Layer by Layer Issue 28: NEAR, Cosmos, and Solana

Economic incentives play a fundamental role in many parts of the crypto ecosystem as it exists today. This might seem obvious when looking under the hood of decentralized finance (DeFi) protocols, which frequently offer incentives to promote different types of behaviors when interacting with their applications. For instance, liquidity providers (LPs) are often incentivized to provide liquidity on decentralized exchanges (DEXs) with inflationary token rewards. Lending protocols might offer different rates or collateralization requirements to attract certain types of collateral. Some NFT marketplaces offer token rewards to incentivize trading, and gaming protocols do the same to encourage continued participation in their game economies. 

Misaligned incentives can result in predatory behavior that is destructive to a protocol, as seen recently on April 11th with the collapse of the synthetic asset protocol Ichi. One of the leading factors for the protocol’s downfall was the fact that the Ichi team created a pool on the permissionless lending platform Rari that allowed borrowing against the ICHI token, as well as LP tokens paired with ICHI, for up to 85% of collateral value. By also offering high token rewards for assets minted through collateral and coupling it with a mechanism to support ICHI price through concentrated liquidity, the Ichi effectively encouraged users to take on high leverage by lending ICHI or ICHI-paired LP tokens. In the end, this high leverage and volatility of the ICHI token resulted in a bank run as the Rari pool became severely undercollateralized, forcing liquidations that tanked the price of ICHI. As of this writing, the price of ICHI is down by over 98% from its all-time high.