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General
Background
Tokenomics:
The study of determining the economic characteristics of a cryptographic token
Prerequisite knowledge
Emissions, vesting, S&D, Airdrops, FDV, Inflationary vs. Deflationary, Game Theory, Price Elasticity, and demand curve models.
Phase Segmentation Breakdown
Standardized tokenomics are non-existent, game-theory behind tokenomics is dependent on a myriad of factors that can have nothing to do with the protocol never mind crypto itself
Phase | Purpose of Token | Value Derived from Token |
Beginning | Fundraising | Utility + Speculative |
Middle | Governance/Utility/Decentralization | Adoption & Network Effects |
Mature | Store of Value & Utility | Adoption/Network Effects/Supply Scarcity |
Figure 1 -- Phase Segmentation of protocol
Token Network Effects and Benefits
A protocol’s token is negligible unless it has clear benefits that can facilitate long-term growth and is useful to hold onto. Along with the obvious importance of the token having true utility within the system, the greater the number of users and liquidity should also generally lubricate the system: increasing efficiency, decreased slippage, higher level of decentralization, and increased revenue sharing.
Figure 2 -- Network and Embedding effects of tokenization [1]
Historical Information
Figure 3 -- Key Token Allocation
Figure 4 -- Token Allocation breakdown -- Team/Founders/Ecosystem
Basic Evaluation Fundamentals
Utility
Questions
- What is the token going to be used for?
- How will the token accrue value or increased utility over time and increased adoption?
- In what case would you buy the token?
- What happens when traders win/lose a lot?
- Can price appreciation feasibly beat potential token inflation?
Token Purpose
Role | Purpose | Features |
Right - Ability to access protocol’s features in entirety | Engagement | Product usage, Governance, Voting, Contribution, Product access, Ownership |
Value Exchange | Economy Creation | Work rewards, Buying, Selling, Spending |
Toll - Aligning incentives of protocol | Skin in the Game | Running smart contracts, Deposit, Usage fees |
Function - Superior experience due to network effects | Enriching Experience | Joining a network, Connecting with users, Incentives for users |
Currency | Frictionless Transaction | Payment unit, Transaction unit, Store of value |
Earnings | Distributing Benefits | Profit sharing, Benefit-sharing, Inflation benefits |
Figure 5 -- Token Utility Potential -- Role/Purpose/Features
Supply
Questions
- Total token count?
- Tokens in circulation?
- Token Distribution schedule?
- How will future tokens be unlocked?
- What are the inflationary/deflationary pressures plotted over time?
Emissions Rates
Factors to consider:
- What is the total amount of supply yet to be unlocked?
- How quickly does that supply get unlocked?
- Market Cap Fully Diluted Valuation (FDV) ratio is helpful as it can show the potential downward pressure of unreleased tokens
- Large enough supply for an extended runway
- Potentially have governance in place to begin slow inflation when token count hits max supply
Deflationary fiscal policy:
Pros:
- Increases the value of individual tokens over time, potentially rewarding early adopters and long-term holders.
- Encourages spending and use of the token, as holding onto it can result in lost value due to deflation.
Cons:
- Can create a disincentive for spending or using the token, as holding onto it may be seen as more valuable.
- May result in hoarding behavior or decreased liquidity, as holders may not want to part with their tokens.
Figure 7 -- Deflationary Emissions of Ethereum post EIP-1559
Inflationary fiscal policy:
Pros:
- Can encourage spending and use of the token, as holding onto it may result in decreased value due to inflation.
- Provides a steady and predictable supply of tokens over time, which can help to stabilize prices
Cons:
- Can decrease the value of individual tokens over time, potentially discouraging long-term holders.
- May lead to oversupply and decreased demand, which can result in decreased value overall
Figure 8 -- Inflationary token design of Dogecoin
Synthetix Example:
- Synthetix Primer:
- SNX is the native token of the Synthetix protocol, used for staking, participating in governance, and as collateral for minting synthetic assets.
- As the demand for synthetic assets increases, so does the demand for SNX, as it is required for the minting of new synths, leading to potential appreciation in value.
- Synthetic Basic Evaluation:
- Strong user base with significant volume with perps V2 being released along with gained transactions
- Token has clear utility with staking restricting supply along with revenue sharing
- High relative inflation rate has likely stifled token appreciate although transaction count has been high
- Many inflationary switches that have created an inconsistent environment for investment
Figure 9 -- 68 million SNX tokens will be released -- 22% of existing supply was released in 2022
Demand Drivers
Questions
- What is the protocol’s competitive advantage?
- What are the factors that would increase demand for the token and how is it correlated?
- Game theory of holding, buying, and staking the token?
Organic vs. Non-Organic Growth
- Organic Growth - stems from protocol growth along with speculative appreciation
- Inorganic Growth - Transactions that the protocol executes to drive demand (e.g., token burning and buybacks)
- Tokens that are driven based on true growth of the protocol are the ones with the best fundamentals, not the tokens that artificially dry up supply or spam buy-backs to spur temporary demand increases
Other Factors
Deflationary Mechanisms
The supply of BTC is capped at 21 million, which means it is a deflationary currency. This is due to the decreasing rate at which new BTC is mined and added to the circulating supply. BTC is often considered to be sound money because of this fixed and finite supply.
