API3 Tokenomics

In decentralized autonomous organizations (DAOs) where there is no hierarchy yet many people working together, tokenomics need to be well thought out to be succesful long term. The survivability of the project depends on aligning the goals of both token holders and project contributors, especially as the project increases in size over time.

Staking

To briefly describe staking to the new initiates to Web3, staking is like locking up your tokens in a savings account — there’s rewards paid out incrementally over the duration that your funds are staked.

Proof-of-Stake networks use the staking mechanism to power validator nodes that vote on what transactions should be incorporated into the blockchain, but there are more ways to use staking than just for consensus as we will see.

API3 tokenomic mechanics

Though one initial function of project-specific tokens is to seed their treasuries, there must be additional utility for good tokenomic incentives.

The API3 token is interesting in that one of its utilities is to act as collateral for a unique service coverage on the datafeeds enabled and curated by the API3 DAO. As such, the tokenomic incentives for this project not only need to encourage people to hold the API3 token, but also to stake it to enable service coverage to a larger base of smart contract developers.

In the API3 white paper, the governance, security, and value capture utilities of the API token are highlighted as tokenomic mechanics, though co-founder Burak Benligiray clarified additional measures for value capture, like token burn, which we will explain in detail.

Governance

Governance is a cool tokenomic incentive because it encourages participation from those who see the long term potential of a project and share in the overall vision.

API3 uses this mechanism, allowing token holders who stake to participate in the DAO’s open and direct governance model.

These contributors are incentivized to stay around for the long-haul by trading token liquidity (the ability to sell their tokens any time) for the ability to make and vote on proposals that affect the direction of the DAO, including direct function calls for token grants and parameter updates to the DAO governance contract itself. As the proposals directly interact with the DAO contract, token stakers are not reliant upon a multisig or third party action to fulfil validly passed proposals.

Discussions on proposals are hosted on the API3 forum, and you can see detailed proposals that are currently being voted on by visiting the API3 DAO.

Yield on staked tokens

Staking comes with direct financial rewards to compensate for the service coverage collateralization risk and for locking up capital. These rewards (sometimes called yield) are like interest, and programmatically mint new tokens to staked addresses at a floating rate. This type of reward which issues new tokens is called an inflationary reward.

Because API3’s staking pool is the collateral for datafeed service coverage, the rate of inflationary rewards issuance is linked to the ratio of funds in the pool versus the target stake amount. The target stake is set by the DAO and based off the cost of servicing coverage plans.

Inflationary rewards converge to a stake target above what the collateral pool holds already.

The greater the difference between a lower staking pool value and a higher target value, the greater the rate of issuance should be as set by the DAO. This will either incentivize new capital to enter the pool to take advantage of the rising rates, or the inflationary reward itself will reach the target on its own given enough time.

The above covers the case when the target stake is greater than the capital contained in the staking pool, but what happens if the target stake drops below what’s already there?

Ideal scenario when target stake is dropped below what the collateral pool holds.

In the event that a DAO proposal passes to drop the target stake below what’s already in the staking pool, the rewards will be reduced on a weekly linear schedule: 1% per week until reaching equilibrium or the inflationary reward lower bound of 2.5%.

Because the inflationary rewards rate can be monitored and adjusted by DAO governance vote, there’s flexibility in changing conditions without the need for centralized intervention. Additionally, this design does not disproportionately reward early adopters and leads to a broader distribution of tokens over time as the inflationary reward only increases as demand for service coverage offered by API3 grows.

To balance positive and negative supply mechanics, API3 is combining the ideas of revenue distribution and token burns.

Revenue distribution and token burns

Flat revenue distribution has its own set of downsides, such as creating swings in the total amount of staked tokens, and attack vectors for the wealthy to exploit distribution events (see dividend capture strategy). To combat this type of action, API3 uses profits generated from a dApp’s use of datafeeds or service coverage to buy-and-burn API3 tokens.

This has a couple benefits:

• Stakers only need to receive inflationary rewards.
• Token value increases proportionately to the amount of tokens being burned as the service is “paid” for (supply decreases as demand stays the same).
• Supply changes are smoother, rather than having periodic spikes if revenues were shared monthly or yearly.
• Simplifies governance: the DAO only has to adjust the target stake which is linked with how much demand there is for service coverage.

Game theory for the win

It’s fascinating to see how goals project-specific goals directly impact the type of tokenomic incentives that can be employed. If API3 didn’t offer service coverage to smart contracts using API3 datafeeds, the mechanics of token burns and yields wouldn’t synergize well at all.

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