Token Incentives and Platform Competition : A Tale of Two Swaps

Platforms compete intensively to attract users. Monetary subsidies are commonly used to incentivize users’ adoption, but such subsidies are expensive. In this paper, we study the impacts of token incentives, an alternative incentive approach, in the competition of two decentralized exchange platforms. Decentralized exchanges enable the exchange between a pair of crypto tokens through a liquidity pool, among many liquidity pools on a decentralized exchange platform. The platform depends on liquidity providers to supply liquidity that facilitates transactions, which makes the amount of liquidity supply the key to platform success. In our context, the entrant platform, Sushiswap, launched token incentives to attract liquidity providers from the incumbent, Uniswap, who then also retaliated with its own token incentives. Our empirical analysis of the two platforms shows that Uniswap’s own token incentives attract more liquidity to the platform. Surprisingly, we find that the token incentives from the competitor, Sushiswap, also bring more liquidity to the incumbent. Regarding potential mechanisms, we find that the increased liquidity of Uniswap mainly comes from the increased number of liquidity providers. The token incentives from the competitor Sushiswap may have brought more new liquidity providers to Uniswap. Meanwhile, the incentives from Sushiswap may also impose a competition effect that decreases the amount of liquidity per provider on Uniswap, as existing providers shift liquidity to Sushiswap to harvest the rewards from both platforms. The heterogeneity analysis reveals that high-volatile pools benefit less from the competitor's token incentives relative to more-stable pools. Our results provide important insights and practical guidelines on the design of token incentives in platform competition