Bisq, the unstoppable organization built on Bitcoin — An analysis of the BSQ token
Screening many token projects, I have come across the BSQ token which design I consider sound and in this article I lay out what I mean with that. The BSQ token is connected to the Bisq network — a peer-to-peer trading network for cryptocurrencies. Essentially, the Bisq network provides a platform on which traders can find a trading partner for the considered trade. The trade is executed directly between peers. This means that the payment for the cryptocurrency is sent directly to the recipient and vice versa. As a result, typical central exchanges are disintermediated by the Bisq network.
Utility of the BSQ token
Transaction fees on the Bisq network can be either paid in BTC or in BSQ. Using BSQ token reduces transaction fees. The initial setup showed a reduction in trading fees by 90% when using BSQ, however, this discount was reduced recently. According to the latest update, fees are at 0.001 BTC per BTC for the maker of an offer and 0.003 BTC per BTC for the taker of an offer. In BSQ, the fees are 5 BSQ per BTC for the maker and 15 BSQ per BTC for the taker (https://bisq.network/blog/cycle-6-results/). One BSQ is currently traded on Bisq for 0.00009931 BTC. This means using BSQ, the maker pays 0.00049655 in BTC according to the current exchange rate, the taker pays 0.00148965 BTC. This equals a discount rate of a bit more than 50%. The difference in fees for maker and taker “should reflect the higher burden on the maker side and incentivize market makers” (https://bisq.network/roadmap/).
Furthermore, BSQ token represent voting rights in the Bisq DAO. Any token holder may propose certain changes and improvements to the protocol on which other token holders vote. The token holders collectively decide which proposals are implemented. In general, any governance requires a representation of voting rights in some form for decision making. Here, this representation is facilitated with the BSQ token. Additionally, BSQ token are needed to compensate contributors for their work for the Bisq network.
Burn-and-mint equilibrium
The BSQ token is embedded in a burn-and-mint equilibrium. This means that on a regular basis, BSQ tokens are burned/destroyed as well as newly created/minted. BSQ tokens are burned when a trader decides to use BSQ token to pay for the transaction fees. The trader has an incentive to do so since this reduces his transaction fees.
When a trader uses BSQ for a trade, these BSQ are burned, i.e. destroyed. This reduces the total supply of BSQ. Due to the laws of supply and demand, a reduction in supply results in an increase in the token price assuming constant demand. So in theory, by using BSQ instead of BTC for transaction fees, the value of the BSQ token is increased. However, BSQ are also newly minted, i.e. newly issued which is discussed in the next chapter.
BSQ that originate from minting are distributed to contributors of the Bisq network who added value to the network through their contribution. More precisely, contributors first provide their work for the network. They can only be compensated after they have submitted their work with a compensation request. This compensation is voted on by the BSQ token holders.
Before the first BSQ tokens were minted, contributors needed to know how many BSQ tokens they can request for their work. The community agreed on assuming 1 USD for 1 BSQ for calculating their compensation. Since then, BSQ has been oscillating mostly between 0.5 USD and 1.5 USD. We assume that this initial anchor at 1 USD mainly contributes to BSQ being traded at around 1 USD since the initial token holder of BSQ have an interest that BSQ are valued at this price. But the mechanics are more complex since the value that BSQ is traded on determines the relative discount in trading fees when using BSQ: The higher the price of BSQ, the lower the discount and the lower the incentive to use BSQ instead of BTC for paying trading fees. This would in turn reduce the demand for BSQ token given fixed trading fees. This mechanism ensures that the price of BSQ is capped since no rational investor would buy BSQ at a price at which discounts are zero. More precisely: the higher the BSQ token price, the lower its utility. However, the trading fees in BSQ could be adapted by the Bisq DAO in a way that less BSQ are needed for settling a trade in case of an increase in BSQ price. Then two opposing effects kick in: On the one side this would increase the demand for BSQ since the discount is increased. On the other side less BSQ are needed for settling the trading fees which reduces demand — and this would also reduce the amount of BSQ token burned in each transaction which negatively affects scarcity. The below diagram shows the mechanics of the BSQ token.
The figure illustrates that the BSQ token shows several balancing (opposing) effects in its token economics. Note that these mechanics hold vice versa, i.e. for the first line: Price of BSQ shrinks ⇒ Discount on trading fees rises ⇒ Demand for BSQ is increased (higher utility) ⇒ Price of BSQ rises.
BSQ — a colored coin
BSQ is a colored coin based on Bitcoin. This means, that a BSQ token has all the functionalities of Bitcoin plus some additional features according to the Bisq protocol. One BSQ has 100 satoshi as underlying which is 0.000001 BTC. As a result, one BSQ is at least worth 100 satoshi. However, since these special BTC token called BSQ have some additional functionalities, the value of one BSQ is considered higher than its underlying of 100 satoshi. When interpreted by a BTC wallet, the BSQ transaction looks like a normal Bitcoin transaction — it cannot be identified as a colored coin. For identification of BSQ transaction, the Bisq software is needed.
The BSQ token does not only entail additional features but also additional rules. The BSQ token is valid in transactions only when both, the Bitcoin rules as well as the additional Bisq rules are followed. If Bisq rules are not considered, then the BSQ token transforms back to normal BTC. It will not be accepted by the Bisq protocol. One rule of BSQ is that the order of inputs is in the right order namely first BSQ and then BTC. Breaching this rule results in burning of BSQ, i.e. reverting back to BTC.
But how were the first colored bitcoins named BSQ token generated? The Bisq network collected some amount of BTC for funding its own genesis block. The protocol then defines that all transactions coming from this genesis block are considered BSQ in case the rules of the Bisq protocol are followed.
Genesis block
For mining the BSQ genesis block, Bisq relied on Bitcoin donations. Altogether, 2.5 BTC were collected from donations. These 2.5 BTC served as the input for the genesis transaction. The 2.5 BTC are transformed into 2.5 million BSQ since each BSQ carries 0.00000100 BTC as underlying value. The first distribution to contributors were issued in the genesis block. Afterwards, new BSQ were minted for contributors only when the whole network agreed to do so.
In the next article we will discuss the governance of the DAO in more detail also on a technical level. Stay tuned!
