In the blockchain world, 2017 was marked by a meteoric rise of protocol tokens — digital assets that act like the arcade tokens fueling decentralized networks.
Thousands of decentralized token-powered protocols arose, many with their own public token sales or “initial coin offerings” (ICOs). And this brought many more consumers into the digital currency space.
Blockchain tokens may be the future, but we’re in the very early days and we have many best practices to define and a lot to learn.
This post is about learning from the history of tokens and how we can get the distribution and the economics and the governance right from the start.
Common Problems with Tokens Today
Here are some common problems we’ve been facing in the blockchain industry when it comes to crypto tokens:
- Too much is focused on fundraising and not enough is focused on real business models and growth.
- Not enough tokens are held by the network users and developers and too many tokens are held by the investors and creators.
- A lack of price flexibility can make the network too costly to use and can impede growth.
From these problems, we can establish a few rules that can help us guide our decisions when it comes to token distribution and economics.
Token Rule #1: Business Modeling First, Fundraising Second
It’s unfortunate but lately more attention seems to be directed at the token sales or “ICOs” rather than the tokens themselves.
Token sales may be powerful tools for raising money but they’re revolutionary for organizing and incentivizing people.
Tokens are the fuel that powers decentralized networks. And that is what makes them much more powerful for business models than for fundraising.
The best token projects focus on tokens as a means to build network effects and help govern the network. The token sale is simply a bonus that can be used to facilitate distribution and raise money.
At Blockstack, for example, we’ve decided to do a token because it creates powerful dynamics for the network and enables new functionality. The token:
- provides for a way for us to grow the network and get many people on board with our mission
- catalyzes the existing network and organizes the people towards a common goal
- provides a mechanism for governance and voting on protocol upgrades
Token Rule #2: Maximize Tokens for Developers & Users
Tokens can be held by many parties, from the creators to investors to developers on the network to end users.
And while tokens being bought up by speculators can be very healthy for the ecosystem in terms of enabling liquidity, the network is best served when as many tokens as possible are held by the actual developers on and users of the network.
A holder of tokens that contributes to the network is more valuable than a holder of tokens that does not contribute to the network.
If we assume that developers have more of a reason to contribute to the platform if they hold tokens, then it follows that a network can gain more contributors by ensuring more tokens get in the hands of developers.
Then as a general principle, projects should try to maximize the number of tokens that are held by developers and users and other network contributors.
To give an example, at Blockstack we’ve introduced what we believe is a much more fair token distribution model and one that will help the network succeed and outcompete other networks in the long term. We did this by incorporating novel mining mechanisms that distribute tokens to app developers and users and miners who each strengthen the network.
You can see more charts about Blockstack distribution and economics at charts.blockstack.com.
Token Rule #3: Price Flexibly to Optimize for Growth
When pricing services on blockchain networks (like payments, name registrations, etc.), it’s important to think through what the characteristics and constraints of the services are and how they need to be priced in order to facilitate efficient allocation and set up the network for growth.
The simplest and most naive pricing method is fixed pricing. However, if you introduce a pricing mechanism based on a certain number of tokens, that can be problematic if the token price fluctuates wildly. That can make blockchain assets and services overly expensive and then in turn end up slowing down network participation.
Two pricing methods can address these problems and are good for different types of services:
- periodically-adjusted pricing
- auction-based pricing
Periodically-adjusted global pricing is something we see with the minimum dust fee in Bitcoin and the conversion rate from Ethereum to Ethereum Gas. It’s great in that it allows for adjustments that can withstand token value changes. This is perfect for simple resources that aren’t fixed in the number of actions that can be performed.
Auction-based pricing, meanwhile, is something we see with the pricing of Bitcoin and Ethereum transactions. It’s perfectly suited here because including transactions in blocks is dependent on a fixed resource of block space that can be lined up against highly variable demand. And auctions are a great way to allocate fixed resources with variable demand.
It’s important to asset what you want in terms of growth and price the blockchain service accordingly.
For example, at Blockstack we want an extremely large number of names to be registered that can grow exponentially over time. Meanwhile, we want steady growth in the number of namespaces created but we want some level of consolidation around major namespaces that apps can share.
This means that namespace creation lends itself well to auction-based pricing, and that’s exactly what we’re working towards with Blockstack.
It also means that name registration lends itself well to periodically-adjusted pricing. As a result, we’re (1) allowing name prices to be adjusted by namespace creators, based on token values (2) working on mechanisms to scale name registrations beyond the current “one transaction, one name registration” limitation.
Building for the Long Term
The three rules mentioned above are designed to help you build for the long term:
- Business modeling first, fundraising second
- Maximize tokens for developers and users
- Price flexibly to optimize for growth
Short term thinking, meanwhile, can lead people astray from these rules. It can lead them to the biggest fundraises with broken distribution models and a ton of tokens going to parties that don’t contribute at all to the network.
There are no guarantees in the rapidly developing world of ICOs, but it’s our belief that following these rules can set up your network for success.
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This blog entry is not an offer of securities. The Blockstack Tokens are a crypto asset that is currently being developed by Blockstack Token LLC (“Blockstack Token LLC”), a Delaware limited liability company. Before purchasing interests in the tokens, you should read the related offering materials. As with any investment, purchasing interests in the Blockstack Tokens involves risk.
