Let’s remember Lewis Caroll’s Hunting of the Snark, a fun quest in search of a strange creature that (probably) doesn’t exist.
Lewis Caroll’s Snark illustrates the idea that there is always a surprising difference between the rules we give ourselves and our actual practices.
Is Tokenomics not about the same gap?
For Nomiks, the Snark is the Active User, a peculiar specie that has an ambiguous parentage with the Holder.
We are building traps and strategies to catch this wild animal.
Everyone in a tokenomics has their role or their “utility”. But some more than others! This would be the case in particular of the Holders. The Holders are indeed considered as the heart of any tokenomics because they are the best guarantors of the adoption of the token.
However, as we have learned at Nomiks during our many expeditions into unknown territory (tokenomics is a fairly recent discipline), the main usefulness of these Holders is to limit the price impact during a panic sell.
Thus, the question is not so much if we should have Holders or not, but rather for how long?
But first, do we know exactly who these Holders are, what are the more or less respectable species and subspecies with which they hybridize and sometimes overlap?
The Hunting of the Snark is opened !
The monetary theory of velocity : a tale
It is widely accepted that the velocity of token transactions is one of the main leverages for determining the value of tokens in the long run. Its origin can be found in the monetary exchange equation. If M is the money supply, P the price, Q the quantity exchanged and V the velocity of money circulation, Irvin Fisher’s equation of exchange is : M * V = P * Q
Initially, the aim was to explain inflation. In this formula, the level of M determines the level of P, i.e. the general price level depends directly and only on the amount of money in circulation. To control inflation, it is therefore sufficient to control the evolution of the money supply.
In today’s crypto-economy, the mechanical impact foreseen by the (traditional) monetary theory for a computation of what is now called a max supply is no longer relevant. No liquidity is anymore constrained by velocity because of decimals: there is no more friction regarding the size of the supply as long as we can exchange fractions of tokens.
As good cartesians, however, we consider that this tale of the monetary theory can still be used to size a supply, to determine its unit and to calculate income, in short to put numbers for a possible “classical” financial valuation, which is generally based on this theory. This is not to question the validity of valuation. The reason is partly linked to a kind of habitus. Sometimes, we even believe in this tale when we are dealing with NFTs for example (precisely because of their non-fungibility)!
Any tokenomics must take into account the context and the adopted language (rather than reinventing it). This sometimes leads us to articulate apparently different logics. Thus, at Nomiks, we see the token, in spite of a logic of classification which separates them, always according to two faces at the same time: a face “financial asset” and a face “currency”.
Take a token its index of velocity on its face “financial asset” could for example be 2, while its index on its face “currency” will be between 7 and 12.
The token will therefore have for us both the advantages and the disadvantages of assets and currency. The dual token is in this respect an invention intended to reduce the disadvantages of one and the other by keeping only the best of both worlds.
One piece: two indexes. So, how to order these two velocities to a single supply?
Other computations are possible
Vitalik Buterin is credited for having transformed and adapted the formula of monetary theory to the crypto-economy. This can be seen as a market place where a token is a simple medium of exchange where the prices of goods and services are expressed in terms of this token.
Buterin’s formula is : M * C = T * H
M being the max supply, C the cost of the token (hence we can say that M * C is nothing else than the MarketCap), T being the transaction volume (the economic value of transactions per day); but H is now 1/V, that is the inverse of its velocity, which is called its “dormancy”. This is, as Buterin says, the time that a Holder holds a token before it is used in a transaction.
This is a particularly interesting notion that would solve our problem: the switch from a “Holder” to a “User”. This is our Snark!
Buterin sees the blockchain as a technology for attesting to an event at time t based on a time event t-1. All crypto-economy is based on this (according to him). He comes up with an interesting general rule: low velocity tokens, i.e. those that stay longer for some reasons (speculation, store of value, etc.) will have higher prices than others,. But he immediately adds that this rule is only valid if “we assume that the quantity of users remains the same. When in reality the quantity of users can change, and therefore the price can change accordingly. The amount of time users hold a coin can change, which can also change the price.”
All these “causalities” follow the arrow of an originary time, according to the tick of a first clock. This is constitutive, according to him, of any crypto-economy based on the blockchain. The latter does include causal links, loops, and feedback effects, but these are not, strictly speaking, co-causalities, since the causalities are, so to speak, unrelated.
The hunting is done on slippery ground ..
Elasticity
One can regret this strange and a bit unfriendly environment but that is not the point. Any tokenomics assumes this first impulse: once the process is launched, one cannot go back. It is in a way against this first condition that the tokenomist designs catch-up mechanisms that are also instruments of capture. To capture what and how? The Snark with an elastic band!
We see that it is necessary to be able to control velocity.
A logical implication of what we have said is that protocols, projects should give holders a good reason to keep their tokens. But contrary to what one may think (and this is another counterintuitive result recorded in our logbooks) : Burn and Lock up would rather be mechanisms to avoid.
