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Part I: What is Token Economics?
Part II: Top Token Economic Models
Part III: Systematic Token Economic Issues
Part IV: A Guide to Creating a Token Incentives
The goal of this post is to give you a basic understanding of the above token economic issues plaguing Blockchain and DAG projects. Self-interests aren’t purely profit-driven. A person’s (or organization) self-interests could revolve around a social cause, spirituality (religion), personal ideology, or family. The reason world Superpowers trust the American Dollar, and Chinese Yuan as consistent stores of value, a financial commodity, and reliable medium of exchange is because they are both integral to interacting with the global financial system.
Let’s look at Bitcoin. It is the most trusted cryptocurrency on the market because it hasn’t fallen victim to a successful 51% attack, launched the entire cryptocurrency space and has multiple use cases: best “crypto” store of value for ICO projects and crypto investors, defacto medium of exchange on most (if not all) crypto exchanges and the interests of miners and cryptocurrency traders (big and small) align around it maintaining a healthy community and asset value.
Lack of Trust:
Trust is the currency of all relationships, households, organizations, businesses, and governments. Since we can’t touch trust, we have turned to money to represent it in the physical form. Having currency in a physical form is an inherent issue for crypto-currency because you can’t actually touch it. With the barrier of being non-physical money, cryptocurrency creators have to create real “use-cases” for their crypto-currency.
The lack of trust comes in due to Blockchain creators poorly explaining their technology into layman’s terms, poor token allocation, and inadequate separation of concerns and debugging practices. When you are creating a blockchain solution ask yourself: “How will my community feel if I own 60% of tokens?” or “If I guaranteed they would get a 10X return, will I reach my funding goal?”. Just be a human and think about how you would want someone to treat you if you were a potential investor, miner, or advocate.
Lack of Uses Cases:
My general rule of thumb is to avoid creating a token unless you have at least three “realistic” token use cases-which evolve around specific behavioral incentives. If you don’t have multiple strong use cases, your coin will only be good for two things: ICO pumping and dumping. Let’s look at Ethereum: Ethereum is used to pay gas fees (utility token), a store of value for ICO fundraisers, widely accepted wallet protocol, and an investment vehicle for crypto-traders.
NEO has multiple use cases as well: on-chain voting, smart contract execution, and an interest-bearing token giving you free NEOgas for holding. NEOgas is used for paying smart contract execution fees (utility token).
I know this looks pretty straight-forward. However, most newly minted tokens fail the use case test-MASSIVELY. To make sure you are producing a token with real value, write down all market participants who could benefit from your token and then list their adjacent self-interests-more is usually better.
Steps For Avoiding Poor Use Cases:
Step 1: Determine each party who would benefit from using the token
Step 2: Determine each parties’ self-interest which would drive them to use your token
Step 3: Determine how you would align each parties’ interest (Detailed explanation in next section)
Step 4: Determine potential bad token behaviors
Step 5: Determine how to stop bad token behaviors
Step 6: Determine how a blockchain or smart contracts could be used
Here’s an “fake” token called Supply Chain-Token:
Step 1: Supply Chain tokens’ interested parties are retail manufacturers and wholesalers, retailers, and retail consumers. I’ll make it simple.
Step 2: Retail manufacturers and wholesalers, retailers, all want profits, Retail consumers are driven by the “best deals” (value or low cost) or in economic terms, consumer surplus.
Step 3: Manufacturers, wholesalers, and retailers would be attracted to using the token for lowering transaction fees, reducing inventory turnaround time, inventory wastage due to theft, or undersold inventory. Retail customers would be attracted to lower transaction fees or “token discounts” for making purchases in native token.
Step 4: Manufacturers, wholesalers, retailers, and retail consumers could perform double spending attacks to reduce their distribution fees and retail consumer costs further.
Step 5: The Delegated Proof of Stake model could be used to reduce the ability to perform 51% attacks (double spending) by requiring all master nodes to stake 10% of their portfolio for all transactions and are rewarded with more tokens for verifying legit transactions or lose their stake for verifying fraudulent transactions.
Step 6: A distributed open ledger of retail transactions across entire supply chain participants could be used to track inventory, provide data for improving supply chain management constraints. Smart contracts could be used to automate payment processes for bill payment between all market participants.
Misalignment of Self-Interests
Here’s where the rubber meets the road. When we look at the American Dollar, it’s been able to remain a dominant fiat currency because all parties’ (Federal Reserve, Banks, IMF, US and other governments, &, etc.) interests align on their dependence of the Dollar remaining valuable.
Let’s go with the example above-the Supply Chain token. How could we align the interests of retail consumers with the “profiteers.”
Ways to Align Each Party’s Self-Interests:
1. Supply Chain management education for consumers
2. Lower transaction fees
3. Provide discounts for transacting in Supply Chain tokens
4. The blockchain is used to track counterfeit products
5. 5% of all tokens in existence will go towards charity or social cause
What if retail consumers fully understood how applying blockchain tech to retail could lower their cost per purchase. This alone could align retail consumers’ interests to all “profiteers”.
Bitcoin Aligns Interest:
1. A Bank replacement
2. Restricted currency supply
3. Borderless Monetary System
4. Immutable and distributed ledger
5. Traceable transaction history
If you notice, these interests are not “profit” driven but evolve a specific ideology of independence from government regulation. This is why the first users of Bitcoin were so small because it wasn’t made to appease everyone, only people who believed in the core ideology driving it. Aligning interests is all about creating a token with embedded interest alignment for all parties who will use your token.
In part four, I will walk you step by step behind creating a basic token economic model. If you have any recommendations on my analysis, feel free to share. I am not a financial advisor, and this is not investment advice. If you are interested in learning more about crypto. Subscribe to my newsletter here for latest crypto industry updates.
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