Incentive Loops — How Crypto Actually Fixes Stuff

Incentive Loops are found everywhere in successful crypto projects. Often, the best cryptocurrency platforms or tokens have robust incentive loops built into them. The cryptocurrencies that garner organic growth and real world utility have an incentive loop as their basic structure, and without them they would collapse.

Incentive Loops — What Are They?

Incentive loops is another way of saying “an economy”. But in the world of tokenized smart-contract platforms, the term “micro-economy” might be more accurate. Good cryptocurrencies/tokens are “backed” by a recursive loop of value transfer that all participants are incentivized to participate in. The design of the protocol itself is what creates the incentive loop, and offers a strong rebuttal for anyone who claims that cryptocurrencies aren’t backed by anything; they are what props up the valuation of a crypto project.

An incentive loop is what is created when a number of distinct parties act in their own self-interest to create something greater than the sum of the parts.

The Bitcoin system represents the first cryptocurrency-based incentive loop. Since it is a loop, there is no good place to begin this illustration, so here goes

1. Bitcoins are created by Mining
2. These value as defined by the perception of people
3. The perceived value provides incentive to mine the blockchain, which provides security to the security of the Bitcoin blockchain
4. The increased security of the platform gives Bitcoin more intrinsic value.
5. Higher intrinsic value of a Bitcoin provides more incentive to mine Bitcoins
6. Repeat Step 3.

Bitcoin represents a very simple loop; immutability and censorship resistance is valuable; mining bitcoin is profitable; mining bitcoin provides immutability and censorship resistance.

Many readers of this article are likely reading from the United States or from other developed countries, and might be thinking “security doesn’t make me value Bitcoin more…”. The response to that is simple: You have never had your currency pulled out from under you. That is a privilege the developed world offers to you. Ask anyone who has been a victim of the growing number of hyper-inflations occurring to fiat (thats the Dollar, Euro, Pound…) currencies in the past century. Maybe the current state of cryptocurrency doesn’t have too much to offer for the first world, today, but it is a financial sanctuary for anyone else. And the reason for that is due to the incentive loop described above.

Tokens as Incentive Loops

With the creation of Ethereum, and the creation of infinite Tokens that exist on-top of a single blockchain, many different projects have been able to create more complicated, more niche, incentive loops that aim to ‘fix’ many different industries.

Smart Contracts, aka the intersection of Code and Money, enable some features that fill a very large void in our modern world. A smart contract dictates how a token (money) will operate in respect to the sender/receiver, and any other relevant data to be included in the transaction. I wish I could get more specific with this, but thats the power of smart contracts; they can literately do anything you program them to. With a smart contract, you can write the rules of how money behaves on your platform.

Incentive Loop Example One: Basic Attention Token

One of the most salient examples of an effective incentive loop is the Basic Attention Token model. BAT even turned the concept of an incentive loop into their logo, and was one of the inspirations for this article. The prominence and succinctness of the Basic Attention Token micro-economy has attracted a ton of attention from crypto-enthusiasts and muggles alike; the incentive loop is simply too attractive of a system to ignore.

According to Basic Attention Token, there are three parties in the online ecosystem, where incentives are broken, which they aim to fix. These parties are: Advertisers, Publishers, and Consumers.

We all know these parties well. We are all consumers: we eat up content for our entertainment, learning, or hobbies. Publishers provide content in order to attract our attention, and then they sell a fraction of the attention they have gained to Advertisers, for money.

The Basic Attention Token project claims that current world of online advertising is broken.

Publishers often extract undue money from advertisers by “boting” their traffic viewership, and getting money from advertisers for fake views.

Consumers widely install ad-blockers, because Advertisers are not incentivized to aid the in improving the quality-of-life of consumers.

Publishers add ad-blocker blockers to their website, requesting you to whitelist their website, so they can continue to generate revenue, and then continue the obnoxious, in-paragraph, seizure-inducing advertisements once you agree to view ads.

So here’s the incentive loop, or lack there-of, in the current world of internet content and advertising:

With this model, we see an incentive structure that never made a complete loop. Value flowed from Advertisers to Publishers, and not from Consumers to Advertisers, but from Publishers to Consumers, and never from Advertisers to Consumers. It’s important to remember that Consumer attention is the form of value that really props up the whole system, and it somehow got cut out the loop.

As a consumer of content, I feel jipped. I am cut out of the economy. Value only flows away from me. Except I am the only party that is actually sought after, because I have what the other two parties want! Money, and attention. Why do I only lose value? I never get my attention back, and I can only hope that whatever product I buy from the advertisers can compensate me for the actual money I gave to them.

You can’t build a very good industry on top of a broken incentive structure. Publishers found out they could fake traffic data and extract more value from Advertisers. Consumers found out they didn’t need to give up their attention for free and installed ad-blockers. Publishers realized that ad-blockers hurt their income, and created ad-blocker-blockers. This is what a slow implosion looks like.

