Value Accrual

I closed my laptop and shook my head.

Minutes earlier I had asked a friend what Value Accrual meant to him on a zoom call

Friend> “Well, it’s when value accrues to the token”
Is Me> “Yeah, but… what does that mean?”
Friend> “Number go up”

I shook my head, not because it was a dumb answer

But because it was the right answer

Here I was trying to tease out a more nuanced understanding of value accrual

And the answer was right there all along.

Or was it?

To truly know if Value Accrual is only about ‘number go up’, we’ll need to crack open a few more concepts, starting with that almighty number that needs to go up. We all know what price means, but what it IS is another matter entirely.

What is a Price, really?

Price is simply a relationship between demand and supply.

If supply is reduced while forcing demand to remain a constant, price would rise.

While price is an indicator of demand in relation to supply, it does not guarantee that value accrual is actually occurring.

While the price may go up when supply is falling, there is no new ‘value’ accruing to the token. How could this be? Perhaps the number going up is simply a symptom of value accrual rather than being wholly value accrual itself… (see venn diagram)

Further, perhaps value accrual can occur without the accrued value manifesting in the price action, such as in the case of a protocol debuting a new feature without any marketing — value increased but no price action occurred.

At its base layer, value accrual is the process by which ‘value’ is captured and retained within a token ecosystem.

No good definition is complete when the word in question is used in the definition itself.

So what is value, as a concept?

Value, in this context, is simply something that a person or multiple people desire. This could be status, exclusivity, economic gain, the ability to use a good or service, decision making power, or even future looking speculation. All of these forms of value are reflected in the price, since price is the means of coordinating an exchange in which this value is transferred from one party to another, absent bartering and non-currency deals.

By this definition, ‘value’ is inherently subjective. What one party values is different from what another party values. If many people value that good or service, or a few people value it a lot, we categorize this as ‘demand’.

So value accrual must be…
How a token ecosystem captures and maintains demand over time, from the users it is trying to attract.

But HOW does a token accrue value?

If a protocol or game is the only way to use/play a product or service, and the payment or usage of the product requires a token (monopoly), then naturally, the demand for the token should match or exceed the demand for the service.

There is inherent value to having the ability to use a product or service. It enables people to do a thing they wouldn’t have been able to do previously, or wouldn’t be able to do as efficiently as before.

This establishes ‘value’, but how does a token ‘accrue’ said value? How does it capture and maintain ever increasing amounts of value over time?

If there is demand for the token from a buyer who wants to purchase an NFT on an exclusive marketplace, but the seller decides to sell the token on the other side, no value was captured. No net new value was created, just transferred. This simple fact highlights a simple truth — for accrual to occur, the protocol in question needs to take a cut, diverting value to the protocol.

Once value is captured and accrued, this value should be reflected in price action over time, assuming the market has perfect information and tokenholders have the ability to access or govern that value.

So I guess my friend was right… number should go up.

Price is the external indicator that a limited resource has demand.

Does the number need to go up instantly to indicate value accrual?

In periods of speculation, value accrual can be occurring, yet the price can go all over the place. In the same way, value accrual can occur without it being reflected in the present price. Imagine a fee switch being turned on for one of our favorite protocols. Price tanks, yet value accrual starts. Anons are mad because the value is no longer flowing 100% to each other.

Price reflects perception. People make purchasing decisions based on that perception. This is obvious to us, as we can say the token’s price is under or over valued in relation to its fundamentals.

Value Accrual isn’t a Perception, it’s a Process.

Value Accrual is how a token ecosystem creates and maintains demand over time, while transforming that demand into captured value.

This is achieved in 3 ways, which may not be reflected in price action instantly:

1. Reinvestment in the system
2. Governance
3. Distribution management

We’re going to explore these more in depth, first by giving the TLDR on each, and then an example of each in DeFi.

Buckle up buckaroo, we’re going for a ride.

Know any other forms of value accrual? DMs are open, lmk.

Please remember, I am not a financial or legal advisor, and laws vary by jurisdiction. I am merely highlighting levers that exist for value to accrue to a token ecosystem. Talk with a legal representative to understand what can work within your jurisdiction.

