Research Update: Web 3 Foundation Practical Token Design

The research on the design of the new token shows that, unlike the centralized web 2 platform, which is conducive to the interests of the platform, the decentralized utility token ecosystem is generally more efficient, thus providing for all ecosystem participants The best service. In addition, it also emphasizes a tension, called the “utility token trilemma”, and shows that Polkadot ‘s utility token model is sustainable and can make the network participants of the entire society reach the best condition.

According to the definition provided by FINMA in the guidelines issued in February 2018, utility tokens are “tokens designed to provide digital access to applications or services through a blockchain-based infrastructure”.

The services that Polkadot can provide are composed of Parachain slots, which have shared security and technical functions for communicating with other Parachains in the network. In order to obtain one of the slots, the user needs to pledge DOT for the supported item in the auction .

Many utility token projects are common, that is, their respective utility tokens are produced on their own blockchain. This means that tokens not only need to consume services, but also need to be used to incentivize consensus among network nodes. This has led to some subtle design issues, which have been explored in a recent research paper: https://ssrn.com/abstract=3954773

In this article, we will analyze the dynamic general equilibrium model of the token. Once, the dynamic general equilibrium model was used to explain the relationship between supply and demand in the entire economic environment. The utility token market shares some functions with the entire economic environment.

This article observes two main aspects of utility tokens. First, utility token ecosystems are usually very effective because they enable the best services to be provided to users. The second is the tension between the value dynamics of utility tokens, that is, the evolution of the service provided and the incentive details on the user side.

Model 

This section describes the theoretical framework of the universal and practical token ecosystem. Readers who are not interested in technical details can skip it and go directly to the discussion results in the next section.

A dynamic model of practical tokens was established on the bilateral platform. A platform is a special kind of market that aims to bring together different types of market participants and allow them to realize network benefits. Traditional platforms include UBER (matching drivers and passengers) and Amazon Marketplace (matching sellers and buyers).

In my model, there are two parts: platform development and maintenance software (usually called runtime in blockchain terminology). In order to cover the cost of doing so, the platform repeatedly sells utility tokens in the market.

Another aspect I consider is that the platform has a fixed number of users who reuse tokens for consumption. Consumption is competitive, and the consumption utility obtained by users continues to increase in the total tokens provided by all users. Basically, the throughput of any blockchain network is limited, but the more tokens you hold, the higher your chance of obtaining a certain service result, such as a parachain slot on Polkadot.

In addition, there are a fixed number of validators who are rewarded by providing security and need to repeatedly sell part of the reward tokens to make up for the cost. Among all validators, the share of rewards they receive in the total amount of tokens they hold will increase. This reflects the nature of the proof-of-stake of the blockchain: your reward as a validator is proportional to your share in the network.

The model assumes that the token ecosystem is in a long-term equilibrium state. This means that the number of network participants remains the same over time, and there is no speculative use of tokens.

The generated utility token value plays an important role in this setting, because it needs to balance the incentive mechanism of users and validators. If today’s price is too high relative to tomorrow’s price, then users will only buy a few tokens to enjoy the service, the validator cannot cover their infrastructure costs, and the network will collapse. On the other hand, if today’s price is too low relative to tomorrow’s price, then the validator may not be able to obtain enough information from the processing of the token. When users expect the value of blockchain services to grow rapidly over time, the value may increase. When the blockchain platform will cost a lot to maintain the blockchain in the future, so too many tokens need to be sold, the value may decrease.

The platform has several options to influence the supply and demand of tokens. First, it can set the rewards allocated for each round. Secondly, it can choose the quality of the service, thereby adjusting the user’s consumption utility. Third, the platform can determine whether the tokens the user proposes to consume are locked (that is, returned after each round, such as Polkadot) or spent (deducted from the token held by the user, such as many smart contract chains). The balance mechanism in this setting is a strategy with the best token value and the relationship between users, validators and each other.

discover

The most important finding is that even if the blockchain platform is modeled as a monopolist on both the user side and the verification side (that is, it does not face competition from other platforms), there is an equilibrium mechanism for selecting the optimal service level. In other words, by choosing the best service level for everyone, the quality level of the platform selection is also the best for everyone.

