Token economics 101
Hi, everyone!
I’m Tomer, a GP at Flori ventures. We are an early-stage VC focusing on the intersection of emerging markets and blockchain.
I was the architect of GoodDollar.org, an early team member at Bancor, and worked with companies like eToro and many more in token economics. I wanted to share my process of designing a token model.
What’s the problem?
Before launching a token, start with the problem you are trying to solve. If your answer is fundraising, go home. This might not be for you.
A token is a tool for creating and managing a shared resource to avoid the tragedy of the commons.
“The commons” are any scarce resource, such as water or pasture, that provides tangible benefits to its users but which nobody in particular owns. Even though this is fair for everyone, because the common resource is unhampered by shared social structures or formal rules that govern access and use, it could easily turn into the tragedy of the commons when some individuals act according to their self-interest and contrary to the common good of all users. This might cause depletion of the resource through their uncoordinated action, for example, in the case of too many users related to the common resource.
Let’s take an example — see the picture below. The land on the left is open, so many farmers come to feed their cows on it. Land of this size could only feed up to 3 cows because it’s free, four farmers come, and it kills the pasture. The land on the right is owned by the farmer, who knows that more than three cows will be too much for the pasture, so limits the usage accordingly.
Could we design a token system that would allow for sustainable use of the open pasture?
Tokens are the tool that will allow us to create a more coordinated society. To solve the problem, i follow this chart:
Start by defining the resource of your economy
If we take the farmer story above as an example, the resource is the pasture, and its value will be defined by how big or how green it is (sorry, people who know much more about pastures!).
In bitcoin, for example, the resource is a decentralized ledger. The more decentralized and secure it is, the higher the value of utilizing such a ledger.
Identify your value-adding agents
In the farmers’ story above, the resource exists, and all agents participating in the story are extracting its value. When using a token economy, we can add a new type of agent. This is called a value-adding agent. It could be the ones that fertilized the land, the ones that made sure no one passed the rules, or even those who contributed new land for the farmers. Thus they are considered “value-adding agents” because their activity adds value to the resource.
When we talk about bitcoin, the value-adding agents are the miners, who maintain a decentralized and secure ledger.
Use distribution for seeding a new resource.
Unlike existing physical common resources, common financial resources (e.g, a decentralized ledger) don’t “just” exist; someone has to seed them. This is why one of the advantages of a token is similar to fundraising. You might also call it “labor raising” because you can pay labor for seeding the resource before demand.
For example, the first bitcoin miners were considered “philanthropists” when it came to the ROI of their mining costs at that time, but they did it because they believed in the asset's value in the future.
A common mistake is treating distribution like a “marketing budget” and not a “monetary policy.”
Contrary to a marketing budget that is “reactionary” to what comes, a monetary policy has predetermined conditions.
e.g. a good marketing budget can be spent a lot when there’s hype and spent less when the market is “slow,” and many times you’ll see projects running their token distribution that way, which will lead to the classic pump/dump graph we all know too well)
The barrier to participation
The holy grail of your distribution methodology is an on-chain event proving that the value-adding action occurred. This means that you need to be able to do something that proves your contribution so that others will reward you with tokens. Thus start thinking, what is your value-adding “moment”?
To identify it, avoid these common mistakes:
- Confusing the value-adding agents with value-extracting agents
- Using a human as a gatekeeper
- Not spending enough time on how someone can “game” your distribution model.
- Confusing value-adding moments with KPI (e.g. our KPI as a company is the number of transactions, rewarding people for transactions will lead to trade washing
In the Bitcoins example, Miners are rewarded when approving a transaction because this is when they contribute to the ledger.
Identify your value-extracting agents.
Defining a clear line between the agents that add and extract value to your project is the key. Consider that a person can play both roles, but their different actions will categorize them distinctively.
A gamer, is he a value-adding or a value extracting?
Going back to the farmer example, the farmers are the value extractors, and yes, when a cow has a dump (fertilizer!) they could be defined as a value-adding agent. However, an individual could choose through their actions what position they would like to take.
Define access to the resource.
The main issue in the tragedy of the commons is the lack of control over access to the resource. When a user is looking to get the resource, he should “pay” for his access in one form or another. Still, unlike in a payment to a company for its product, where the digital product is endless, the resource we manage with a token is finite, and its supply might vary over time.
There are two common ways to gate access, and one is not better than the other; they just fit different use purposes:
Fees: Fees are a good strategy when you want anyone to have access to the resource, and if you want to limit the access to a certain period ( e.g 10 people doing ten transactions in the same moment will pay more than ten people doing ten transactions on different days, which could be useful in examples like the farmer’s problem above)
Staking: Staking can be used as a barrier for value-adding and value-extracting. In both cases, it’s used for curation and collateralization. Note that staking is not a weird way to give passive income to your users.
If choosing to stake, take into account that the staked tokens must be utilized for at least one of three things:
Collateralization — in both cases of using staking as a barrier for value-adding or value-extracting, Collateralization is used to give the protocol the ability to punish the staker in case of “inappropriate” or “underperforming” behavior (your validator is down your slashed), or reward them in case of good performance.
Curation — When the value of staking increases as more people stake, it becomes harder to stake (the bar for participation rises). Best performers are rewarded, and bad actors are punished — if you are not looking for a curation model- don’t use staking.
Liquidity- staking for liquidity is a tool for financial products that are unrelated to the “core protocol,” aka DeFi
Say we want to “reimagine” the farmers' story (simplified)
Meet Cowtaverse, a new protocol feeding cows globally
Today it’s not enough to own a cow. You need to own land to graze, making it very expensive. We want to democratize the ownership of cows.
That’s why we issue “BTC (Bitcow).”
- Anyone with land can Delegate his land to the protocol.
- Once delegated, the farmer will start earning BTC immediately.
- Now any farmer can find land on the app.
- Each land has a score calculated by satellites of how many cows the pasture can feed at any given time.
- Farmers that wish to access land pay fees to the protocol
- Farmers on the land are validated using satellite images, and the farmer gets a notification when a “non-validated” cow is roaming his land.
- The fees are distributed between the lands that were in use in the last 30 days.
Hope we see you in the discord channel of Bitcow! (Joking..)
I’ve been told to keep my articles short, so I’ll stop here. My next article is “common mistakes in token economics,” also known as “stop launching securities and calling them tokens.”
Working on a new decentralized protocol that generates a new type of common good? Physical or financial? I want to hear about it, reach out to me at
