Why Token Incentives Matter a World for the Web3 Economy

Today we live in the era of transition towards the Creator Economy.

We no longer want to passively observe how the world changes from afar without being a part of it. Instead, we crave to participate, co-create and leave our marks on something meaningful and innovative. Immersion and participation are becoming our new normal.

On the other hand, we also want to get the benefits of what we self-dedicate to. Alongside the possibility of participating, we seek to be the owners of our creation. The more we own, the more effort we are willing to invest.

The concept of incentives is poised to address all these needs. No matter what economic context we take - the conventional or crypto one - incentives are meant to drive passionate performance in exchange for fair rewards.

However, this article will focus mainly on crypto (token) incentives. I will walk through why they matter, what positive effects they bring both to startups and users, and the most common cases of their application.

Enjoy your reading and share your thoughts in the comments.

Let’s get started.

What are incentives in economics, and why do they matter?

First,  a bit of theory here.

In economics, incentives stand for potential gains offered for particular desired behavior patterns. Those gains come in many different forms - financial rewards, stock vesting options, job promotion, an honorable title assignment (like the employee of the year), etc. Incentives could even exist in the form of threatening some punishment for failure to do what’s required. These are called disincentives.

While the variety of incentive types is wide, they all have one goal in common - to push someone’s motivational button and get them willing to do something with the highest level of self-dedication. Therefore, incentives work closely together with motivation.

Essentially, there are two types of motivation: intrinsic and extrinsic.

Intrinsically motivated behaviors are performed because of the sense of personal satisfaction that they bring. In this case, the reward is the pleasure of doing the activity itself. You do something just because you love it, and it gives you dopamine.

Extrinsically motivated behaviors, on the other hand, are performed to receive something from others or avoid specific adverse outcomes. The extrinsic motivator is always an external factor: job promotion, money, likes from subscribers, gratitude, etc.

An ideal incentive design is that one that incorporates both intrinsic and extrinsic motivators altogether.

What is cool about token incentives?

Before we jump into uncovering all the potential superpowers of token incentives, please remember that we are discussing them here as a conception, which can be easily messed up in practice.

Incentives can have a positive impact only if they're appropriately designed and executed by a professional trustworthy team.

Now let’s assume that everything is in place. In that case, the importance of token incentives cannot be overstated. These tools would be indispensable for solving at least two critical tasks: a new network bootstrapping and aligning its participants to work together towards the network's growth and increased value of its token.

What is more, they could be far more effective and fairer than their conventional counterparts, i.e., cash and ESOPs (employee stock ownership plans).

Here is why:

Better than cash

Though cash is always a nice-to-have, it's not enough to make people want to entirely self-dedicate. Cash doesn't give them a sense of ownership and having their skin in the game. They got the cash - they are done. There is no upside potential behind it.

On the other hand, tokens represent a network's overall value. They are like slices of a common pie whose value in many aspects is defined by the amount of effort of its participants. The more they contribute, the higher-priced tokens can potentially get.

Another advantage of tokens over cash is that they could be used in more strategies for capital increase. As the crypto environment grows and matures, we will see even more income-generating options available with tokens but not possible with cash.

One can trade and swap their crypto into another crypto, put it on deposits, lend it out, provide as collateral to liquidity pools, stake it, build yield farming strategies, etc. In other words, even now, the possibilities for making money through crypto are wider than through cash and the potential upsides are way sexier.

Better than ESOP

Ok, now why is it better than ESOP?

For the uninitiated, ESOP is a short-hand for “employee stock ownership plan.” ESOP is an arrangement between a company and an employee that grants the latter the right to obtain the company’s shares or their value if particular conditions are met (a specific term of employment, KPIs, etc.).

As the ESOP concept has been existing already for decades, apparently, that was what has given the inspiration to the idea of token incentives.

At first sight, both ESOP and token incentives have a lot in common - they both motivate through ownership and the feeling of having skin in the game. However, if we look closer at how each applies in practice, we will see a whole different world between them. Unlike token incentives, traditional ESOPs are extremely clumsy, complicated, and pretty unsafe for employees.

When an employee resigns, the company often disputes their right to exercise ESOP. Just an example here that happened to my friend recently.

He was one of the key employees at a company. Once he decided to quit and implement his ESOP, the company started pushing him to undertake a bunch of obligations that were, to say the least, not in line with his interests (like a five-year ban on performing the same role as he had in the company). Otherwise, they would create for him a bureaucratic nightmare so that he would not be able to exercise his rights under ESOP within the term specified therein, and they would expire.

How do you like it?

That sort of manipulation is excluded in the case of token incentives. Tokens distribution is powered by self-executed smart contracts that are tamper-proof, i.e., eliminating the risk of any third-party interference and manipulations. Moreover, tokens are granted for a wider variety of activities and are way more liquid than a company’s shares (especially if it’s a private company).