1. Reinvestment in the system

• Taking profits and using them to fuel the product or service offerings of the token ecosystem.
• As an example, this can be achieved by:
• Making a protocol that does one thing well, and requires payment in their token to use their unique good or service. They have a de-facto buy-side demand for the token,
  - - assuming the unique good or service is valuable/needed (demand)
  - - and a cut is taken from the transaction (value capture)
• That pay cut would be reinvested into the core developers or a grant program to build extension products or things for the group

As an analogy, companies do this by reinvesting revenue into fueling the growth of the business, to increase product offerings or expand their audiences.

At what point does one stop fueling additional capital reinvestment in the business? Who decides this?

These are the important questions to consider on this vector.

2. Governance

• If a protocol allows token holders to vote on how the protocol makes decisions and operates, and those decisions are deemed valuable, they have a built-in buy-side demand for the token…
  - - assuming some people value the unique good or service enough to pay attention to growing or maintaining it
  - - and the protocol’s governance decisions result in directing its resources effectively to pursue that goal

That’s a tough one-two punch.

But if executed correctly, there is value here, especially if the decision making around the use and deployment of the limited resources is grounded in expertise.

If value is created by the efforts of a decentralized base of people with varying levels of contribution, how should the fruits of the labor be distributed? Can this change, outside of just holding the token?

Will the protocol need to change and adapt to capture more value, or is it doing one thing the best and will never get replaced? How will it incentivize?

Are the results of governance enough to justify the financial and temporal effort required to influence it? Put another way, does anyone have enough of a personal stake to care?

These are the important questions to consider on this vector.

3. Distribution management

• This concerns how the token gets distributed to holders
• Where the ecosystem’s value is going
• How is it getting there
• Why someone might want to hold their own value in the ecosystem

Companies do this by working with broker-dealers to manage liquidity, improve their KPIs, distribute dividends, and generally prove themselves to be stable and anti-fragile.

The stability is based on historical proof of execution, and the future opportunity to capture additional market share for that good or service. Basically, making more profit by… capturing value.

What are the rules of the system and what are they incentivizing? How frequently are tokens distributed? How much do the rules hamper the future growth of the system by distributing these incentives? Are these incentives worth it? At what point are they not worth it?

These are the important questions to consider on this vector.

Example Time

What’s that? You want some DeFi examples to prove these vectors of value accrual? Rest easy anon, we’ve got some blue chips running hotter than China’s debt to GDP ratio.

Keep in mind, these 3 vectors of value accrual are not mutually exclusive. Tokens with excellent value accrual may exhibit all 3 in varying amounts. For the sake of simplicity, we have chosen tokens that we believe exemplify the 3 sources of value accrual as their dominant form. While they are all ‘winners’, they were chosen because of their clarity.

One more disclaimer: Tokenomics are not a silver bullet. You can have all the right value accrual mechanisms and still fail to have your price go up if you don’t create demand or attention. These can stem from sustainable means such as a great product that is a step-change from what existed previously, or it can come in speculative bursts such as with a viral meme coin.

Value Accrual is the process by which a token ecosystem creates and maintains demand over time, while transforming that demand into captured value. Demand is the quintessential precursor of value.

Ok, time for the examples.

1. Reinvestment in the system

Reinvestment in the system means that revenue coming in from use of the protocol or service is being used to grow the depth or breadth of the product offering.

Look no further than the grandaddy LSD, Lido. This protocol, governed by a DAO, is an example of value accrual that has continually reinvested in itself. It has resulted in great success in terms of ETH staked and quantity of active addresses staking. Yet, even with the success of Lido, the tokenholders of LDO haven’t received any economic benefits such as dividends.

According to TokenTerminal and additional analysis, Lido is generating about $4.6 million per month, or roughly $56 million annually. These profits have led to a substantial treasury of $62 million denominated in stablecoins and ETH, and $162 million denominated in LDO. Most of the profit earned is converted into stETH to earn additional yield for the treasury. Their expenses consist of compensating core contributors and allocations for marketing and ecosystem growth. Their commitment to reinvesting in the growth of the ecosystem (and being the lindy LSD) has created a sizable treasury governed by LDO holders.

