Are Airdrops Effective in Building Strong Communities?

If you’ve been following our blog posts about the value of curated token distributions, you’ll know that getting tokens into the hands of value-added community members is critical to bootstrapping growth.

One popular method of token distribution has been token airdrops. A project airdrops (or distributes) free tokens into crypto wallet addresses of recipients that have met certain prerequisites, completed certain tasks, or been early adopters of the protocol.

But just how effective are airdrops at galvanizing new users and building quality communities? What are the risks associated with airdrops? And how can they be improved?

Let’s dive in.

1. What is an airdrop and how does it work?

In most cases, an airdrop is distributed to users in exchange for completing certain on-chain tasks indicative of protocol usage (e.g., interacting with a smart contract, minting a specific NFT, staking tokens). Thanks to the transparency of blockchains, protocol activity can be adopted for curating airdrop recipient selection. On-chain activity is recorded within a specific timeframe, after which a snapshot is taken to determine airdrop eligibility. Users can claim their tokens on the protocol site, or, in some cases, have tokens airdropped directly into their wallets.

2. Why do projects do airdrops?

Short answer: User acquisition and awareness.

Long answer: Building crypto networks is hard, and for a protocol to be successful, it needs validators who run nodes that secure the network, token holders that feel empowered to participate in DAO governance, developers that build on top of the protocol; the list goes on. Bootstrapping all those processes boils down to one thing: quality communities. So how do you overcome the cold start problem and build an engaged community?

Unless you’re an already established project, attracting new users is very difficult and allocating tokens via airdrops is one way to do it. In the Web3 space, tokens often come with governance rights that confer the authority to vote on the protocol’s development. As a result, airdrops can enable users to create value while having skin in the game.

A properly executed airdrop to a well thought-out group of recipients can attract good users, reward the community for their efforts, and help projects ensure they have an active and aligned group from day one. Two examples:

• Uniswap: Perhaps one of the most well-known airdrops in recent history, Uniswap issued 400 UNI governance tokens to anyone who had used the protocol before a certain date in 2020. This was at once a move towards decentralization and a move to keep up with their rising competitor, SushiSwap. While post-airdrop sell pressure saw the token drop from ~$6 to ~$2, those who held on to their tokens saw a dramatic increase, reaching highs of $~42 about 8 months after the airdrop (the token trades at ~$6 in the bear market today). At one point in 2021, those airdrop recipients that held on to their UNI tokens from 2020 were sitting on roughly $12,000 per user following the explosive growth of the platform.
• Ethereum Naming Service: The Ethereum Name Service (ENS), a protocol that sells nonfungible tokens (NFTs) of domains representing wallet addresses, generated massive buzz within the crypto community in November of 2021 after it airdropped tokens to its users. ENS NFT holders (the recipients) reported allocations worth upwards of $20,000, and the project’s market cap shot up to above $500 million. The airdrop required a number of governance steps prior to claiming tokens, and an overnight price surge had traders eyeing valuations in the tens of billions.

3. The challenges with airdrops

Despite their popularity, airdrops have their share of major flaws and risks for both projects and users. On a high level, the challenge with airdrops is to avoid devaluing the token and distributing tokens to a large group of freeloaders with no interest in contributing apart from receiving the airdrop and dumping the token at the first opportunity.

The challenges for projects:

• Flaky communities: Because airdrops happen on-chain, there are few reliable ways for a project to evaluate a recipient’s on-chain reputation. This creates two problems: 1) airdrop farmers and Sybil attackers who game the system to receive outsized airdrop allocations, and 2) unengaged users who may not be well-educated on the token utility or committed to the development of the protocol.  Without sufficient “buy-in” from the token recipients (as is the case with token sales) or existing widespread confidence in the protocol, tokens are often dumped immediately, causing price crashes and harm to the overall ecosystem.

The challenge for users:

• Pump and dumps: Because recipients receive free tokens in their wallets, there have been multiple airdrops that are nothing more than pump-and-dump schemes. More specifically, the creator distributes a token and hopes there will be enough hype surrounding it to have it listed on an exchange. Once tokens begin trading, the creator sells their sizable portion of tokens, potentially crashing the price.
• Phishing attacks: In some cases, scammers may try to airdrop fictitious tokens to a user’s wallet to prompt them to visit a phishing website. How it works in a nutshell: Scammers send a useless token, which can't be rejected by the recipient. The user is then directed towards a website that claims to be a decentralized exchange where they can supposedly sell the tokens they’ve been given. The site asks users for permission to access their Metamask crypto wallet. If the user approves, the scammers can drain their funds.
• Privacy attacks: Another attack vector is the so-called dusting attack. A scam project will send a small amount of cryptocurrency to an unsuspecting group of users to erode their privacy. Then, the attacker will track down the transaction activity of a recipient’s wallet to de-anonymize the person or company operating the wallet. The amount of tokens sent is so small that they are barely noticeable.

A few examples of airdrops gone wrong:

• Optimism: To many, airdrops are nothing but free tokens, most recently illustrated by the botched Optimism airdrop that saw the OP token down over 70% with many airdrop recipients immediately selling the freshly claimed tokens. Notably, Optimism was able to successfully work around a substantial number of Sybil addresses by identifying duplicate accounts, reclaiming the airdropped tokens, and redistributing to other addresses. Nevertheless, airdrops need a better way to identify recipients and incentivize them to use the tokens.
• Ribbon Finance: In 2021, a researcher at a VC firm was revealed to have initiated a Sybil attack on the RBN token airdrop - creating dozens of wallets that met the minimum eligibility requirements and selling the airdropped tokens to net a profit of hundreds of ETH - worth millions of dollars at the time. While the funds were ultimately returned to the protocol after suspicious activity was circumstantially identified, this airdrop unveils the potential challenges of having to deal with Sybil attacks which can compromise the faith users place in airdropped tokens and raise additional questions around the quality of the recipients.

4. How can airdrops improve to overcome these challenges?

So, are airdrops effective tools for galvanizing new users and building communities? They can be, if done right. As we look to the future, we believe that airdrops will need to become significantly more curated to be successful in the future.

Projects launching tokens will need to confirm users’ on-chain reputation and focus on users with proven track records of contributing to protocols, rather than airdropping to misaligned users that dump tokens at first opportunity.

Curated airdrops may be part of a broader movement of curated distributions where recipients are determined by their value-add activities and on-chain behavior. This, in turn, should lead to more engaged communities.

To learn more about the future of token distribution models, and what products CoinList offers to make them possible, click here.

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