In order to facilitate my own learning and reference to the knowledge and content of token economics, I have worked hard to collect information from various parties and contributed to this article, which covers various examples of token economics for everyone to understand. Tokens have a better understanding. This post is for the Web3 hardcore who want to design tokens and liquidity pools.
“Tokenomics” has become a very trendy phrase in recent times to explain the logic and incentives that govern cryptocurrency assets. It includes all aspects of an asset’s operation, as well as any psychological or behavioral factors that may have an impact on its long-term value.
This article is a checklist for what to know about tokens. So let’s start with the basic terminology and understand what token supply and demand actually mean.
When there are fewer tokens available, the value of the tokens rises, which is called deflation. Inflation means that as more and more tokens are produced, the value of the tokens is lost.
In this article we only consider the supply of the token and how it will evolve over time, not the utility or profit it will bring to holders.
Questions we need to think about include:
- How much of this token is in circulation now?
- How many will there be in the future?
- What is the rate at which new tokens are issued?
When it comes to the supply of tokens, distribution is the last thing you want to think about. Do a few investors own a lot of tokens that are about to be released? Does the protocol really distribute most of its tokens to the community? How fair does the distribution of tokens seem? If a group of investors owns 25% of a token’s supply and the token will be released within a month, you may be hesitant.
Return on Investment (ROI): ROI is not determined by how much you believe the token price will rise. It refers to how much income or cash flow these tokens can earn you just by holding, through staking, reassignment, and other methods. It is crucial to consider the ROI of a token, because if a token has no intrinsic value or cash flow, then it is difficult for us to justify owning it.
Game Theory: As Game Theory suggests, consider what additional elements in token economics design may help to increase token demand. On the other hand, staking is a popular variant of good token economics game theory. The protocol incentivizes you to lock up your tokens in a contract, usually through higher incentives, Curve is a great example of this.
Meme: Assuming other people want this token, and will continue to need this token in the future, meme could be another reason why people might want this token. What’s the atmosphere like in the token project’s Discord? What is their Twitter activity like? Does the individual consider this token or protocol part of their personality? How long have members of this community been involved?
Evaluate Convex Finance (CVX)
The maximum supply of tokens set by Convex is 100 million pieces. According to the recharge of CRV, the tokens of CVX will be gradually released at a decreasing rate. According to Coingecko, 78.5 million of the 100 million tokens have already been produced, which means that the current token supply will increase by 33%.
Most of the tokens will be distributed to Convex users. Therefore, this is a very fair token distribution, with only a small portion left for the team and investors. Consider what would happen if Amazon gave 75% of its merchandise to Amazon’s customers.
Curve Token Allocation
To assess the demand for the token, consider why you are holding CVX tokens.
If you hold CVX tokens, you earn a share of Convex Finance. That’s not a lot of money, but it’s now yielding around 4% annualized. However, that’s not all, you can also lock up your CVX tokens for up to 16 weeks at a time, earning bonus incentives from various protocols designed to reward Convex staking users.
The APR here is still only 5%, but that doesn’t include any rewards you might get from other platforms. Additionally, you can use the Votium service to delegate your Convex to other voters in exchange for “bribes”.
Therefore, Convex has a fixed supply, which is mainly distributed to the community. Most of the tokens have already been distributed, and the supply of tokens will not inflate much further. Holding CVX is greatly rewarded through protocol fees and other token holder benefits, so if the price of the token falls, users have less incentive to sell. In my opinion, this is one of the good token economics models.
Cryptocurrencies, like fiat currencies such as the US dollar, have monetary rules that govern the specific characteristics of the token, such as supply, inflation, etc. This can be used as a technique to raise, lower or keep prices stable. The token supply schedule may be fixed or flexible.
Bitcoin is an example of a cryptocurrency with a predetermined supply. Currently, 6.25 new bitcoins are mined per new block, and this will continue until all bitcoins are mined, and the block reward will be halved every four years.
Ethereum is an example of a token with a variable monetary policy, meaning its OR policy can be modified at any time. Ethereum’s block reward started at 5 ETH per block and has since undergone two revisions. This reduces the block reward to 2 ETH, creating a Bitcoin-like supply schedule where the block reward falls over time, effectively reducing the inflation rate – see graph below.
Bitcoin’s inflation rate versus time
Ethereum’s issuance rate
When it comes to issuing tokens, a team usually has two options: fair issuance or pre-mining. Fair issuance means that everyone has an equal opportunity to receive tokens. Pre-mining refers to a token offering where some or all of the token supply is created. It is first distributed among a combination of founders, private investors, development libraries, and others with a chance, before being sold to the public.
Bitcoin is an example of fair issuance because everyone who wants to get bitcoin has to follow the same steps. In order to get Bitcoin, everyone has to mine.