But has this caused the LDO price to rise? Surprisingly, no!
Does this mean value accrual isn’t happening though? They’re maintaining market pole position and attracting obscene amounts of ETH. The value accrual is in the form of future opportunity. This is what ‘reinvestment in the system’ is about.

The larger the market share Lido captures, the larger a future potential economic dividend can be. But at what point should this dividend be turned on? Who decides it? Should the original holders who are taking on this risk by reinvesting into the future be compensated? Or should the future holders be compensated equally because that’s when an economic distribution actually occurs instead of reinvesting?

Reinvesting profits into the protocol is a strategic move grounded in future potential. It prevents capital from leaving the ecosystem, grows the future profit potential of Lido (more ETH staked = more potential for fees), and allows funding for developers and community members to build useful services to augment the protocol’s value proposition.

Is value accruing to the protocol… or the tokenholders? Is this value accruing directly to tokenholders in the form of economic benefits or indirectly to tokenholders by making the protocol’s treasury larger or by building more ancillary products around the ecosystem? When should capital stop being reinvested and instead be distributed to tokenholders, if ever? How much will turning on this distribution hamper the future potential for Lido?

Lido DAO is governed by LDO tokenholders, so it’s up to LDO tokenholders to decide when this switch occurs. Everyone voting has a direct interest in seeing the most value for their tokens while also continuing to accelerate Lido growth. The question mark is if that value will be distributed according to the level of risk the participants have taken on at the time they took it on. Tricky tricky… If I were designing it, I’d have a method for aligning rewards to benefit those who are taking the risks in the present, as long as they continue to hold until the rewards come.

Here’s a general equation of my above proposal:

Reinvesting in the system is a way of increasing the future value of dividends, stake in the protocol, or potential value for governance votes. While tokenholders can determine when to flip the switch, the DAO’s current decision has been to continue growing the size of the treasury, rather than distribute it.

2. Governance

Governance as a vector for value accrual concerns the economic or political value a tokenholder has in determining how the protocol functions, directs its resources, or shapes its future roadmap.

Governance matters (has value) when the results of the decisions carry economic or social weight regarding how the resources or people involved in the system operate.

To illustrate this vector, look to CRV, the governance token for Curve Finance. Curve is a liquidity hub and decentralized exchange that incentivizes liquidity to flow to specific pools by adjusting CRV emissions based on the number of votes each pool receives. If a protocol wishes to deploy CRV liquidity incentives for their tokens, the protocol can either purchase CRV tokens to vote directly or they can indirectly pay CRV holders to vote for their pools.

Since the presence of liquidity can make or break an up-and-coming new protocol, Curve’s position as a leading liquidity source correlates to economic value. In this case, it is the possible depth of liquidity for a new protocol, which could jump start its TVL or in the lackluster case, be considered noise.

The value of Curve, then, is exemplified with the price users will pay to direct the decisions of vote-escrowed CRV tokens (veCRV) to achieve their end means — getting liquidity set up, and attention directed towards their protocol.

To date, there has been $3 million paid directly to veCRV holders for their votes. In addition, holders of alternative liquid wrappers for CRV votes such as yCRV, sdCRV, or cvxCRV have attracted significantly more, such as $281 million for cvxCRV holders as per Votium.

When the benefit to voting is economically or socially valuable, the votes become a powerful source of value. As such, controlling governance of a protocol with value is a form of value accrual towards tokenholders. This effect is similarly displayed when wielding decision making power around how a protocol utilizes its resources such as profit or treasury reserves. The economic power of this capital is held in the decision making power of the tokenholders.

The opposite is also true though. If a token has governance in name only, or the votes don’t have any meaningful impact, they do not assist in value accrual. Again, demand and attention combined with tokenomics that are set up to capture value are the key factors for value accrual to occur.

TokenTerminal displays Curve’s annual profits to be around $11 million. These annual profits certainly represent resources to fuel the growth of Curve. Currently the profits are distributed back to veCRV holders but this can change if voted on by the tokenholders. $11 million liquid cash per year has superb opportunities for liquidity growth, incentive design, and building out additional scope for the Curve protocol… if desired. Otherwise, tokenholders can determine that the present day payouts are worth it and continue to distribute to veCRV holders.