So call token incentives ESOP 2.0 if you like ;).

Outcomes that token incentives help achieve. Perks for startup networks

Ok, now that we’re clear on token incentives' supremacy over their traditional counterparts, let’s look closer at what kind of positive outcomes they can bring to both networks and their users.

(i) Network bootstrapping at a low cost

Crypto networks are often moonshots. There are no best practices or accumulated knowledge for them to rely on while launching.  Often, networks' founders resort to traditional marketing strategies, like buying ads on social platforms, doing “cold” LinkedIn outreach and inviting strangers to "join their movement," involving Youtube influencers, and the like.

In most cases, none of that helps for successful network bootstrapping. Why?

Because the crypto world is an entirely different reality with its unique philosophy and standards. It requires an out-of-the-box vision and creative ways of doing things to align with its mission.

Why would Web2 ads work effectively for a new-gen Web3 reality? Trying to achieve something new while sticking with old-fashioned practices is the wrong approach at its core.

Regular (non-crypto) projects struggle to overcome the bootstrapping problem as well. However, for crypto startups, things get even more complicated. The key reasons are:

• lack of trust due to scammy image of crypto
• a network's value proposition is not clear (yes, this is a serious problem - crypto startups usually can't properly articulate what they do)
• lack of user engagement - a user is offered nothing more than just to “join and utilize a platform.” But what's unique and attractive about becoming a passive customer of yet another network?
• a squeamish attitude of dominant advertising platforms to anything crypto so that they can ban your advertising campaign any time they want.

Token incentives could help fix that. Instead of blind throwing out money on ads-based experiments with unpredictable outcomes, token incentives could make things more flexible and cost-effective.

Unlike ads, token incentives don't sell. Instead, they offer prospective users the potential upside of ownership and participation in a network's development. Therefore, they engage.

Another great advantage of token incentives is that they target the right prospects by default. When someone agrees to invest their skills in exchange for the offered tokens, it automatically makes them ideal network users. This category of users already trusts the network's mission and wishes to contribute. In the end, this could create a potential for a network’s viral growth: when users are motivated and engaged, they tend to invite other users to join the journey.

(ii) Great user retention rate

User acquisition is just the beginning of the story. Once they join, it's essential to retain and encourage users to continuously utilize the network's products or services for as long as possible. The key marketing metric tracking this goal is "user retention rate." Essentially, it reflects the percentage of users who continuously use a product for a certain period after joining it.

Failing to retain customers means that every new business will lose money and go bankrupt one day. Only by retaining users, any startup has a chance to strive.

Token incentives can help a lot here. When they are appropriately designed in a user-oriented manner and offer a wide range of utilization cases that align with users' needs, why leave the network?!

(iii) Effective community-based marketing

The larger the community, the more chances a network has to scale. The stronger people feel like an integrated part of a network, the more they are prone to evangelize its mission across the globe and convince others to join.

By aligning token incentives within the community, a network tremendously increases its chances for fast viral growth and boosts its “network effect” (sorry for the tautology).

(iv) Driving high-quality content creation

Incentives motivate digital creators (bloggers, YouTubers, artists, writers, etc.) to produce valuable and engaging content for a network’s audience. Nowadays, it’s no secret that content is king in marketing. In terms of conversions and brand awareness, it outperforms any ads and other existing marketing activities. Don’t trust me? Ask __Seth Godin __then.

However, the content should be done right. It must be data-driven, customer-oriented, and provide a lot of value. In other words, it must be high-quality content. Now how do you think who has more chances to deliver such content for a project - an outsourced stranger creator or that one who has ownership in it?

(v) Financing

I don’t mean here those shameless ICOs that we’d been evidencing throughout 2016-2018ish. Apparently, in those days, the industry had not been wise enough to foresee all the massive scams that had happened. The great concept of crypto crowdfunding was roughly abused.

However, things have impressively progressed since then, and new protected mechanics were offered to the market.

Essentially, I’m talking about “investors’ incentives.” We will cover them below in the next chapter in more detail. Here is just their outcome: they increase the chances of getting “smart money” when a project needs it. Because through tokens, you can offer investors way more perks than through any classical venture deal.

What are tokens given out for? Perks for users

There is a wide variety of activities network participants can be incentivized for. Below I will walk through the most common examples.

1. Co-development

Depending on the regularity and level of dedication, network development can be roughly split into leading, active and peripheral. The leading developers include those who guide the project, have been continuously involved in it for a long time, and have made significant contributions therein. Active and peripheral developers are those who participate occasionally. The difference is that active developers more often contribute new code to modify the source code, while peripheral developers do it sporadically and for particular task solving.

