A Year in Review: Token Economics

While many may have considered 2019 a slow year for crypto, we witnessed a number of exciting developments signalling growth in the industry at large.

There may not have been as many 100x ICO millionaires, but there were ten times as many teams hard at work genuinely trying to deliver the best product(s) possible.

In this week’s Token Tuesday, we’ll be taking a look at the takeaways we learned from the past year, along with how they apply to trends we may expect to emerge in 2020. We hope to shine some light on what a “strong” token economy looks like, along with how your project or business can benefit from their economic designs.

Key Summary

• How to approach a token economy
• How to distinguish between utility and security
• 2019’s strongest token models
• Growth first, native token second

We’ve got a lot to cover, so let’s get right into it!

Token Economic Design

Our role here at Fitzner Blockchain Consulting has largely allowed us to deal with the research and design of token economies across a wide variety of niches. We say this to provide some context that we’ve had the pleasure of designing and iterating on a wide range of token models over the past two years.

As we continued going through the process, we quickly found a formula that helped our clients become much more focused on what they were hoping to accomplish. Without giving away all our trade secrets it goes a little something like this:

Alright now that we’ve gotten the jokes out of the way, let’s continue.

In all seriousness, a lot of our research ended up showing us that making a new token was not *necessary* for most projects. Instead, we encourage our clients to consider the following:

• Is there an existing cryptocurrency that would allow you to accomplish the same value transfer use-cases? (Likely yes, consider ETH or DAI)
• Is price stability important for your use-case? (Likely yes, consider DAI)
• Is your project a protocol or a dApp? (If dApp, consider one of the above)

We may be generalizing, but for the sake of the article, we want to highlight that for any project building on Ethereum (or really any blockchain protocol) we largely believe that designing a native token economy should come further down the line (more on this below).

In 2019, we saw the emergence of Total Value Locked via a leaderboard called DeFi Pulse. What was unique about TVL was that it encouraged projects to design value-capturing use cases surrounding popular currencies like ETH and DAI.

By lowering the barriers to entry and leveraging an existing liquid, permissionless asset to utilize your service, we saw a number of notable products gain some serious traction. In particular, DeFi projects like Uniswap, Compound and Set Protocol are good examples of projects leveraging ETH and DAI as a strong foundation for a friendly-user experience.

Token Fundraising

Now at this point in the process, we start to get a lot of questions in the vein of:

“But if I’m not creating my own currency how am I supposed to fundraise?”

To be blunt, we see a lot of founders eager to issue a new token as it *theoretically* allows for teams to raise funds without the sale of equity.

As such, 2019 saw a big revitalization of Initial Exchange Offerings (IEOs) which piggybacked on the demand for Initial Coin Offerings (ICOs) by selling utility tokens directly through secondary exchanges.

While this did allow for better due diligence on some of the more prominent exchanges, we quickly saw lower-tier exchanges try and leverage the hype by charging teams exorbitant listing fees to host an IEO on their site.

In summary, the days of being able to raise north of $10M pre-product for a utility token are *mostly* behind us. Instead, we encourage teams to consider the following:

• If you REALLY need to fundraise, consider the sale of equity. If your project is compelling enough, you should have no problem getting crypto-friendly investors on board.
• If you’re REALLY opposed to the sale of equity, consider leveraging grants from consortiums like MetaCartel, Moloch, Gitcoin, Ethereum Foundation or Consensys to get your product up and running.

The biggest thing to note here is that legal frameworks are slowly being set for token sales at large. In particular, 2019 marked the first approval of a Reg A+ offerings, most notably from Blockstack, along with another approval for Props.

For those unfamiliar with Reg A+, this is a security filing which allows companies to raise anywhere from $20–50M from unaccredited investors (a big part of what made ICOs so appealing to founders). If you’re looking to brush up on the filings we’ve dealt with in the past year, we recommend this resource.

This is important to highlight as the days of setting up off-shore companies to conduct a token sale *should* be behind us. We want to emphasize that following proper legal guidelines is always recommended and in the event that your team can’t afford the costs to do so, it should serve as a good indicator that you’re *probably* not ready to raise.

For any of our token founder’s out there, please be sure to distinguish tokens that are pure utility and those which your holders can expect to accrue in value (making them securities). There is nothing inherently *wrong* with creating a utility or a security token so long as you are very clear cut and follow the proper legal frameworks.

