DeFi has always had the problem of token value accumulation and retention, and now is the perfect time to address it.
This article explains why DeFi tokenomics needs to be adjusted, and what the new model might look like.
Tokens as income rights
Holding tokens can have governance capabilities, which creates a compelling reason, but many tokens still struggle to effectively accumulate and retain value.
As a result, there is a growing consensus within the Web3 community that tokens must start providing revenue share as well as governance.
It’s worth noting that offering revenue-sharing tokens to holders may make them look more like securities.
Many would use this to object to DeFi tokens offering revenue share, but it is, but if this change does not occur, DeFi as a whole will continue to exist as a mass speculative market.
If DeFi is to gain mainstream legitimacy, it is impossible for all token price movements to be nearly positively correlated, since in this case, the different profitability levels of the protocol are not reflected in the token price movement.
While one concern is that enhancing a token’s capture of protocol revenue will increase its security-like properties, the argument that limiting tokens to governance rights is clearly wrong when considering the path to be taken over the long term.
As summarized in the DeFi Man article, the protocol now pays out revenue to token holders in two main ways:
- Repurchase native tokens from the marketplace and (1) distribute them to stakers, (2) burn them, or (3) keep them in the protocol’s treasury.
- Redistribute protocol revenue to token holders.
Yearn.finance made waves after announcing an update to its tokenomics and buyback program last December, with YFI prices rebounding 85% in the short term. While this is only a temporary spike, the strong desire for a better token model is palpable.
However, in the long run, the share of distributing protocol revenue is significantly better than token buybacks.
The primary goal of any DAO should be to maximize the value of long-term token holders. As Hasu writes, “every dollar owned by an agreement or received as revenue should be allocated to the use that is most beneficial to it.” Therefore, a DAO buyback of its native token is the best option only if its native token is undervalued.
We can build a valuation framework applicable to native token stakers based on the cash flow established by the protocol that provides revenue sharing to these stakers. By paying incentives to stakers, we can value tokens, while also needing to rethink incentives paid to LPs.
When analyzing the revenue generated by an agreement, a common approach is to divide the revenue into two categories: protocol and LP. Assessing the value of tokens by the income distributed to token stakers exposes the true face of LP revenue – operating costs.
More and more protocols have begun to establish revenue sharing with governance token stakers. GMX, in particular, sets a new precedent. GMX is a zero-slippage, decentralized, Avalanche and Arbitrum-based perpetual futures and spot exchange. GMX stakers receive 30% of the agreement fee, while LPs receive another 70%, which is calculated in $ETH and $AVAX instead of $GMX.
Similar to how growth stocks retain their earnings instead of paying dividends, many believe that paying token stakers instead of reinvesting them into the protocol’s pool is detrimental to the long-term development of the protocol itself. However, GMX shows that this is not the case. Despite sharing revenue with token stakers, GMX continues to innovate and develop new products such as X4 and PvP AMM.
In general, reinvestment only makes sense if an agreement or company is able to make better use of the accumulated funds rather than distributing them to stakeholders.
DAOs tend to be less efficient at managing capital and have a decentralized network of contributors outside of their core team.
For these two reasons, most DAOs should be in distributing revenue to stakeholders earlier than their centralized Web2 counterparts.
Learning from the past: burning and staking
Despite the harm caused by Terra’s crash, it is highly educational and offers some references for shaping the future of sustainable token models.
In the short term, Terra proved that token burning is an efficient way for tokens to accumulate and capture value. Of course, this did not last long. In manipulating the burn rate of $LUNA through the Anchor Protocol, Terra caused an unwarranted, unsustainable reduction in $LUNA supply. While supply manipulation ignited the fuse for self-destruction, Terra’s collapse was ultimately due to even after a series of supply contraction. Eventually we found that $LUNA the growth of circulation was so easy.
At the end of 2021, the decline of (3,3) economics also brought many references.
OlympusDAO proves that staking a majority of the protocol’s native tokens can lead to a significant increase in short-lived token prices.
However, we also later saw that if stakers were allowed to exit at any time with little impact, they did so at the expense of other stakers.
The purpose of implementing the rebase is to strengthen people’s motivation to participate in staking. If a user stakes, he/she receives “free” tokens to maintain his/her current share of market capitalization.
In fact, anyone who wants to sell does not care about being diluted at the time of release.
Due to the nature of rebase, those stakers who enter first and exit first profit by utilizing newcomers as their exit liquidity.
In order to implement sustainable staking in the future, stakers must be punished more severely for canceling the staking. In addition, stakers who cancel their mortgages later should benefit from those who cancel them earlier.
The common reason for all previous failed token models is a lack of sustainability. Curve’s ve model, a widely adopted token model that attempts to implement a more sustainable staking mechanism by incentivizing token holders to lock up their tokens for up to 4 years in exchange for inflationary rewards and expanded governance powers.
Although the short-term effect of ve is good, there are two main problems with this pattern:
- Inflation is an indirect tax on all token holders and negatively affects the value of tokens.
- When the lock-up period finally ends, there may be a massive sell-off.