3. Distribution management

Distribution management encompasses how supply is distributed, and where the supply is distributed to. In addition, distribution management includes methods like buybacks, burns, liquidity provisioning, and how value is distributed back to tokenholders.

Why would a protocol wish to distribute value back to tokenholders? Holders have taken the risk to hold the token; for what reason would they do so? Past distributions of value may indicate a propensity to do so in the future, giving prospective buyers a reason to want to hold the token.

While ‘value’ could be interpreted as entertainment or social value, this section primarily focuses on economic value.

To exemplify this vector, we turn to MKR, the governance token for Maker DAO and the issuer of the debt-backed stablecoin DAI. Maker DAO profits by charging an interest rate to crypto users who borrow DAI in smart contract controlled loans.

Initially, MKR used profits to buy-back and burn MKR. This method adds market-driven buying pressure to the token (number go up) while reducing the token supply, making each token’s actual governance value more powerful in percentage terms. A burn quite literally redistributes the burned token’s ‘value’ equally and instantly to all other tokens in the total supply. In this way, it is the most economically efficient method for value redistribution, though this is only half the story.

Burns aren’t value accrual. But they are a form of value redistribution.

This concept needs explaining. Short detour into web3 gaming.

Below is a generic game token model to illustrate an important point on burns and value. It’ll have direct implications with the MKR example.

Burn Baby Burn

This is the classic “we give out a lot of tokens and we burn a lot of tokens.”

“We have 30–50% of our token supply set aside for player rewards. We intend to distribute these rewards to players who are playing the game. Anytime someone upgrades their level we burn 50% of the payment, so we know we’ll be sustainable.”

Merely the action of burning tokens does not constitute value accrual — instead, it is value redistribution.

Merely the action of minting tokens does not constitute value creation — instead, it is value debasement.

A token ecosystem only gains economic value when a token is acquired through economic means.

If a token is distributed from supply that was not circulating,
such as being issued from ‘player rewards’ or ‘partnerships’,
then spent by users, and then burned;
No value was accrued.

Instead, the value is just redistributed.

Without the addition of outside value,

When more tokens enter the ecosystem, everyone’s percentage of value of the ecosystem decreases equally and instantly (debasement).

When tokens are burned, the opposite occurs.

To drive this point home (because it’s super important and definitely not understood), it is outrageously silly to issue game tokens to players via a rewards pool and then beg players to spend it again, just to recycle it back into the rewards pool. (Looking at you, most web3 games coming out this year.) While this may constitute ‘volume’ and make your ‘circulation and spend’ numbers look nice, no value was actually captured here.

Let’s say that all players who got those tokens from playing the game, spent them. And any tokens spent would immediately burn. In this scenario, you still don’t have any value captured. Instead, value was redistributed. The current tokenholders now have a higher percentage of the ecosystem.

Instead, in the likely scenario that some, if not many, players sell those tokens on the open market, this contributes to value extraction instead. It’s a risk without any sort of reward.

Instead of spending all your time trying to convince players to spend the free money you gave them, focus instead on how the tokens you’re distributing to them come into existence and obtain economic value.

If you give players tokens newly minted tokens that you whisked into existence for free, no value has accrued. In addition, you are diluting every tokenholder’s share of the ecosystem. This is colloquially known as your inflation rate but it really should be known as your debasement rate.

Infographic time, let’s really drive this home. Behold, a tokenomics flow chart of epic proportions.

As the ^picture with a thousand words shows, if a token is issued from the ‘treasury’ or ‘ecosystem incentives’, and then burned at a later date, you have a net 0 value accrual transaction. If that token is spent and then recirculated into supply, the total supply has still been debased equal to the amount of tokens that were added via that faucet.

Buybacks are a form of value accrual because value is being transferred from outside the token ecosystem into the token ecosystem through a market purchase. This market purchase raises the demand for the token which impacts the price.

The impact on the price is directly related to the amount of liquidity the token has. Tokens with a lot of liquidity will only move the price slightly, and vice versa. Tokens with low liquidity will look very choppy.

