Prominent DeFi projects such as Uniswap, Curve, Aave and MakerDAO have declined inETHbasis since at least the first quarter of 2021. Some see this as a fundamental failure of the DeFi protocol to gain value and create a moat. Some wonder if the composable and open nature of crypto is preventing sufficient moats from being created at all.
I disagree with this; I think the DeFi project is poor at creating sticky rewards and utility with tokens.
In traditional markets, reward and utility schemes are called loyalty reward programs. In this article, I argue that a loyalty rewards program could not only create a moat, but could become the core business of a DeFi project. The reason this has not yet happened is because of a lack of understanding of the proper use of loyalty rewards programs. To support both parts of this argument, I will examine the airline industry.
Increased Air Mileage
Modern frequent flyer programs (FFP) were first introduced in the late 1970s. Although airlines had programs that tracked customers before then, the major innovation of the modern frequent flyer program was the use of mileage tracking to reward passengers. This was a clever marketing tool designed to create loyalty among the most profitable customers, the frequent flyers.
Since then, it has become more than a tool to increase customer stickiness; FFP has developed into a major source of revenue for airlines. For example, according to this paper on the frequent flyer program, Qantas’ frequent flyer program accounted for 23.2% of its profits in the 2017-2018 financial year, and Overall Qantas Group
FFP now extends beyond the air travel industry to include tourism, banking, telecommunications, insurance and retail. Air miles have become an economy unto themselves, acting like a virtual currency. Sounds familiar, doesn’t it?
Why encrypted loyalty tokens are better than traditional ones
Air miles are the closest thing to money among traffic loyalty points, but they are only accepted by participating partners and have minimum thresholds for redemption, expiration dates, etc. The key innovation of loyalty tokens in the crypto world is that they are equivalent to real money because they can be easily redeemed for fiat. This means that loyalty points in the crypto world have the same power as real money in acquiring customers and motivating customer behavior. For projects that do not have access to the hundreds of millions of dollars of VC runways, loyalty programs represent a tremendous opportunity.
The Failure of Loyalty Programs in Crypto
My thinking on this is partially informed by this article in the Harvard Business Review article on loyalty rewards programs. This quote summarizes the mistakes that some loyalty programs in the legacy and almost all crypto markets are making:
“A great many companies treat rewards as short-term promotional giveaways or specials of the month. Rewards approached that way can create some value by motivating new or existing customers to try a product or service. However, unless designed to build loyalty, rewards will at best return only a fraction of their potential value. This requires developing a system that continually educates and motivates customers to earn the rewards that loyalty brings. A strategic, sustained approach is needed to achieve sustained loyalty measured on an annual basis.”
Key Lessons”
These are the most salient ideas I gleaned from the aforementioned HBR article. I am confident that as more projects begin to internalize these lessons, they will create and sustain project value.
The value created must outweigh the cost of the rewards provided.
This seems obvious, but many (perhaps most) DeFi projects with a loyalty component violate this first principle. Typically, the playbook is to offer a very high APY for staking in the hopes that the liquidity launched will stay and the project will achieve critical mass. In reality, however, mercenary participants will abandon your tokens and move on to the next high-APY project the moment your rewards are depleted.
The only way to avoid this is good old-fashioned product-market fit. You can bootstrap growth with loyalty tokens as an incentive, but customers need a reason to stay.
Rewards need to reinforce customers’ beneficial behavior.
High APY staking rewards are a widespread example of maladaptive incentives. In fact, billion dollar crypto companies are putting hundreds of millions of dollars into new crypto projects, sucking all the value out of them, and moving on to the next project. Your reward is teaching participants to do harm to your project. Make sure your rewards encourage behaviors that are beneficial to your project.
Do you want your good customers to actively participate in governance and thereby feel psychologically invested in the long term? Consider the possibility of rewarding them for their suggestions, votes, and community outreach.
Customers are not equal.
It is common for DeFi projects to integrate a tiered reward system, but too often rewards are distributed linearly. A more effective model is to make the tiered rewards top-heavy. This provides a compelling reason for your most valuable customers to stay with you, but also provides a powerful incentive for lower-value customers to move up the ranks.
Rewards should be aspirational.
From the HBR article
“Companies that offer average value products and services to everyone oversatisfy less profitable customers and under-satisfy more valuable loyal customers, thereby wasting resources. The results are predictable. Highly profitable customers with higher expectations and more attractive options will disengage.”
I have been repeatedly struck by some of the pedestrian rewards on some projects, such as Netflix, Hulu, or Amazon Prime one month subscriptions. Does that motivate people, let alone high-end crypto users? It certainly does not for me.
What about rewards like a bottle of Yamazaki 12 year whiskey or a new M1 MacBook Pro? A few quality rewards sounds more appealing than a constant drip of mediocre rewards.
It is often joked that crypto is speedrunning the entire history of the legacy financial system. I don’t think this is limited to financial markets. Loyalty program work done in legacy markets provides a proven path to loyalty and profitability. I am confident that crypto projects will speed run through them to win in a short period of time.
Dennis Jarvis
Chief Executive Officer Bitcoin.com
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Dennis is an accomplished executive who is passionate about building a team of talented individuals and promoting economic freedom through the adoption of cryptocurrencies. Dennis joined Bitcoin.com in 2018 as Chief Product Officer and became CEO of Bitcoin.com in 2020.
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