For short-term returns and long-term development, Token design is based on basic principles

Original title: "Short-term return and long-term development, token design from basic principles"

Original source: FastDaily

In the past two years, many agreements have established Token economic models. In order to allow investors to put money in, many projects that focus on making money have designed economic models that consider short-term returns and sacrifice lost long-term sustainability.

But we all know that we can’t live until the next wave of encryption comes, and the winter season is very suitable for Builders to settle down and design a well-founded Token , these designs can provide sustainable results for next-generation protocols.

In our content today, we provide builders with a new perspective. Discussions start from our belief that protocol tokens should follow two basic design principles.

Token economics should reconcile public benefits that are difficult for participants to provide effectively and economically on their own. Token economics should direct value to those who create value, and prioritize value distribution to high-utility groups rather than value transfer between participants.

Similar to the "Liquidity Mining" framework, these design principles are based on the basic idea of rational and value-maximizing economic exchange. There is no free lunch in the world, short-term gimmicks are often at the expense of long-term value. Both project owners and us participants should look for designs that clearly create and distribute fundamental value, and be skeptical of designs that do not.

OK The Importance of Economic Models

The definition of the term "Token Economics" is vague and fascinating. It is a catch-all term that includes all of the following design categories:

Initial supply and distribution to teams, investors, community and other stakeholders

Including distribution methods for token purchases, airdrops, grants, and partnerships

Revenue distribution between users, service providers, and protocols

Funding scale, structure, and expectations Uses

Including inflation, minting/burning rights and issuance plans for supply caps

Token governance including voting, custody, pledge weighting, attribution and measurement standards

Compensation for miners and verifiers such as fees and fines,

The use of protocol native Token and external Token (such as ETH , USDC)

In this article, we will regard "Token Economics" as Token-based incentive distribution. We focus not on individual and operational issues, but on defining first principles. Based on these principles, protocol designers can answer each question based on the most pressing trade-offs and concerns for their particular product.

Principle 1: Provide public interest

First of a strong token economics model A core principle is the ability to deliver public benefits. A good design should address the problem of collective action, organizing and motivating participants to collectively provide services that cannot be generated by individual actions.

Without a reward system, no participant is willing to provide security for the network. But with a reward system, that decision-making changes. Participants stake for individually rational reasons, but collectively they provide benefits that can be enjoyed by all.

The public interest in crypto is motivated by the same motivations as taxpayer-funded goods and services such as public transportation, national defense, or public schools. In both cases, a well-designed public good typically has the following properties:

Positive net utility: total benefits to the community as a whole exceed total costs.

Cannot be privatized: it is not economical for the individual to provide the item due to direct and coordination costs.

Principle 2 : Combining rewards with value creation

The second core principle of a sound token model is the ability to compensate individuals for the value created (and destroyed). In other words, a good design creates a clear and salient link between action and reward, maximizing incentives to create value.

At a high level, compensation (and punishment) for any participant in the system can theoretically be broken down into two parts: Provides value obtained) and non-consistent (anything else). For example, the benefit of slashing a dishonest validator would be consistent, since the cost is associated with the change in value (in this case, the loss). In contrast, giving random validators a large token bonus would be inconsistent since there is no value to justify that reward.

While this is simple in theory, it is much more complicated in practice. First, any interaction within the system is often shared responsibility by multiple parties, and attribution is not always measurable. Second, the rewards for many key actions are remote (e.g., distributing community grants, establishing long-term partnerships, etc.), making it difficult to develop clear incentives up front. Nonetheless, we believe this is a key principle that protocol builders should strive to achieve.

Furthermore, there is a strong link between consistent compensation and long-term value maximization. When protocol designers choose between optimizing short-term target metrics and long-term utility, two trends emerge in practice:

"Consistent" health: Consistent compensation incentivizes risk or cost commitments and other forms of long-term investment. Conversely, inconsistent compensation incentivizes employed capital, which tends to preserve maximum freedom to exit. For example, “farm-dumping” (i.e. immediate sale of reward tokens) demonstrates an asymmetry in liquidity mining.

"Distorted" is costly: design mechanisms without adjustment compensation tend to destroy long-term value, especially when interacting with feedback loops. For example, artificially high rewards for holders of NFT collectibles could trigger speculative behavior, with brutal reversals once the rewards are exhausted—potentially destroying the perceived value of the collectible.

 

Evaluate the current design

So far we have defined our principles abstractly, But how to apply them to real-world examples? We examine a range of common and specific token economic designs.

Gas fee:

Gas fee perfectly embodies our two principles. Follow along as I imagine a blockchain with no gas fees. In this case, there is no cost for participants to submit low-quality transactions (pure spam in extreme cases), which crowd out high-quality and high-priority transactions. Meanwhile, miners and validators are not rewarded for their computational effort in processing transactions.

So, as we would expect, gas costs are critical. This is evaluated against our core principles:

Public interest: gas fees protect the system from low-quality or resource-intensive transactions that would otherwise block The chain will be slow or unusable for high-quality transactions. Additionally, fees serve as a coordination mechanism that allows participants to coordinate by default on relative transaction priorities.