For example, when building a token and the ecosystem around it, there are costs such as labor and other development overhead. It stands to reason that the development team needs funds to fund future development.
Take UNI’s token distribution as an example
During the four-year vesting period, 60% of the UNI is distributed to the public and 40% to the team and private investors. At the launch of UNI in September 2020, 15% of the UNI supply will be immediately available to anyone using the platform, trading or providing liquidity. Liquidity providers receive 49,000 UNI (or 4.9% of total UNI), with rewards biased towards those who participated in the platform early when liquidity was low. A total of 10% of UNI is distributed equally to all 251,500 historical user addresses who can claim an airdrop of 400 UNI.
The Treasury of Governance holds 43% of the UNI that will be released to the community over time through grants, community initiatives, liquidity mining and other projects. After four years, 2% of UNI per year will be used to maintain participation and contributions to the platform. Essentially, they will allocate funds to activities that encourage user growth. This is very beneficial for the platforms that implement it, because if done well, it can lead to long-term growth, which is critical to token economics.
Allocation of UNI
A framework for analyzing tokens
We should ask these questions when analyzing any new coin.
- Why does this protocol need a token?
- Is it useful as an information source?
- Is there a reward for the holder?
- Is it for mining and selling to cash out?
- Exit liquidity for insiders?
- What role do tokens play in the ecosystem?
reason for holding
- Why would anyone want to hold this token?
- Who is the target buyer?
- Will they buy and hold more tokens? Or rely purely on hype and narrative?
- In case of inflation, as is the case with most tokens, is there a good reason for investors and liquidity providers to hold rewards?
- What is the token supply schedule and what does it mean for selling pressure?
- What creates and eliminates supply?
- Who owns most of the coins?
- When are they likely to sell?
- When do they *must* sell (eg, venture capital funds unlocked)?
Value Accumulation Mechanism
- How does the token benefit when the protocol benefits?
- How do various interactions within the protocol affect the price of the token (buy/sell/mint/burn)?
Let’s consider a few examples
Perp Protocol V1: Perp V1 is a derivatives exchange. People trade on their platform, and half of the transaction fees go into a pool, which is then paid to speculators. Protocol value acquisition and token value acquisition.
Luna: The native token of the Terra blockchain is LUNA. Destroying 1 LUNA produces UST, a stablecoin. When users have higher demand for UST, more LUNA is burned, reducing supply and increasing prices.
CVX: CVX is a great example of token economics as it employs game theory, provides Curve governance and revenue sharing, while also being built on a protocol with a strong economic moat (Curve is the most stablecoin of its kind) good decentralized exchanges). When CVX reaches the maximum supply of 100 million coins, each CVX will represent more CRV, which means more incentives, and therefore, the protocol shares more revenue with investors.
Investor’s point of view
It’s always good to get investors’ opinions on a coin as it helps stabilize the coin’s value.
Market Cap and FDV (Fully Diluted Market Cap)
The market capitalization of a cryptoasset is calculated by multiplying its price by the number of tokens in circulation. Another valuation metric is FDV, which stands for “fully diluted value.” FDV is the price multiplied by the total number of tokens ever created (of the asset). Market capitalization is either less than or equal to FDV.
Market capitalization = measures demand, FDV = measures supply. FDV grows 1:1 to market cap
We can consider a scenario where a project held a funding round in January, raising $2.5 million from private investors at a $50 million valuation. Private investors can buy tokens for $0.01 each, but their tokens will be frozen for one year. The token had a market cap of $5 million in March.
However, airdrops represent only 1% of the overall supply. The token’s market cap is $5 million, and the FDV is $5 million multiplied by 100, which equals $500 million (since $5 million’s market cap equals 1% of the total). The price of a token is now $0.10, and the seed investor has made ten times the profit.
We can imagine more hype for the coin if FAANG announced the merger of the project, or a Youtuber picked up on the news. The amount of public funds willing to allocate to this token increased from $5 million to $100 million, a 20-fold increase. Because team and seed round tokens are held for one year, no new tokens are unlocked. Market capitalization has risen to $100 million. The cost of the token was $2, the FDV is now $10 billion, and the seed investor has made 200 times the profit.
Seed investors with locked tokens are willing to sell for as much as $5 billion, giving them a 100x return. This means that they will be happy sellers even if their tokens are issued at 75% less than their current price.
On the other hand, locked tokens can have their own active markets. Professional and sophisticated investors trade locked tokens with the assurance of trust and legal enforcement. Basically, they buy or sell locked tokens below market prices and enter into a contractual agreement with counterparties to send tokens when they are unlocked. During such over-the-counter sales, the lock-up period for these locked tokens is sometimes extended (especially if the team is the seller).