According to GitHub data on the date of this writing, over 130k open-source blockchain projects are available for collaborative development. The way they incentivize developers each time is different.

For example, Yellow Network allocates 30% of its token pool to those willing to participate in its ecosystem project development.

2. Mining activity

In proof-of-work (PoW)-related networks, miners usually receive two types of rewards: new coins created with each new block and transaction fees from all the transactions included in the block. To earn this reward, the miners compete to solve a complicated mathematical problem based on a cryptographic hash algorithm.

3. Co-creation

As we mentioned earlier, well-written and engaging content is the backbone of successful marketing these days. Content helps a project achieve better brand awareness, build a stronger rapport with users and convert them into loyal customers way more effective than ads. Content has an everlasting and a higher ROI effect, while ads lose their magic once their campaign term expires. Knowing about this tremendous potential of content, blockchain networks actively stimulate digital creators to produce videos, photos, graphics, blogs, and the like and distribute it across various channels like YouTube, Reddit, Discord, etc., to get more traffic.

Promotion and moderation

Besides creation, incentives are also given out for content promotion and moderation.

For example, Yellow will host user-generated reviews and news about crypto. Core systems to promote good-quality content will be user karma and upvotes. Yellow will offer a smart system where users delegate part of their karma to creators they upvote. More karma means more influence on the community and content. Each upvote will cost some amount of  YELLOW tokens. On upvote, 50% of a token would be burned, and another 50% would be transferred to a creator.

Data sharing

Creation is not only limited to content. As Paul Saffo has mentioned in his brilliant speech on the Creator Economy, we are engaged in co-creation not only when we produce videos, posts, and the like. The biggest act of creation happens when we share our personal data. By doing this, we shape a network and help it improve, accelerate, innovate and generate more income. Without data, most network/platform-type projects would be dead.

Privacy of personal data is one of the central values of the Web3 economy. Some networks manifest this by rewarding users for sharing their information with tokens.**
An example here:LUCE.

4. Investment

Currently, the variety of ways of incentivizing investors is not so rich. Essentially, they can be boiled down to the discounts given at the stage of token sales and burning mechanics that are purposed to boost token value by reducing existing supply.

However, recently, new forms of investor rewards started to show up. For example, I came across the idea of the so-called “success token,” which offers to provide investors with a call option alongside their token purchase.

“Success tokens” are two tokens wrapped in one: a project token with a call option on that token. This means that instead of offering the VC investor a discount, we offer the investor a call option alongside their token purchase. They pay the full price of the token for this package. The option portion is only valuable if the project rallies, which better aligns incentives: the VC investor only gets their “bonus” if the project performs well, which of course, benefits the whole community.

Instead of paying the VC investor a bonus upfront (in the form of a discount), the success token pays the VC investor a bonus only if good things happen. In fact, VCs will have doubled exposure as the price rallies. It’s a win-win.”

At some point, this approach reminds me of the convertible loan mechanism that is widely used in regular (non-crypto) venture deals. Essentially they mean that you can buy out shares at a discounted price when a particular financial event is triggered. Probably, this could work well for crypto, too; why not?

Other strategies to incentivize investors are those that leverage the possibility of earning passive income on their holdings. Essentially, these strategies are staking and yield farming relating to the DeFi segment.

Let’s briefly break each one down.

Staking

Staking is the act of posting certain crypto assets as collateral to participate in the operation of a blockchain. As compensation for locking up holdings, users receive regular rewards in a manner similar to interest payments. Staking is useful for blockchains that operate a proof-of-stake (POS) consensus mechanism.

For example, Yellow offers “broker staking pools.” Investors can delegate their token to a broker and take a revenue share of the trading fees of the broker.

Yield Farming

Yield Farming is a complicated strategy to maximize a rate of return on capital. It implies that users could shift their tokens between different DeFi protocols to chase higher yields.

Super risky, but returns are insane.

4. Other “X-to-earn” activities

The sky's the limit for the types of users' activities that can fall under incentivizing. Apart from those described above, the Web3 economy keeps constantly experimenting and offering new motivational designs that could be broadly named "x-to-earn" incentives.

These are participate/play/learn-to-earn) (network participants, community members), contribute-to-earn (bounty hunters, service contractors), invest-to-earn (token holders), work-to-earn, and the like. They are all examples of community members participating as individual value providers based on their unique skills and earning income for their contributions.

Final thoughts

Token incentives are the key drivers of Web3 economy development. They create favorable circumstances for new projects to successfully launch and grow and give users unlimited opportunities to monetize their passions and skills multifacetedly. Undoubtedly, this is a win-win deal for everyone involved.

ByJulie Plavnik for Yellow Network

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