Value Adjustment: Compensation is consistent, as fees are paid directly by participants who impose computational costs on the system, in addition to providing Miners with the necessary computing power.

Costs can be allocated and optimized in a variety of ways. For example, Ethereum’s EIP-1559 reduces deadweight loss by introducing a base/priority system that allows users to compete for relative priority within a block while minimizing impact on the price of the lowest priority transaction. Ethereum has historically had high and variable gas fees, which complicates decisions for users. However, all reasonable variants of the gas system achieve the key goals of providing public good and aligning rewards with value creation.

Validators Staking

In proof-of-stake systems, validator staking (and slashing) is another classic example of good token economics design. As before, imagine a blockchain without collateral. In this case, validators are not penalized for compromising the security of the chain. With weakened security, users don't use the network -- and the blockchain becomes useless.

Staking is therefore equally important and can be analyzed according to two core principles:

Public Good: Staking provides security to the chain, making it available to the community. Without such a mechanism, private actors are not incentivized to provide security, since the costs are immediate and the benefits are diffuse. Additionally, staking is a coordination mechanism for the network to agree on the relative importance of validators.

Alignment of value: As mentioned above, compensation for good actors is consistent. Furthermore, as punishment for weakening security, incompetent or malicious validators will relinquish their stake to other members of the community.

Delegated pledge has the same characteristics. For example, users staking Solana on a centralized exchange still contributes to the security of the chain, as the exchange still has an incentive to direct its tokens to high-quality validators who will preserve capital.

While staking is still an effective mechanism, there is still room for improvement. In particular, staking is usually done entirely with native tokens on the chain. In extreme cases, a drop in Token price will lead to a decrease in security, which in turn will lead to a further drop in Token price. In this case, staking would fail to provide public good and properly adjust value.

(3 ,3) and unrestricted staking

gas and validator staking successfully aligns value between parties, rewards good behavior, and or malicious behavior imposes costs. In contrast, many of the unrestricted staking rewards currently provided by DeFi protocols neither require users to provide value directly nor require them to make any kind of behavioral commitment. The most prominent example is OlympusDAO (and its many imitators), which introduced a "rebase" every 8 hours to issue more OHM Tokens to staked OHM Tokens (sOHM). While technically locked, sOHM can be unlocked at any time by forgoing a single rebase worth of rewards, making it effectively "OHM with an interest rate".

Olympus is in 2021 ended 2021 with a staggering APY (sometimes up over 8,000%), attracting nearly $5 billion in capital investment at its peak. The skyrocketing and falling price of its token — from $200 to $1,300 to $17 — has been staggering even for a cryptocurrency. Are these dynamics just the inevitable outcome of a speculative environment?

Maybe, but we propose another hypothesis: the staking mechanism does not pay enough attention to public interest and value alignment. Instead, the mechanism focuses on the transfer of value from non-stakeholders to stakeholders. Let's see how it plays out on the design principle:

Common Good: Minimize. Arguably, this form of staking creates two public benefits—liquidity and marketing—but at excessive and unsustainable levels. In terms of liquidity, staking contributes to “protocol-owned liquidity,” which allows the protocol to earn fees for providing liquidity to AMM pools. However, the need for such a public resource is questionable, since users can provide liquidity directly to pools. In terms of marketing, high returns attract a lot of attention, which is valuable in part because attention translates into ongoing activity, increasing the long-term value of the protocol. However, the protocol's high returns crowd out all other initiatives, making it harmful overall.

Alignment of value: While modest rewards can be used to provide liquidity and marketing, the rewards are expensive. Therefore, this mechanism in practice mainly results in the redistribution of value from non-stakeholders to stakeholders.

We can also use this lens to understand Cobie's critique of Bored Ape Yacht Club rewarding unproductive staking. The rewards it offers are unlikely to spur any real, value-providing use cases, and mostly look like a way for early investors to cash out. In prioritizing value transfer over value creation, this mechanism weakens the long-term foundation of the protocol.

Governance

Given the importance of decentralization and broad participation in cryptocurrencies, governance Should be a rich design space, but the governance models of most protocols are simple and highly similar. In fact, most protocol governance can be explained as a combination of two key design choices. First of all, almost all agreements follow the rule of "one coin, one vote". Second, the "ve" (voting escrow) model, which gives locked tokens more voting power than unlocked tokens, has grown in popularity as a means of empowering long-term holders. How do these models score on our design principles?

Public Interest: There is no denying that the governance model creates a strong public interest. First, the governance model serves as a coordination mechanism that can enable decentralized communities to commit to well-defined actions. Second, the community-driven model allows the protocol to be more flexible and adaptable to changing conditions than hard-coded rules. Finally, community-driven governance can reliably reduce the risk of builders being expropriated relative to centralized governance.