Let’s say that “friction” (which reduces velocity) is sometimes “good”, sometimes “bad” depending on the project. In other words, not all artificial retention mechanisms should be systematically activated.
Note that the formula of Vitalik Buterin can be translated into the Network Value-to-Transaction Ratio (NVT), which represents the ratio between the Network Value and a Total Transaction Volume. Note that it is similar to the P/E (Price to Earn) ratio of stocks for example. This more financial ratio can indicate whether a token is undervalued or overvalued by displaying the total capitalization compared to the transaction volume. This ratio actually measures the utility that a user gets from the network (a very high ratio indicating a potential overvaluation of the tokens).
We can effectively transform the Buterin formula to this NVT ratio.
M *C = T * H <=> AvgNetworkValue = TotalTransactionValue / Velocity
Let’s take the case of a currency (btc ), the Total Transaction Value will be the product of the number of transactions and the average volume of a transaction (in btc).
TotalTransactionValue = NbrTrs * AvgVolTr
Therefore : AvgNetworkValue = (NbrTrs * AvgVolTr)/Velocity
The different terms being :
- NbrTrs: the number of transactions (determining the activity)
- AvgVolTr : the average volume of a transaction (depending on the price of the token)
- Velocity: the Velocity.
Each term can increase (+) or decrease (-).
Several cases may arise. The most interesting ones are those that allow us to highlight a variation (derivated for a continuous time, a delta for discrete time) allowing us to calculate what we call a specific elasticity.
Simply explained, elasticity is the divergence within a given protocol between the price of a token and the activity that this protocol allows. A divergence that must be monitored by identifying turning points.
One of these critical points to watch is the following: the price of goods and services of this protocol should not be too high, otherwise the activity will decrease. A too important deviation can even have the effect in the long run of “freezing” the activity: drastic decrease of the transactions + a lesser number of new adopters = decrease of the price of the token itself.
The elasticity game can be seen as a “string” pulling the activity of a protocol with that of the price of the token. Another way of seeing it consists in considering it as an adjustment allowing the Holders to release their tokens in a fluid way in the course of time: neither in totality because they would simply disappear from the game (they will have been “retrospectively” only “opportunistic” Holders), nor in a too “ greedy” way.
Advanced technique
Let’s go further: instead of direct or indirect rewards mechanisms to the credit of obedient but passive Holders, we could promote inflationary rewards in order to make the creature come out of the crypt in which it is hidden.
The solution is to turn monetary theory on its head by adding money printing, thus creating something that looks like inflation. The development phase of a project is propitious for this. Suppose that the project has a pool of rewards during this phase, and that these rewards are entirely disconnected from the value generated. If these purely inflationary rewards were given to active User profiles rather than wait-and-see Holders, the incentive would serve its purpose properly.
The price that results from inflation would then no longer depend on velocity (its slowing down); price and activity would work together.
The beauty of this is that these rewards are not “artificial”. Let’s say they might not be. In a later phase this “pure money printing” (to speak in the terms of traditional economics) could be replaced by forms of “dividends” once the project is self-sufficient,. These “dividends” would then be nothing more than Aligned reward in return for the inflationary rewards issued. The latter would disappear in a second time by burn or “natural” buy-back.
The Snark definitely cornered?
A judicious rubber band, a trap, baits, tricks to regulate the populations: all the means are good for the tokenomist who is an inventive hunter!
Tokenomics is an art rather than a science. But any art is difficult. The main difficulty is that we cannot anticipate the Holder’s strategies. There are several subspecies into which he is likely to metamorphose: the shark, the whale or the fish.
We could never predict it for sure. That’s why some tokenomists ( aware but perhaps excessive ) would say : “Holders must be limited to the maximum because they are, at the end of the day, the ones who provoke the Panic Sell ! ”
It may be excessive but it makes sense. Actually, a too large population of Holders who have accumulated a large part of a so-called “mature” supply after a certain latency period (which refers to this famous retention created more or less artificially we mentionned) becomes a danger for the ecosystem because of the unrealized profits, causing a pressure to sell. Too many Holders ⇒ Price going up ⇒ Opportunity to take too much profit ⇒ Panic Sell.
So you have to see this over time and in a kind of dialectic (which is a more subtle, almost philosophical art). Too many “dormant” Holders are in the local token economy mirroring traders in the secondary markets. These effects of accumulation and distribution proper to speculation indirectly impact all tokenomics.
But at the same time, Holders are needed!
Hence comes the idea of a turn over. What is the idea of this turn over? Everyone has a place in a tokenomic, but maybe not at the same time! The “big cash-eating Holder” must leave the place to the “domestic Holder” who would leave it to the “active Users.”
At the right time!
These are active Users who generate value in an ecosystem (fees, royalties, according to the use of the goods & services of the platform and its possible market places, etc. ).
We brought out the beast, at last.
“For the Snark was a Boojum, you see”.
This article is an abbreviated translation by Pascal Duval and Maximilien Dreier of a french article — a collaboration of the Nomiks team.
