Blur into the dominant Ethereum NFT trading venue by volume.

Passive and Active Networking

The hot start problem is easier to overcome in passive supply networks than in active supply networks. The history of token economics shows that tokens are very useful in bootstrapping networks when users can participate passively, such as staking, providing liquidity, listing assets, etc.

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 in active networks is more difficult to overcome than in passive networks.

The issue here is not that tokens have no role to play in active networks, but rather that applications and marketplaces that offer token incentives for tasks that users actively complete (usage, games, services, etc.) must take additional steps to ensure that token rewards are used for organic usage and drive important metrics such as engagement and retention. For example, the data labeling network Sapien gamifies labeling tasks and lets users stake points to earn more points. In this case, passive staking while performing certain actions has the potential to act as a loss aversion mechanism, ensuring that participants provide higher quality data labels.

Hot Start Tradeoffs

Speculation is a double-edged sword. If token incentives are introduced too early in a product’s life cycle, it is likely to be a strategic mistake. But if this mechanism is used strategically, it can also be a powerful feature and growth tool to attract user attention.

Startups that choose to issue tokens before gaining organic traction have not solved the cold start problem, but instead face a hot start challenge. They weigh the pros and cons of using tokens as an incentive to attract user attention, hoping that the product will gain organic traction amidst the speculative noise.