The Basic Attention Token economy fixes this model. By creating a browser that blocks ads by default (including ad-blocker blockers), there is no way to advertise to consumers, unless consumers allow it. The ball is in the consumers court; where it should be, because they are the sought after commodity.

The Brave Browser: Downloadable here, treats the consumer as the priority. You only get to advertise to consumers if you pay them BAT tokens. You also only get to advertise on publishers site that accept BAT tokens for entrance. This barrier of protection enables a number of features that fix so much of the broken internet we know to day. The incentive loop is seen below:

Here’s the official Basic Attention Token structure:

Basic Attention Token fixed this by creating a functional incentive loop between the three parties, and it needed a cryptocurrency to do it. With the Basic Attention Token model, Consumers are paid for their valuable attention from Advertisers, Publishers still get paid for having a valuable website, and Advertisers don’t pay for traffic from bots. Additionally, value can be paid directly from Consumers to Publishers for the first time; something we know is a viable use from platforms like Twitch and Patreon.

Now, the original incentive loop that was supposed to be enable by the first iteration of the internet can finally arrive:

Incentive Loop Example Two: Golem

Golem is one of Ethereum’s shining examples of a use-case of it’s platform. It’s easy to understand, and easy to apply. Golem intends to utilize idle computing power from un- or under-used computers, and apply that computer power to tasks that people pay GNT tokens to use. Use cases such as animation/CGI rendering, machine learning, data analysis, and artificial intelligence are enabled from the ubiquitous availability of cheap computing power. We have never seen a world where industries are allowed to develop with the availability of cheap, efficient computing power; we should be excited to see what comes forth!

The broken incentive loop. Computer owners have an unused resource, computing power, but no way to utilize it effectively. Those in need of buying computing power are forced to go to centralized seller of computing power, usually Amazon Web Services, and pay their price. In this scenario, computing power is expensive, unaccessible to small-time buyers, and siloed away behind a company’s walls.

Incentive loop: Complete. Computer owners download the Golem application, and allow the Golem Network to utilize the computers unused resources to contribute to the power of the distributed cloud computer. Buyers of computing power can access this Golem network from wherever there is internet. They can buy as much, or as little, computing power as they need to complete their tasks; no more and no less. This unlocks access to computing power to small-buyers, who were previously priced out of using an expensive centralized service from Amazon or others, as they can now simply buy just a few moments of high-powered computing time to complete their tasks. As more buyers enter the Golem marketplace, computing power becomes in higher demand, and more people can allow Golem to access their idle computers, as it becomes more profitable to do so. More supply of computing power lowers the cost of buying computing power, which further attracts buyers to the network. A positive feedback look has been created!

The cherry on top. This makes centralized cloud computing services obsolete. Instead of Amazon hosting warehouse’s full of high-capacity computers, this service is provided by consumer-owned products that already exist. Resources that were once allocated to the purpose of building a computer-farm, can now be allocated elsewhere, because that service is provided by products that already exist, and now are able to serve multiple purposes. It’s just one more step towards becoming a efficient society, where we use all of our resources in a maximally efficient way.

Incentive Loop Example Three: The Augur Prediction Market

Augur is a prediction market that uses a token to incentive people to report the outcomes of real world events. Holders of the REP token (Short for Reputation) are able to stake their REP to the outcome of an event (usually a Yes/No outcome, but it can be more complicated). For staking to the correct side (as determined as the side that has more REP staked to it), REP stakers are able to receive a small portion of total ETH that has been gambled on the market.

An explainer video is available here: https://youtu.be/yegyih591Jo

The incentive loop that is created is depicted here:

The larger a particular market is (for a bet on a single event: “Who will win the World Series”, “Who will win the election”, etc), the more reward there is for REP token holders to stake their REP to the truthful outcome of the event, since they get a small fee for staking in the majority of stakers.

When REP is staked more and more to the truthful outcome of events, the Augur platform gains validity, due to its track record of providing truth to more and more markets.

Due to the promise of truth that is offered by the Augur platform, more and more niche markets are able to be created, due to their being more Truth to go around (from more REP being staked)

The more markets there are created, the more valued the REP stakers are, as they are the vehicle of truth for the platform. Which in turn, incurs more incentive to accurately stake your REP to the correct outcome of an event.

What is created as a result, is a platform with so many markets available, that you will be able to “Google the future”, using the phenomenon of the Wisdom of the Crowd… or so is the Augur vision. Hopefully the positive feedback loop from the described incentive structure will be able to bootstrap its way into being the vehicle in which humans can see into the future!

Incentive Loop Example Four: AdChain & Token Curated Registries (TCRs)

Token Curated Registries are super cool. If you don’t know these, check out Mike Goldin’s paper on TCRs.

