The combination of tokens and innovative products has been proven to effectively alleviate the cold start problem. However, this strategy also brings new challenges: how to achieve sustainable user retention and activity in the face of short-term liquidity waves brought about by speculation and non-organic user groups?
Marketplaces and networks that are tokenized early (or before establishing sufficient organic demand) must find product-market fit (PMF) within a tight timeframe, otherwise they will deplete the chips needed for subsequent business growth.
My friend Tina calls this the “hot start problem”, as tokens limit the time window for early-stage companies to find PMF and gain sufficient organic traction, making it difficult for them to retain users and liquidity when token rewards decrease.
Applications launched through a points system also encounter the hot start problem, as users have potential expectations for tokens.
I really like the framework of the “hot start problem” because the core difference between cryptocurrency and Web2 is the ability to use tokens (financial incentives) as a tool to bootstrap new networks.
This strategy has been proven effective, especially for DeFi protocols such as MakerDAO, dYdX, Lido, and GMX. Token bootstrapping has also been proven effective for other crypto networks, from DePIN (e.g., Helium) to infrastructure (e.g., L1), to certain middleware (e.g., oracles). However, networks that choose to solve the hot start problem by using tokens for rapid expansion face several trade-offs, including the confusion between organic growth/PMF, the premature consumption of chips needed for subsequent growth, and operational resistance caused by DAO governance.
Choosing Hot Start
Hot start is preferable to cold start in two cases:
1. Startups competing in red ocean markets (highly competitive markets with known demand).
2. Passive networks or products.
Red Ocean Markets
The core drawback of hot start is the inability to determine organic demand, but this problem is mitigated when establishing a strong product-market fit category. In this case, late entrants to the market have the potential to compete with early market entrants by launching tokens early. DeFi is an area where late entrants have overcome the hot start problem most successfully, effectively using tokens to guide users and liquidity into new protocols. While BitMEX and Perpetual Protocol were the earliest to launch perpetual contracts in centralized and decentralized exchanges, later entrants such as GMX and dYdX quickly guided liquidity with token incentives and became leaders in the perpetual contract space. Newer DeFi lending protocols like Morpho and Spark have successfully guided billions of dollars in TVL. Today, when new protocols have clear market demand, tokens (and points) are the default option for liquidity bootstrapping games. For example, liquidity staking protocols actively leverage points and tokens to increase liquidity in a highly competitive market.
In the consumer crypto space, Blur demonstrated a strategy for competing in red ocean markets through its marketplace-defined points system and token issuance, making Blur a dominant Ethereum NFT trading venue in terms of trading volume.
Passive vs Active Networks
The hot start problem is easier to overcome in passive supply networks compared to active supply networks. The history of token economics shows that tokens are very useful in guiding networks when users can passively participate, such as staking, providing liquidity, listing assets, etc.
On the other hand, although tokens have successfully launched active supply networks such as Axie, Braintrust, Prime, YGG, and Stepn, the early appearance of tokens often confuses the true product-market fit in active supply networks. Therefore, compared to passive supply networks, the hot start problem is more difficult to overcome in active supply networks.
The problem here is not that tokens cannot play a role in active supply networks, but that applications and markets that introduce token incentives for tasks performed by users (usage, gaming, services, etc.) must take additional measures to ensure that token rewards are used for organic use and drive important metrics such as engagement and retention. For example, the data labeling network Sapien gamifies labeling tasks and allows users to stake points to earn more points. In this case, passive staking while performing certain operations can serve as a loss avoidance mechanism, ensuring that participants provide higher-quality data labeling.
Trade-offs of Hot Start
Speculation is a double-edged sword. Introducing token incentives too early in the product lifecycle can be a strategic mistake. But if this mechanism is strategically harnessed, it can also be a powerful feature and growth tool to attract user attention.
Startups that issue tokens before gaining organic traction do not solve the cold start problem but instead face the challenges of hot start. They weigh the pros and cons of using tokens as incentives to attract user attention, hoping that their products will gain organic traction amidst the speculation frenzy.
