What’s Next For DeFi Governance Tokens & Community Incentives
In February this year, at DAOfest, which was part of ETH Denver, I gave a talk titled “6 Thoughts On Community”, which included a few slides I’m using here:
I see crypto as a set of new technologies, enabling new processes, most notably decentralization, with community as the fuel. Similar to how electricity powered the second industrial revolution, community is powering the crypto revolution. I define community as:
The biggest communities are religions. That’s because of the massive “value differential” religions enjoy between the zero cost of manufacturing the good community members want (faith), and the huge value many people place on their faith. Because of that massive value differential, many different religious communities have developed. It seems self evident that there’s a high correlation between value differential and the size of communities.
In addition to a massive value differential, religions benefit from the “value impact” to existing community members of of providing faith to new community members. Notably, the value that a new community member gets from their new faith, doesn’t detract from the value of the faith that other members hold. In fact, it can increase the value of the faith that others hold as people can derive great social value from others that share their faith.
Community Remains Under-Appreciated In Crypto
This post was inspired by Tushar Jain’s “Exploring The Design Space of Liquidity Mining”. The purpose of that piece was to “ …outline a framework by which DeFi teams can construct a useful liquidity mining program that incentivizes long-term capital retention”. While I learned a ton (thanks Tushar!), I was struck by the fact that the word “community” was never used. While Tushar recognized that DeFi “.. has just scratched the surface of what is possible with well designed liquidity mining programs”, his post referenced no “Design Space” beyond the token/economic reward earned by DeFi participants.
Current Liquidity Mining Incentives Are Often Flawed
I’m a huge believer in DeFi (e.g. “Defi Is Crypto’s Netscape”). But while some DeFi protocols like Synthetix or Compound are creating value, many are simply taking different “money legos” and stacking them on top of one another (e.g. $Yam) in what Brian Flynn has termed a zero sum Massive Multiplayer Financial Games:
Even those projects that are creating value, are often offering incentives that reward behavior like wash trading, which is adding no value to the project. To alleviate the wash trading problem, Tushar suggests putting restrictions (e.g. lockups) or adding rewards retroactively, that are just jerry-rigging “broken” incentive mechanisms.
Another problem is the limited time frames of the incentive programs. When the incentives run out, the miners will go someplace else unless there are other compelling reasons to stay.
What’s Next In Liquidity Mining/Token Economic Designs & Dimensions
Bitcoin’s token economics continue to work because it’s still able to create value (new Bitcoins) at little cost to the network itself, and miners mine because the expected value of the Bitcoin rewards are higher then their expected cost of mining. While billions and billions have been spent on mining Bitcoin, the value of the ecosystem is worth $225 billion today. So massive value has been created.
But is real value being created in liquidity mining today? The idea of paying early customers to participate as a way to get to scale and networks effects, is not new. What is new is governance tokens, which can be earned by people who participate in the protocol that accrue value due to their ability to be used to vote on protocol changes.
Governance tokens are being deployed by DeFi protocols to reward participation. These protocols are often launching without any value capture as a way to optimize value for it users. Potential revenue models/value capture mechanisms can even be built in to the protocol, like Balancer’s “Exit Fee”, without being activated in the initial protocol release.
Governance tokens are free to produce, and they can be hold great value for their owners, as they confer the right to vote on the future evolution of the protocol, including value capture that could accrue to the token holder. Governance tokens have proven to be very powerful in terms of incentivizing DeFi user behavior. And there’s tremendous innovation to come. For example, Andre Cronje and the YFI team kept no governance tokens when the initial YFI token distribution was made They wanted to delegate governance rights (and responsibilities) to the community in a decentralized and fair manner, something pretty revolutionary.
But Governance tokens do have negative value impact, as every governance token produced decreases the voting power conferred by all the outstanding governance tokens, if it’s not offset by other factors. I believe there is tremendous design space in granting rewards at minimal cost that don’t meaningfully decrease the value of the rewards already outstanding.
One area that holds promise is community “status” conferred for providing value to the community. While status can be rewarded with additional comp, status also holds tremendous value for many community members in and of itself. Badges or other symbols of status in a community can provide tremendous value to some community members, without any cost or negative value impact. Status in Community “A” can also used as a signal by Community “B”, who can provide value to members in Community A, at no cost to Community A.
I think NFTs hold a lot of promise as incentive tools for decentralized communities, as they cost zero to produce, and can have/attain significant value.
Projects can gain from having missions beyond making money that community members believe in and benefit by association.
I also believe communities can work together in ways where 1+1=5. Or 1+1+1=25.
Crypto’s Netscape moment has truly arrived, with so much innovation to come. And the world has no idea.
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