But wait, isn’t that good? Number go up means value accrual? Not quite. Correlation does not equal causation — low liquidity can cut both ways due to volatility, reduced confidence in long term stability, and propensity to be manipulated by bad actors.

Steady, stable increases in price are better than sharp spikes. Sharp spikes are nice for attention, but the forces that drive these sharp spikes often guarantee a crash following the peak. Preferably, a token ecosystem should grow more in lockstep with the demand for the service it’s rendering — this is its underlying sustainable value.

We took this little gaming detour to understand how burns do and don’t work, and we got mired in the swamp that is liquidity. Ugh. To understand distribution management effectively, we need to learn a little more about liquidity.

All this connects to MKR, the reveal is cookin’.

A Little Liquidity Lesson

Liquidity is the ability to move in and out of financial positions through buying and selling. For a more technical definition, liquidity is the availability of limit orders or tokens in an AMM that enable someone to make an instant trade. (or exit).

A token has high liquidity when it is paired with one or several other tokens in large amounts, occasionally across multiple pools or chains. Tokens with high liquidity enable these trades to occur quickly and without much impact on the price. In addition, high liquidity engenders trust in the ecosystem because there is time to exit quickly in the case of a crisis.

Buy-side liquidity is the volume of bids for purchasing a token. Buy-side liquidity is high when several people are trying to buy the token at the same time, or when a few people are trying to buy a lot of it. Vice-versa for sell-side liquidity. For the token price to go up, buy-side liquidity needs to be higher than sell-side liquidity.

Maker Making Money

With these concepts in mind, consider MKR again. When Maker DAO makes a commitment to buyback and burn, they are saying that they will provide buy-side liquidity in the market for the MKR token. This buy-side liquidity is what increases the price — not the burn. The burn takes the value that was contained in those bought tokens and distributes that value to all other tokens equally and instantly. So, Maker DAO buyback and burns are 2 forms of value accrual:

1. Transforming revenue from outside the token and using it to purchase MKR on the market
2. Reducing the number of MKR tokens on the market, effectively distributing that value that was just captured to all remaining tokens instantaneously and equally

Naturally, there is a psychological impact of performing buybacks due to the buy-side liquidity impacting the price of the token (price going up). If the timing of buybacks can be predicted, arbitrage opportunities exist for speculators (bad for you). In addition, merely announcing the commitment to do buybacks/burns can trigger more price action than the actual buybacks/burns themselves due to the belief that buy-side liquidity will regularly exist in the future.

A few months ago, Maker DAO decided to change their strategy from buyback and burn to buyback and pair. This method involves Maker DAO creating buy-side liquidity for MKR through buybacks, then immediately pairing the purchased MKR with DAI from their revenue at the market-purchased price. This pair is then deposited into the liquidity pool, deepening their liquidity.

This additional liquidity decreases price volatility over time because speculators need to use increasingly larger amounts to move the price. This means that the MKR buybacks will also have less of an effect on price, but MKR will also be trusted to be a more stable cryptoasset with steady growth.

Since we’re talking about value accrual, try this one on for size. Due to the above factors and a concerted effort by Maker DAO, the DAO now controls 99%+ of the on-chain liquidity for MKR. This means they profit every time someone trades MKR. These additional profits can then be used to buy back more MKR and pair or burn it at their discretion. Since their pivot to buyback and pair just under 4 months ago, there has been $36 million deposited, with the pool’s value hovering around $36.47 million. This disparity is a 477k profit. This profit can be used to buyback and pair even more tokens.

This has been achieved by buying back around $20,000 every 2 hours for many of the last 90-some days. As long as the sell-side liquidity doesn’t keep up, this will have a large impact on the price. $20,000 per 2 hours daily is $87.3 million annually. That’s a lot of buy-side liquidity.

While MKR is obviously an outlier here because of the size, it was picked to show the power of distribution management. How you choose to distribute tokens and the value within the ecosystem has a massive impact on value accrual.

A Note on Speculation

This little bugger.
In last year’s article Why Fun Games Won’t Solve Web3 Gaming, I noted that speculation wasn’t good or bad, it just is. But is speculation a form of Value Accrual?