This is similar to the situation with Solana, where SOL’s SAFT is being sold at a 66-80% discount until it unlocks in December 2020. If there is no over-the-counter market and no demand for locked coins, the only option for locked investors is to dump them on auto market or Binance when unlocked, which may be a problem among seed investors stupid behavior.
Will the coin be bullish after unlocking?
To assess “how good is this project?” Active users, TVL (total lock-up), and product-market fit are all good proxy indicators. If a cryptocurrency attracts institutional interest, it is likely that funds have attempted to buy any existing locked tokens. Long-term investors also have more sophisticated valuation models, so consider them more like “smart money.”
Token Unlocking Program
Bitcoin’s current market cap is $970 billion, with a fully diluted valuation of roughly $1.07 trillion. However, this additional $100 billion will be unlocked over the next 100 years as part of the dwindling block reward.
Bitcoin unlocking schedule over time
Projects that generate funds through private fundraising and distribute tokens to investors and lock vesting may have a different supply schedule as shown below. In this case, the supply of tokens starts above 0 (perhaps through public auctions or airdrops), while the internal tokens are unlocked in large numbers every year. The most typical vesting schedule for team or investor tokens seen in cryptocurrency is the format of X years locked, Y years linearly unlocked, where 0.5, 1.
RIDE’s unlock schedule over time
The Science Behind Token Liquidity
A liquidity pool is a collection of cryptographic tokens locked in smart contracts. Liquidity pools facilitate inter-asset transactions on decentralized exchanges and ensure liquidity.
Ways to incentivize native token liquidity
Pool 2 (Second Pool) is a decentralized liquidity pool for the native tokens of a project. They exist on decentralized exchanges (DEX) and reward liquidity providers (LPs) with their native tokens that provide liquidity for human guidance.
Erchi’s annualized rate of return can be used as a major marketing tool to draw attention to the project agreement. Second pools are poor marketing tools because the liquidity they attract exists only for mining incentives. Almost every second pool in history has had a liquidity reduction of more than 50% within 30 days of the end of the incentives.
This is a delicate balance as liquidity providers are effectively judging large price movements and are only encouraged to be liquidity providers if they believe the token will trade within a certain range. If they predict that the token price will rise soon, it will be more profitable to stop providing liquidity and keep the token. On the other hand, if they expect the token price to drop, they will rush to sell. If a coin is newer, price discovery can be dramatic in either direction, which highlights the concept of impermanent loss. The main issue for the second pool is to determine the right cost and pay the right amount of liquidity.
If a project decides that two pools are the best way for them, then I have three suggestions here:
- To allow for reconfiguration and empirical testing, run shorter projects (30-90 days) (interesting cases to look into include PancakeSwap, 1 inch, and CREAM)
- Experiment with strategies like lower APR (<100%), vested block rewards and non-transferable tokens to ensure alignment with long-term participants. (In addition to Aave’s second pool, Ribbon Finance experimented with withdrawal fees, non-transferable tokens, and capped total lockup for their early liquidity pools)
- To avoid overpaying for liquidity, set a liquidity cap target
Finding a liquidity cap target is as simple as determining the minimum allowable trade size for larger investors and making sure the pool has enough liquidity to support it within a 2% slippage range.
Liquidity Cap Target
One way to think about liquidity cap targets is to consider liquidity depth in relation to market capitalization. Determine which market cap category the project falls into and use the lower bound on notional transaction size as a guideline. Use this formula/spreadsheet to calculate how much liquidity is needed to facilitate these trade sizes at various levels of slippage.
Example: I’m the founder of a $50M project with a low-to-mid market cap. At best I want large investors to trade 0.1% to 0.3% of my protocol with 2% slippage. This resulted in trading volumes ranging from $50,000 to $150,000 ($50m * 0.1% and 50m * 0.3%). According to calculations, a $5 million pool (50/50 weighting) can hold $50,000 in trading volume with 2% slippage. This means that I don’t need more than $5M in my pool to accommodate huge investors, I just need to have $2.5M in my own tokens and $2.5M in USDC/ETH in the pool.
The power of uneven pools
The biggest advantage of the uneven pool is that the free loss is small. Because the risk of impermanent loss is reduced, liquidity providers are more willing to provide liquidity in exchange for lower yields. This reduces the amount the protocol has to pay back in terms of cost.
gratuitous loss and relative price
While uneven pool liquidity providers are friendlier, it also comes at a cost. The main disadvantage is that higher lockup is required to achieve the same slippage environment. As shown in the chart below, the 50/50 pool is the most efficient in terms of slippage.