When comparing ve and (3,3), they have a similarity in that they both offer inflationary rewards in exchange for token holders’ commitment to staking. Lock-up can act as a curb selling pressure in the short term, but once the inflation reward becomes less valuable over time and the lock-up period expires, there will be a large sell-off.
In a sense, ve is comparable to time-locked yield mining.
Ideal token model
Unlike the volatile token models of the past, the ideal token model of the future will sustainably adjust the incentives for users, investors, and founders. When Yearn.finance proposed the ve based on tokenomics initiative (YIP-65), they claimed to have built their model around several key motivations, some of which could be applied to other projects:
- Implementation of token buybacks (distribution of revenue to token holders)
- Build a sustainable ecosystem
- A long-term view of the incentive project
- Reward loyal users
With this in mind, I propose a new token model that provides stability and value accumulation through taxation.
Income and tax models
I have determined earlier that an ideal token design would empower holders to govern and receive a share of the protocol’s revenue when staked. For this mode, the user must pay a “tax” to unlock the lockout instead of using a lockout period. While the tax/penalty for decollateralization is not unique to this model, the associated tax mechanism is.
The unlock tax that users must pay is determined by a percentage of the number of tokens they stake, a portion of which is taxed will be distributed proportionally to other policyholders in the pool, and the other part will be burned. For example, if a user stakes 100 tokens at a tax rate of 15%, they will spend 15 tokens to unstake. In this example, if the user chooses to uncheck, 2/3 of the tax (10 tokens) will be distributed proportionally to the other stakers in the pool, and 1/3 of the tax (5 tokens) will be burned.
This system rewards the most loyal users, with those token holders who stay longer benefiting the most. It also reduces downside volatility during market sell-offs.
Theoretically, if someone unmortgages, it’s because income has fallen or is predicted to decline in the near future.
When viewing agreement revenue as a pie, the decrease in revenue can be seen as the overall pie shrinking. In the previous example, the taxed tokens were distributed to those who were still staked, increasing their piece of the pie and reducing their losses.
1/3 of the burn will exert deflationary pressure on the token supply, which will increase the overall token price. In the long run, burning will cause the token supply to follow an exponential decay pattern. The chart above shows how holders may lose less if they continue to stake during a market sell-off, while the graph below shows how the burned tax portion reduces losses for all token holders, whether staked or unstaked.
The graph reflects the inward shift in token demand due to reduced protocol revenue. As a result, a portion of investors unstaked their tokens for sale. In the process of unstaking, a part of their tokens are burned. The burning mechanism reduces the total token supply and shifts the supply curve to the left, with the result that the token price drops less.
If protocol revenue drops significantly and whales decide to unstake and throw their tokens, the worst-case scenario for this model could occur. Given that Convex currently controls 50% of all veCRV, this could mean half of the tokens being unstaked and sold off. If most tokens are locked up before the sell-off, even if there are taxes, this will inevitably crash the token price in the short term.
This underscores that regardless of the stake/burn mechanism the protocol may implement, tokens remain worthless if the underlying protocol fails to generate revenue. However, suppose in this example, protocol revenue will rebound in the near future. Those who stake after the whale sell-off will receive 5% of the total token supply, which will be reduced by 2.5%, greatly increasing their share of future revenue.
Since whales are inevitable, further improvements to this proposed tax could be progressive. While progressive taxation may be difficult to implement, agreements may utilize analytical tools, such as Chainalysis, or build their own in-house tools to enforce them. It is difficult to say what the best solution to implement progressive taxation will be. It is clear that more research and development is needed to answer this question.
Whether a flat tax or a progressive tax is implemented, the agreement should adopt this revenue sharing and taxation model only after accumulating a large amount of TVL. At the beginning of a protocol’s lifecycle, priority should be given to channeling liquidity, decentralizing its tokens, and building attraction. Therefore, in the early stages of the protocol’s development, the token model built around yield mining may play a positive role in its long-term development.
However, as the protocol matures, its priorities must shift from bootstrapping TVL to creating long-term, sustainable token value accumulation. Therefore, it must adopt different token models to better align economic incentives with new goals.
Compound is an example of a protocol that has not changed its token design to meet its maturity stage. Despite accumulating a large amount of TVL and generating a lot of revenue, these value creations are rarely absorbed by $COMP holders. In an ideal world, the profitability of a protocol should be reflected in its token price, however in reality, this is only occasional.
The most important thing about this proposed token model is that it is sustainable. Staking incentives are more sustainable because they benefit those who are “first-in-first-out” rather than the typical first-in-first-out (FIFO) principle.
The token burning element in the design also reinforces sustainability because it is unidirectional (supply can only contract). If there’s one takeaway from the recent market downturn, it’s that sustainability matters.
While the path of Web3 will be led by disruptive innovation and greater user adoption, none of this would be possible without a more sustainable token model that effectively accumulates and retains value.
Posted by:CoinYuppie，Reprinted with attribution to:https://coinyuppie.com/reflections-on-defi-tokenomics-staking-dividends-burning-deflation-and-long-termism/
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