Value Alignment: Despite creating a huge common good, most governance models are surprisingly poor at giving value back to those who generate it. For example, voters are generally not rewarded for good decisions and punished for bad ones; in fact, voters are not even rewarded more for participating than non-voters. As long as markets for rewards (aka bribes) exist, they will incentivize the success of any proposal, be it beneficial or harmful.

On the topic of value alignment, we Also note that those who create, research, and lead successful governance proposals are often not rewarded for their efforts. While some innovations (e.g., Vitalik discusses “skin in the game” system), but these are mostly assumptions. The rare exception is the ve model, which better links long-term returns to current governance choices.

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Despite voting escrow, token governance as a whole should innovate. There are indeed some efforts making progress towards mitigating Sybil attacks and better linking votes to identities, such as identity proof systems (discussed by Fred Ehrsam), pseudonymous political parties (discussed by Siddarth et al. 2020), and “webs of trust ” solution (ibid.). There are also efforts to enhance the voting escrow model to more effectively tie voting power to long-term staking (as discussed by Ong and Reucassel). Future protocol designers should consider this when designing governance Expanded arsenal and experiment with stronger token economics designs.

Play-to-Earn

Play-to-earn is a combination of tokenized ownership and game mechanics, which at first glance should seem like a natural fit for value alignment, but the reality is much more complicated. Compared to traditional games, crypto games The protocol offers the potential for a more complex in-game economy, with a wide range of liquidity and tradable assets. Play-to-earn is a way to distribute economic ownership through token-denominated rewards for participation. Token value aside, how does the Play-to-earn model perform on our two key principles?

Public interest: In theory, Play-to-earn mode can help games solve the "cold start" problem. Without incentives, games such as MMOs may fail to attract initial participants, and even good games will fail. However, the ideal model would only reward early players until critical mass is reached. In practice, the Play-to-earn model typically distributes more valuable rewards as momentum builds and prices rise (often driven by asset scarcity). At this point, rewards simply transfer value from the protocol to players, promoting short-term usage at the expense of long-term sustainability.

Aligned value: In theory, the Play-to-earn model shares rewards with early adopters who earn money by playing the game before it is engaging enough in itself Provide value. However, most Play-to-earn games transfer value to early adopters regardless of their contribution to the game community. This lack of consistency benefits short-term players and distorts community development.

At present, the main problem of Play-to-earn is the efficiency of value distribution. Broadly speaking, the ideal mechanism for rewarding early community builders should be to only reward actions that make the game more enjoyable for all, only when needed to build critical mass, and only for ongoing contributions.

Of course, the actual issue may be more subtle, but the same principles still apply. For example, if the game's current mechanics primarily attract low-skilled players, the designer could focus on rewarding skill per match (e.g. bigger rewards for beating better players) rather than rewarding match count. If the problem is that early stakeholders take an excessive share of the rewards when the token price rises, the designer can tie the rewards to some global activity indicator.

Finally, If the cold start problem is the most critical, then the reward can be gradually reduced. More specifically, web3 game developers could make the first 1,000 players of a new game get a higher reward rate in the first few weeks, and less rewards for later weeks or later.

While play-to-earn is the most obvious example of value alignment challenges, the preceding discussion applies to any "X-to-earn". For example, Stepn, the pioneer of the "move-to-earn" pattern. We recommend that these protocols carefully consider the type of value they want their tokenomics to incentivize and reward.

Some future ideas for the token economy

So far, we have retrospectively Our principles are applied and existing models are ranked according to their performance. Furthermore, how else can we provide direct and targeted incentives to individual champions of the public good?

Decentralization: Miner honesty is highly incentivized in practice, but miner diversity is rarely considered. In theory, miner diversity is widely understood as a form of public good. Does it make sense to have a progressive tax on validator rewards above a certain stake size?

Marketing: Visibility is critical to the survival of the protocol, so being first is useful in the sense of providing initial liquidity or usage to the network of value. Once a protocol reaches critical mass, participation driven by artificial rewards can be incremental or harmful. Could the protocol reward early backers by offering larger rewards to the first $X million in TVL, and then amortize those rewards as total liquidity grows? (APY is already falling as TVL rises, so this would be a more substantial drawdown above some expected level of liquidity.)

< p>Grants and partnerships: Token cap tables typically include large, open-ended allocations for developers building on the protocol and for partners integrating with the protocol. However, these rewards can be quite decentralized and actionable. Is it possible to tie grant-based token rewards to on-chain metrics in a way that is not exploitable?

Conclusion< /h3>

Token design is difficult because it requires answering a highly abstract, open-ended question: what deserves to be incentivized? It would be ideal if the protocol could try out different models, solicit early feedback, and iterate. But most teams only get one chance to set the dynamics of the system, and must provide a solid foundation on the first try. We believe following these two core principles—creating common good and aligning rewards—will give these teams the best chance for long-term success.

This burden also falls on the wider community. Early investors, retail participants, and protocol users should all drive strong and principled token economics — now more than ever. During the last crypto bull run, many of the momentum-driven designs could only last in this exuberant market. Despite its flaws, a bear market needs real utility from the start.

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