Imbalances create more slippage, which leads to lower volumes and annualized returns. As the project grows, the imbalanced pool will affect the rise of the token, as the funding pool needs more stablecoins/ETH to increase the price (vs. 50/50 funding pool).
Leverage idle Treasury funds for liquidity
To provide two-way liquidity, established projects should consider using all or part of their Treasury’s raw liquidity and converting a portion of it into ETH/USDC. This has a litany of benefits, including:
- Allows projects to make more money through transaction fees
- Ability to have more control over liquidity, not entirely determined by APR
- If the price of a token falls, an automatic “buyback” mechanism will be activated
- Increase the diversification of the Treasury (with other currency pairs like ETH/USDC)
One thing to note here is that items can be lost. Here are some creative ways that protocols can use two pools to implement mixed strategies.
- Utilize idle Treasury funds to provide 50-80% of liquidity needs, then use protocol tokens to incentivize further liquidity when needed
- Leverage Treasury to provide liquidity and transaction fees to attract more liquidity providers
- Use idle long-term Treasury funds to provide liquidity for the first 6 months to 1 year, while short-term testing with liquidity incentives
- Alternatively, simply remove the liquidity cap target and use idle Treasury funds to provide liquidity without incentivizing any further liquidity providers
Token Pool Research
Nansen’s research looked at all token transfers from 400 mining fields and found that 36.4% of farmers left within the first five days of entry, while only 13% of all addresses are still mining continuously to this day.
The analysis of more than a dozen previous pools also found that while most incentive pools experienced a short-lived liquidity boost, most of the liquidity levels plummeted by more than half within 30 days after the rewards ended. Badger’s second pool, which was launched at the height of the bull market, is one of (many) examples.
Liquidity Pools on Badger
The protocol adopts the ve token model. ve stands for voting escrow, let’s see how Curve implements the ve token model.
Escrowed: Users can choose how long they want their tokens to be locked up (eg CRV). Unlocking in advance is not possible. Tokens are unlocked in a linear fashion over a selected time period. Users can lock their tokens indefinitely to maximize their voting rights and interests.
Voting: Users earn an amount of ve tokens (like veCRV) proportional to their lock-up period. Because ve tokens are used for governance, community members who lock up their tokens for longer periods of time have more influence. The same is usually true when it comes to rewards. For example, locking CRV for a maximum of 4 years increases liquidity provider rewards to users by 2.5 times.
All in all, stakers lock up their tokens for a certain length of time and receive the right to vote (and reward) accordingly.
ve token benefits
The long-term commitment of the stakers is manifested by locking. In exchange for voting rights and benefits, they are willing to keep their stake illiquid (opportunity cost). This should strengthen governance as dedicated members have more influence in decision-making. These people in the community are more useful to the protocol than others, and as a result, they are rewarded more.
Disadvantages of ve tokens
Lower-than-expected incentive alignment
Build a community of stakers. The way of locking can be used in two ways. While removing the token from circulation reduces selling pressure, it also makes the token less attractive to buy. If I had to lock it up for four years to get the most bang for my buck, would I actually buy it? In a volatile environment like Bitcoin’s, the opportunity cost is enormous. Liquid wrappers, on the other hand, deal with this by tokenizing locked staking. However, as mentioned earlier, this reduces long-term consistency. There is also the issue that tokenized positions are disconnected from the underlying ve tokens. The main pool of funds is the “tokenized vetoken/vetoken” pair, and exit liquidity is often poor.
Governance stalls: Unmotivated stakeholders are eager to leave, but they are unable to do so. They have been locked. They still have ve tokens, which they use to vote on governance. They are unlikely to be interested in any governance decisions that do not focus on short-term profits. This makes governance difficult when it is most needed, and can even bring governance to a standstill.
ve token summary
It can be challenging to find long-term focused stakeholders and contributions. While a strict lockdown can secure people’s financial commitment, it may not be an ideal strategy for encouraging behavioral commitment. The protocol should do more testing, especially soft locks like time-based token economics. Of course, the dynamic design of these tokens can promote long-term sustainability, or accelerate Ponzi schemes, which is always the case. As a builder or researcher, it is instructive to look at the design space and trade-offs and draw your own conclusions. Remember, token economics is only one part of the equation when it comes to long-term retention of the community.
There are many factors that affect the value of a token. Creating a token is simple, but adding value to a token and stabilizing its price is a huge task. When it comes to token economics, there is no one-size-fits-all equation. It largely depends on the demand for the token, and how organic the token adoption is. Providing a good liquidity pool has become the core force of the token’s success. The degree of gamification of the system can also help solve the cold start problem and enable organic growth.
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Posted by:CoinYuppie，Reprinted with attribution to:https://coinyuppie.com/here-is-a-detailed-list-of-studies-on-token-economics/
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