ETH, on the other hand, has had a variable supply due to the ongoing issuance of new ETH through mining rewards. However, with the EIP-1559 upgrade and merge to Proof of Stake, ETH has become deflationary. This is because transaction fees are burned, leading to a decreasing supply of ETH over time. This change to ETH's monetary policy makes it a candidate for becoming ultra sound money. While BTC's fixed supply and ETH's deflationary issuance make them both attractive for those seeking a store of value or medium of exchange, they have different underlying characteristics.
Figure 10 -- Deflation and fixed supply of BTC & ETH
Token Allocation
Token allocation is a critical factor in the success of any cryptocurrency or blockchain project. It refers to the distribution of tokens among various stakeholders, including the development team, investors, community members, and other participants. It is essential to ensure that token allocation is done in a fair and balanced manner to maintain the integrity and stability of the project. Centralization of token allocation can lead to a concentration of power, which can be detrimental to the long-term success of the project. Therefore, it is crucial to distribute tokens in a decentralized and equitable manner to prevent any single entity from having too much control over the project.
When it comes to team token allocation, a balance needs to be struck between incentivizing the team and avoiding red flags. A 20% allocation to the team is considered a reasonable amount as it provides an incentive for the team to work hard and contribute to the project's success. This allocation ensures that the team has a vested interest in the project's success and will work towards its growth and development. However, if the team's token allocation goes beyond 40%, it can raise red flags as it indicates a high level of centralization, which can lead to a lack of trust in the project. It can also lead to the team having too much control over the project, leading to potential conflicts of interest and a lack of transparency. Therefore, it is crucial to strike a balance between incentivizing the team and maintaining a decentralized token allocation to ensure the long-term success of the project.
Framework Project Proposal
Background -- Demand Inelasticity
This graph shows that, assuming no forecasted change in demand curve, given a discrete increase in supply, we observe a forecasted future equilibrium price. Supply would be inelastic for discrete periods meaning that we can calculate and fit the demand curve for that specific supply, as forecasted demand and supply change over time, so will the optimal emissions, inflation, or deflation.
Although the rewards pools for staking for example are fixed so although the amount of staking rewards are being emitted we can calculate since the total reward amount for that pool is both discrete and fixed.
An important factor is demand elasticity or inelasticity, we want change in price to have relatively small changes in the price i.e. stability of the token. We can calculate this factor use the slope of the demand line. Can be calculated for beginning, medium, and mature phases of protocols.
Note: Fee structure would simply shift the Demand curve to the left similar to a tax structure
Flow Chart -- Fiscal Policy Framework
Note:
- Have done a lot of research to find very little research on tokenomics modeling, the information out there is sparse, which means that this can add a lot of value to many protocols.
- Math and plotting can be completed with potentially excel, but most likely python
Step-by-Step Example
Protocol:
- Determining the maturity of the protocol
- If it is currently live on a mainnet
- Are they restructuring
- Functionally are they currently up and running or not
Segmentation:
- Type of protocol
- Borrow/Lend, Derivatives, Swaps, etc
- Characteristics of the protocol: high interest, TAM, chain, etc…
- Fundamentals of general tokenomics
Calculate Fitted Demand:
- Plot points (price, volume)
- We can find the best-fitted curve/line using data science techniques
- We can use polynomial, linear, exponential, and logarithmic curves to capture highest variance with the least over-fitting
- We can use that curve to estimate demand projections for projects
Use Personal Forecasting to calculate real Demand Curve:
- Use growth projections to track curve over different supply levels
- Starting points will be markedly different based on a myriad of different factors: chain, marketing, reach, segment, etc
- Those will need to be input to calculate their protocol’s forecasted demand curve (the y-intercept)
Solve for optimal fiscal policy:
- Use this demand curve and demand elasticity to calculate emissions/inflationary schedule, etc..
- We can calculate price equilibrium at different supply schedules
Next Steps
- Need to add Stress Testing section
- This will include situation that may face a protocol in the event of extreme market turbulence or anomalous
- What happens when all traders win?
- What happens when everyone unstakes at the same time?
- Organic vs. Inorganic example
- Thinking about using AR
- Areweave using a combination of both so would be clear examples
- Framework Math/CS
- Would like to do a BTC/ETH or AVAX/ETH example
- Run through the whole flow chart and draw out an example of what it would look like
- Token Allocation
- Add charts for token allocations that were too heavily centralized vs. a good example
- Aptos, Sui, etc.
- Too word heavy without any charts
Impediments
- Just need to have time to work through the examples, create charts, etc
- Would like to update the styling of the document to make it look more professional when shown to clients
- API data is expensive, need to find data for the price and volume data
- Need to ask Winston about ways to get around the API fees for volume data
- I don’t think it needs to be super granular so shouldn’t be hard to find
- Data Science
- Don’t have a ton of experience with fitting and linear regressions in Python
- Need to make sure that the curve/line isn’t overfitted and generates realistic information
Resources: