- Token incentives are a powerful mechanism for initiating cold start problems and initializing two-sided marketplaces.
- However, various Web3 infrastructure protocols are burning tens to hundreds of millions of token incentives every quarter.
- Web3 infrastructure protocols need to analyze their token incentives and determine the specific value they generate from the incentives. Additionally, as protocols scale, they need to dynamically adjust the protocol’s incentives.
In all markets, buyers need sellers, and sellers need buyers. But usually, two-sided markets struggle to generate enough supply and demand to initiate such an exchange. While there are many possible solutions to this “cold start” problem, tokens have clearly emerged as the most effective mechanism for incentivizing both supply and demand. Crypto networks employ unique strategies for their token incentives, resulting in different efficacy of each token.
Analysis of Web3 Infrastructure Token Incentives
While token incentives for DeFi have been explored in detail, there may be less research on token incentive distribution in Web3 infrastructure networks and middleware protocols.
DeFi protocols almost always provide liquidity (supply side) incentives to attract users who want better pricing. This rather simple trade-off makes it more straightforward when evaluating incentives for DeFi networks. In effect, DeFi protocols have incentives to maximize token incentives per dollar to get the most dollars in liquidity or users. In Web3 infrastructure, however, protocol dynamics are more complex due to non-standard metrics and various stakeholders.
Looking at four unique protocols – The Graph (indexing), Pocket (node infrastructure), Helium (Internet of Things network) and Livepeer (computing network), it is clear that they have a wide range of token incentives.
The Graph, as a protocol API protocol, provides valuable services for institutions or individuals who need to query protocol data. The network has several core participants, the most important of which are subgraph indexers — parties that maintain the query network. Over the course of 2021, coupled with The Graph’s token appreciation, the Index Protocol has distributed an average of $60 million in token rewards over the past five quarters.
These incentives apply to many use cases, such as rewarding participants in the network—Delegators, Indexers, Curators—to help incentivize growth.
Considering that The Graph’s demand income is very low, GRT’s rewards/incentives are mainly used to subsidize users’ query fees. This is normal outside the cryptocurrency industry, where many VC-backed companies use venture capital to help subsidize costs for users until a certain customer or revenue threshold is reached.
One threshold that may need to be monitored is the ratio of inflation to token incentives. Token incentives should not be greater than the inflation of the network for a long period of time, as this will not be sustainable in the long run. Notably, The Graph offered a minimum amount of token incentives in the last quarter, which may indicate that the fundamentals of its network are improving.
Livepeer is essentially a computing marketplace where applications can pay for various video transcoding services.
Livepeer provides inflationary rewards to node operators who stake LPT to perform work (provide transcoding services). Livepeer’s network operates under a dynamic inflation model, where LPT rewards fluctuate based on the percentage of LPT staked.
From the perspective of mechanism design, Livepeer’s staking architecture is complex and elegant. Livepeer staking issuance is dynamic, so it incentivizes participants to reach a given threshold. If the participation rate in a certain round falls below 50%, LPT inflation will increase by 0.00005%, incentivizing token holders to pledge to the Livepeer network. Conversely, if the participation rate exceeds 50%, the inflation rate will drop by 0.00005%. Therefore, as the value of the Livepeer network grows and operators earn more fees, the issuance/incentive of LPT will eventually drop to zero. If inflation rewards become nominally valuable on top of token appreciation, Livepeer’s minimum inflation drop may need to be increased so that the network does not overreward node operators.
Livepeer node operating revenue (in ETH) increased 22% (down 13% in USD due to the overall market downturn), and revenue from LPT staking rewards increased 18% (down 12% in USD). Additionally, Livepeer processed 33 million minutes of transcoded video, a 12% increase from the previous quarter.
Arguably one of the most discussed infrastructures over the past few months has been node infrastructure. The goal of Pocket Network is to create an alternative to centralized node infrastructure that is censorship-resistant, always up and running, and is cheaper than existing service providers. Similar to The Graph, Pocket is a two-sided marketplace between node providers and developers who want to query data from a specific blockchain.
Unlike its centralized competitors, Pocket Network does not use a pay-as-you-go model. Instead, it employs a “staking-to-use” model, requiring users to stake POKT in order to obtain services. The network has experienced hyperinflation due to the original design of Pocket, which rewards POKT tokens linearly to node relayers. In the last quarter, Pocket distributed $375 million in POKT rewards. This action effectively brought new node operators into the Pocket ecosystem, but also resulted in significant selling pressure, with the price of POKT dropping more than 50% in the past 30 days.
While POKT is perpetually inflationary, it will eventually be capped through a burning mechanism managed by the DAO. Recently, Pocket stakeholders proposed and approved a significant reduction in inflation to create a more sustainable inflation system. The average daily inflation reward has been systematically reduced over the past few months to help stabilize the coin’s incentives.
Perhaps one of the worst purveyors of token incentives, Helium has paid out $770 million over the past four quarters. That said, Helium is incentivizing a global hardware network of IoT devices. To date, Helium has nearly 800,000 hotspots, with 85,000 units coming online in the past 30 days.
Historically, telecommunications companies have paid billions of dollars in spectrum auctions for the right to transmit signals in specific wavelength bands. In this regard, distributing a $1 billion token reward might actually be good unit economics. Nonetheless, given the appreciation of HNT over the past year, a reduction in the token reward seems appropriate, especially given the passive nature of hotspot operators.
Final Thoughts on Web3 Infrastructure Token Incentives
Notably, none of these protocols fall into the same infrastructure category, or provide the same services. Therefore, it is difficult to compare their token incentives. Helium’s $200 million quarterly token giveaway is significant in name but incentivizes global hardware infrastructure. And The Graph’s $40-80 million tokens incentivize developers and heavily subsidize network usage (both for users and developers). Is one better than the other? Maybe, but it’s relative.
Broadly speaking, inflation/token incentives should be dynamic, or at least change as the adoption of the network increases or the token appreciates. Over-incentivizing the demand or supply of the network may attract hiring capital and operators who are not long-term stakeholders. Furthermore, with no holders willing to experience significant dilution, many potential business partners may become persistent forced sellers to maintain operating margins.
While using tokens to bootstrap the cold start problem can be effective, it also has two drawbacks. Using tokens to bootstrap the cold start problem is a very effective strategy, but it also has its drawbacks. First, when a network issues tokens to the wrong behavior (for example, before product-market fit), the network may incentivize lower-value activity. Second, the token effectively captures returns from later participants, benefiting early adopters. But token incentives need to evolve over time so that the protocol has enough incentives for continued adoption to avoid massive dilution to stakeholders.
As more and more encrypted networks emerge, they will undoubtedly learn to standardize around the best model for certain services. Until then, each strategy should be analyzed in terms of how much crypto protocols spend in terms of incentives, and the tangible value these protocols gain.
Posted by:CoinYuppie，Reprinted with attribution to:https://coinyuppie.com/messari-an-article-explaining-4-types-of-web3-infrastructure-token-incentives/
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