Speculation primarily sits in the department of attention and demand. It is predicated on the perception that the market has about the protocol or service in question. While there are ways to capture value from speculation, which can lead to value accrual, speculation by itself isn’t value accrual.

The one caveat here is mindshare. In this department, speculation absolutely is a factor for value accrual. Take Axie Infinity’s token for example, AXS. Regardless of your opinion about it, AXS is known by more people. It has mindshare. That simple fact alone can cause more perceptual ‘safety’ when comparing it to a lesser known ATLAS.

So is speculation a form of value accrual? Kind of. It’s gray. Speculation will happen, the real question is, how can you capture value from that speculation? What mechanic would you put in place to ensure you can grow the protocol or service effectively over time while using speculation to your advantage?

Anon Call

I called my friend back to tell him what I learned

I was midway through explaining the epic drama that is the Curve Wars,

When my vape-fueled conversational sparring partner blurts out:
“Yo bro, get to the point, what’s just, like, the best way to accrue value to the token?”

I paused for a second.

And then said something much dumber and less polished than:
“There is no best way to accrue value to a token. But there are 3 broad categories of methods. Value accrual happens through reinvesting resources into making the system more profitable or defendable, allowing governance over something that has value or can direct value, and implementing strategic distribution mechanisms to manage supply and demand with fundamentals. Using a mix of these 3 methods is preferred, though the weight of each should be determined based on the specific needs of the protocol or service in question.”

There are no ‘best tokenomics’. But there are patterns to know.

1. Reinvest to grow the network effects, possible products, services, or market share
2. Governance over decisions with economic implications, or having power around the treasury
3. Distributing value around the system efficiently to achieve the protocol’s goals
4. Number will go up over the long term by practicing Value Accrual

Now you have seen the path
This chart may be more accurate

Focus on Value Accrual to find the way

Bonus info

1. ‘Sustainable Tokenomics’ are not a silver bullet. The token ecosystem must have demand, attention, and a litany of other factors, while also utilizing tokenomics that capture and distribute value effectively over time.
2. Economic value must first originate outside of the token ecosystem, enter the ecosystem, and then remain there. Why would someone choose to hold value in your own token when ETH is an alternative?
3. How is the economic value controlled by the protocol distributed? Where is it distributed to? Are resources, earned from profit, marshalled to grow the ecosystem? Or are they distributed to everyone? Is this set up effectively for the protocol you are trying to create?

About the authors:

None of this is financial or legal advice. Please consult with licensed professionals before integrating any of the above methods of value accrual. Some jurisdictions may be adverse to this crypto thing. We are not financial or legal advisors. We have memes in our article. This is for comedic and entertainment purposes only. The information in this article is not reflective of Shima Capital’s stance, and should be attributed solely to the authors.

Nick Metzler is a Venture Partner with Shima Capital and a lifelong gamer and game designer. He’s designed games in every medium you can imagine including Survivor challenges, murder mysteries in a castle for a wedding, award winning board games such as Jumanji and Hail Hydra, and is now a gaming tokenomics advisor for several upcoming web3 games. Favorite games include Marvel Snap, Slay the Spire, Foosball, Smash Bros, Survivor, Quidditch, Terraforming Mars, Quiplash, and countless more.

Benjamin Sturisky is a contrarian thinker who enjoys exploring game theory and decentralized finance. Studying finance at the University of Florida, Benjamin has a strong interest in seeing traditional finance integrated with crypto rails to create a more inclusive financial system for the world.

We’d like to give a special shoutout and thank you to our peer reviewers, as this article would not be this excellent without them. No part of this article is meant to be reflective of their opinions or the stances of the companies they work for, as their own stances are nuanced, varied, and quite good.

Alex Wetterman and Kevin Eun at Shima Capital
Kiefer Zang at Economics Design
Michael Arnold at Mighty Bear Games
0xKepler at ggQuest
Steve Ip at Conductive AI
Matt Cheung at Immutable
Devin Becker at Naavik and Nami
Kent Byers and Jason Perkins at 32 Bit Ventures