Now that we’ve touched on the due diligence aspect, let’s take a look at some token economies that were unique or effective this past year.

2019’s Strongest Token Economies

Before we dive in, we largely recognize that there are plenty of compelling token economies out there beyond what we mention. We are merely covering the tip of the iceberg and want to highlight the reasons why these specific tokens have performed well in the past year.

We’d like to note that we calculated price in terms of the token’s native asset. Therefore, Synthetix (SNX), MakerDAO (MKR), and Nexus Mutual (NXM) reflect price changes in ETH while Binance (BNB) price performance is in BTC. With that, here’s a quick glimpse at our favorite token economy’s performances in 2019:

Binance Coin (BNB)

The past year for one of the most popular centralized exchanges was nothing short of exciting. The team expanded into multiple different verticals at an absurdly high rate including becoming the premier platform for IEOs, enabling margin and futures trading, releasing a multitude of stablecoins, and launching a US-based exchange as well as a *Decentralized* Exchange (DEX).

The best part of it all is that the BNB token has an ever-expanding list of use cases as it serves a core purpose in every new vertical the company breaks into.

The cherry-on-top for the BNB case is the quarterly burns from the team, driving an increasing amount of scarcity over time as the exchange continues to operate. In 2019, the team burned a total of 5,321,482 BNB (US$207,338,000) burned. This is up from $120,000,000 worth of BNB burned at the end of 2018.

Here are some stats surrounding the Binance ecosystem that should give you some additional confidence in the state of the ecosystem as a whole (via Year in Review report):

• US$2,852,591,354 average daily trading volume
• 15,000,000+ Binance users worldwide
• 180+ countries and regions where Binance are based
• 1,000,000+ users holding BNB
• 40% increase in the average number of daily BNB-holding users for 2019 compared that of 2018

Synthetix (SNX)

In the latter half of 2019, we saw a breakout from Synthetix: a synthetic asset protocol built on Ethereum. Since implementing native inflation into the protocol back in March 2019, Synthetix has surged to #2 on DeFi Pulse’s Total Value Locked (TVL).

If you’re one of our recurring readers, you may remember our valuations on the token back in early September and then again in November. SNX’s price-performance was a clear leader in the overarching crypto ecosystem, surging nearly 3,000% in ETH terms this year alone.

The thing that we like about the Synthetix token is the ability to earn exchange transaction fees in sUSD, creating a clear evaluation model for the token. This coupled with the potential for DeFi and the derivatives market provides a clear value proposition for the protocol.

In addition, rather than taking a rigid approach to token economics by establishing the token economics in the whitepaper and then never touch it again, the team has elected to constantly iterate to find the right formula for success. Not only have we seen native inflation to the token model, but the protocol also shifted the issuance schedule to a smooth decay as well as added terminal inflation to incentivize staking in perpetuity.

This iterative approach will take into an even higher effect when the protocol transitions to DAO-based governance in 2020 as token holders will be able to seamlessly vote on protocol changes.

Synthetix also has one of the highest staking participation rates to date. Nearly 86% of all circulating SNX is staked in the protocol. Synthetix’s community is highly active in both on-chain participation and governance participation which we believe is one core aspect to a successful token economy — a community. Ultimately, Synthetix is doing it right with the help of an engaged community. We’re extremely excited to see how DeFi, its derivatives market, and how Synthetix plays a role in it over the course of 2020.

Synthetix Exchange Performance via Dashboard

Nexus Mutual (NXM)

As the only token economy built on a bonding curve, we have to shed some additional light on what makes this token so interesting. If you’re a DeFi bull, the value proposition is very clear for Nexus Mutual: as the value locked in DeFi grows, the value for that capital to be insured grows in parallel.

Right now, Nexus Mutual is the clear leader in decentralized smart contract insurance. Active cover amount recently surpassed $1M and the recent changes to a dynamic MCR% create a consistent mechanism for growing its capacity to cover smart contracts.

Nexus Mutual Active Cover Amount via Nexus Tracker

In terms of the NXM token, the most interesting aspect is leveraging a bonding curve to establish a transparent token valuation. If the amount in the capital pool is $x, then the token is equal to $y. It’s that simple. There are no secondary trading markets as all users are trading against the curve and all tokens represent a pro-rata claim to the capital pool (denominated in ETH).