Token-Curated Registries 1.0

Token Curated Registries are decentralized lists. If you haven’t had your head in the sand, you have been bombarded with these clickbait buzzfeed lists: 100 pet photos that will melt your heart! 13 reasons to breakup with your boyfriend. 43 ways to get out of work. etc etc etc

Token Curated Registries are a way of creating more legitimate lists, by using crowdsourcing and economic incentives to provide value to the system.

Top 10 Colleges in the US,

Top 25 Sushi Restaurants in San Francisco,

Top 100 Multiplayer RPG games,

These are more legitimate, sustainable examples of lists that could, one day, be curated through crowdsourcing.

TCR’s and AdChain (which is a TCR for advertising) work in the following way

1. A publisher submits an application to be listed on the AdChain list, with an AdChain token deposit
2. A “challenge period” starts during which any ADT holder who believes the publisher is fraudulent can issue a challenge and match the publisher’s ADT deposit.
3. If no challenges are issued during the challenge period, the publisher is accepted into the adChain Registry, and their deposit is returned.
4. If a challenge is issued, the publisher and challenger go head-to-head and ADT holders vote (1 ADT = 1 vote; majority rules) on the outcome.
5. The winner of this vote has their ADT deposit returned to them and is rewarded some fraction of the the loser’s deposit. The remainder of the loser’s deposit is divided amongst the majority voters.
6. If the vote is in favor of the publisher, they are accepted into the adChain Registry. If the vote is in favor of the challenger, the publisher is not accepted.

The Incentive Loop

TCR token-holders want their TCR to grow in value. This incentivizes them to monitor/curate the list in which they have stake in. Using a TCR of Top 100 Sandwich Restaurants as an example, if a Token-holder sees that Subway has submitted an application to enter the list, they are incentivized to submit a challenge to decline Subway a spot on the list (sorry subway). The premise is that if a list of Top 100 Sandwich Restaurants has Subway on it, it clearly is a poorly curated list, and a good sandwich shop is less incentivized to attempt gain entrance. TCR token-holders also want more tokens (who doesn’t want more tokens?) If Subway submits a 100-token deposit to Top 100 Sandwich Restaurants, a token-holder who believes that other people are going to vote ‘no’ on allowing Subway entrance, will also vote no, because Subway’s 100-token deposit will be forfeited and allocated to the majority-voting decision, allowing those that vote with the crowd to accrue more tokens.

Sandwich shops want to be on high-quality TCRs. If you are Al’s Gourmet Sandwich Shop being on Top 100 Sandwich Restaurants gives your sandwiches a place of high regard, due to the prestige of the TCR that has been curated by sandwich connoisseurs. If you make it on the list, your sandwich shop will be blessed by a constant influx of sandwich-eaters willing to pay a premium for your TCR-verified sandwich shop. ‘

The last party involved are the sandwich-eaters. They are able to look at the TCR, as they do with Yelp! or and other reviewing entity, and are able to get suggestions for the sandwich shops that they should look for. Sandwich connoisseurs might work their way down the whole list, auditing and verifying each entry, to see which belong, and which might be worth submitting a challenge to. If this Sandwich connoisseur sees a less-than-worthy sandwich shop on the list, they can submit a token-backed challenge to the TCR, in hopes of winning some tokens if the token-holder community agrees with them.

And thus, the loop is complete. Three parties, each with different goals and incentives, are able to create an interdependent loop between them, and creates something that is greater than the sum of the parts.

Incentive Loops: Enabled by Cryptocurrency

The creation of a tokenized incentive loop is made possible due to a number of key features of cryptocurrency.

Smart-Contracts: The integration of Code and Money, smart contracts get to determine how money is operated under certain circumstances (if-then statements). All of the platforms are build in a particular manner so that their native token behaves in particular way, and it is smart contracts that enabled these functions.

Micro-transactions: Many projects are enabled through the power of micro-transactions, which I define as ‘transactions sizes that are too small to be feasibly enabled by Visa or Mastercard”. While business owners are okay with selling you a $1.00 bottle of water, even though it cost them ~0.25 cents to process the transaction, a business model that operates solely in micro-transactions cannot operate where 25% of the income gets sent to a third party.

Cutting out a middleman: Many tokenized projects are simply the same businesses found in legacy systems, but instead of there being a 20–50% cut taken from value creators, the only loss is from the small transaction fee on the network.

Incentive Loops: What Cryptocurrencies are “Backed” by

Many people claim that Bitcoin, Ethereum, and other cryptocurrencies are “magic internet money” that aren’t backed by anything. While, the magic internet money part is 100% true, this article provided (I hope) a sound argument for what is actually propping up the value of these tokens and coins: A positive feedback loop created by aligned incentives.

Positive feedback loops grow exponentially. These loops have the power to bootstrap the adoption of cryptocurrency by the modern person, simply because of the strong pull of incentives that they create.

While some people think that we are 20–30 years out from global adoption, the exponential growth illustrated by positive feedback loops make me far more optimistic.

Lets see how fast the feedback can reverberate!