Given our knowledge of classic double-sided platforms, such findings may be surprising. Typical double-sided platforms include UBER, Amazon, and the iOS app store. All these platforms match the two aspects of the market (drivers and passengers, merchants and customers, application developers and users), thereby realizing the benefits of network effects. However, we note that realizing all benefits is usually not in the interest of the platform. On the contrary, it is well known that platforms will distort the price and/or quantity of their services, thereby reducing the welfare of platform participants while maximizing the benefits of the platform.

However, if we aspire to the effect of decentralization, it is not too surprising to find effective results produced by the utility token ecosystem. A feature of this platform is that the price of the service is not fixed by agreement, but is determined by users competitively. In Polkadot, the number of tokens required to obtain a parachain slot is determined in the auction; in Ethereum , the fee that users attach to their transaction determines the processing speed of the transaction in the block.

If the platform has no influence on the price of its services, then it can seek the best option to provide the quality of the service. The main contribution of this paper is to show that there is a competitive balance in which it is indeed so effective. Technically speaking, this is achieved by formulating a balanced strategy between validators and users. These validators and users have adapted to their token usage decisions so that their utilities remain unchanged in terms of service quality, leading to the largest selection of platforms To improve the quality of services for total welfare.

First consider value stability. Over time, by improving the quality of service, or removing some users’ tokens from circulation in each round, the decline in value can be offset to a certain extent. Either way, having a business model based on stable value is certainly attractive from a psychological point of view-certainly more attractive than a well-known platform that continuously dilutes its symbolic value.

Consider token locking. Under the locking scheme, the user’s offer to use the service’s pass is locked while in use, and then returned. Therefore, their holdings will not decrease over time, which in turn may give users a better understanding of what they can do with tokens. In addition, locking can be used as a substitute for pledge; locking tokens means that its holders can directly participate in the ecosystem and reduce the circulating tokens, so it is valuable from a security perspective.

Consider a constant quality of service. For many projects, having a constant blockchain value is a natural necessity: a business model that relies on a declining value proposition may be questioned, while a business model that relies on increasing blockchain value It may also raise the question of sustainability. In particular, people may worry that the cost of providing ever-improving service quality may grow too fast to be sustainable.

Polkadot relevance

The main conclusion of the above results is that the overall setup of Polkadot is sustainable. The token value reflects some of the services that DOT can purchase. Parachain auctions generate demand for tokens, and the supply of validators will meet these demands, thus keeping the system running normally.

Another conclusion is that decentralized platforms like Polkadot will abuse their power. The reason is as follows: Since this type of platform does not set a clear price for its services, but allows users to compete for it, it cannot engage in anti-competitive pricing behavior through design. Therefore, the question is whether a platform is willing to provide inefficient service quality.

It is now clear that Polkadot does not rely on a certain platform, but is led by the community, with a clear governance process. Although the model is abstracted from this point, the conclusion is still valid. We can consider platform designers as the third group of stakeholders, namely software developers, to decide the further development of the service together with users and verifiers, and then implement these community decisions. The analysis shows that the overall goal of the developer is consistent with the goals of users and verifiers: maximizing output. Of course, how the generated surplus is distributed among different stakeholders depends on governance decisions.

There is an indication that Polkadot does give users and verifiers more incentives than is needed to keep the system self-sustaining. The analysis in this article shows that the platform’s optimal equilibrium (that is, the equilibrium of platform profit maximization) does not involve the locking of user tokens. (The reason is that if the user’s token is locked, this will reduce the token demand on the user side, which is bad news for the platform that needs to sell the token.) Therefore, Polkadot must be in an equilibrium different from the optimal equilibrium of the platform state. This means that the added value of Polkadot is exactly what it should have: getting closer to the community.

Posted by:CoinYuppie,Reprinted with attribution to:https://coinyuppie.com/research-update-web-3-foundation-practical-token-design/
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