Similar to Synthetix, Nexus Mutual is constantly looking to iterate on the token model and the mutual’s insurance model at large. In addition to the shift towards a dynamic MCR%, Nexus Mutual is also exploring other options including staking reward changes and leveraging the DSR to earn a return on the idle capital in the pool.

In summary, the Nexus Mutual team is definitely on the right path to perfecting their recipe for managing the capital pool while the need for smart contract insurance is only getting higher. The protocol is barely 6 months old at this point in time so there’s plenty of time to continue to iterate.

MakerDAO (MKR)

It goes without saying that 2019 was the year of DeFi. With that, it’s hard to not mention MakerDAO as it provided DeFi with the world’s first permissionless stablecoin. The MKR token model is actually rather intuitive: as people mint DAI, they accrue a debt in MKR which is burned upon payback.

The proliferation of Dai drives cash flows into the MakerDAO system to burn MKR, constantly creating a demand for MKR and an increase in scarcity for MKR as Dai grows.

While 2019 was a relatively mellow year in terms of price performance, the launch of Multi-Collateral Dai was a vital milestone for the future of Dai and DeFi at large. We saw Dai hit its debt ceiling of 100M while total MKR burnt reached 1% of the total supply. Additionally, the Maker Foundation recently completed a token sale to expand into Asia in 2020 so we may see an uptick in Dai usage as the Asian markets come around to Dai and the DeFi ecosystem as a whole.

What We’ve Learned

2019 marked the revitalization of compelling token economies. To quickly summarize some of the better design cases from above, we’ve seen token economies succeed that:

• Have clear value-adding use-cases (not just transferring from A to B)
• Encourage staking to capture rewards
• Leverage reserves and use native tokens to dictate claims on that reserve

Now this may be very broad, but want we want to highlight is that projects are starting to care about how their tokens are performing once they hit secondary markets. Unfortunately, we saw way too many cases where projects more or less abandoned their token economy, ultimately resulting in 90+% losses.

Moving into 2020, we’ve seen numerous projects leverage the DAO model to bring life back into their project while trying to put the power back into the hands of their community members.

More importantly, we expect more projects to leverage the following trend.

Growth First, Token Second

Many popular blockchain projects have thrived without a native token. Examples of this include Compound, Uniswap and Gitcoin. All three of these projects have amassed serious value and an established user-base all without the creation of a native token.

Once the foundation has been paved, the question then becomes: “How can we further incentivize this community?”

Once there is a group of users actively utilizing a product without solely monetary incentives (I use X because if their token goes up I could get rich) it becomes much easier to consider which actions could be optimized to their advantage.

While Compound has cTokens, Uniswap has LP tokens and Gitcoin has Gitcoin Grants, none of these are required to get started. They merely serve as a stepping stone to additional benefits and are the start to what we call the Growth Blueprint.

Once specialized users become familiar with the advantages of your product, there becomes more incentive to tokenize those benefits.

For example, Uniswap may choose to issue a token which represents partial claims on all trading fees, without having to add liquidity to a pool. Similarly, Compound may choose to issue a token which represents a claim on a slice of cToken interests, without having to deposit collateral to receive it. In the case of Gitcoin, a native token could represent a claim on service fees or commissions earned from bounty campaigns.

What we want to highlight here is that these models would never work if there wasn’t proven traction. Since there is a clear demand and clear income opportunities, it then becomes possible to tokenize that model to unlock deeper liquidity and composability.

Looking Ahead

As we step into 2020, we encourage you to be on the lookout for teams who are putting serious effort into revisiting their token economies. More so than that, keep an eye on teams that are shipping products without worrying about native token value accrual.

The days of “if you build it, they will come” have been replaced by “if they come, choose to build (a new token)”.

The coming year is shaping up to be the most wholesome year for tangible products leveraging the tools and concepts that makes web 3 so exciting.

If you or your team are interested in learning more about any of the topics covered in this article, please reach out.

We’re excited to spend 2020 researching and developing as many compelling blockchain products as possible and would love to include you in that conversation.

Until next year!

Written By: Cooper Turley & Lucas Campbell