TOften discussed, rarely understood. Tokens serve many purposes, but there's no widely accepted definition of “good tokenomics.”
I’ve spent the better part of the last year in the nitty gritty of DeFi token models.
Here's a 🧵on how to analyze tokenomics.
Before we can understand crypto tokens, we need to first understand the OG “tokens” that drive the entire global market’s economic wealth.. equity and debt.
Equity is ownership of an asset, and debt is money owed attached to that asset.
Equity represents ownership of a company. If it's sold, you get a chunk. If it issues a dividend, you get a chunk. Don’t like the board or CEO? You can vote with other owners to get rid of ‘em.
In the case of debt, you’re a lender and expect to be repaid the loan + interest.
Whether you’re an owner of equity or a lender of debt, your rights are backed by law.
If someone doesn’t fulfill their obligations to you, you can sue their ass. This keeps people who operate companies, especially public ones, in check (to a degree).
Crypto has no such legal backing. Crypto isn’t backed by a legal system that can send you to jail for non-compliance – crypto is backed by code.
People often ask me, should governance tokens be thought of as equity shares?
The answer is NO. Governance tokens give you rights to vote within a defined set of parameters, which is similar in some sense to equity. But you are not an “owner” of the protocol – not in any traditional sense of the word.
Governance tokens depends on the likelihood of the people on the other side (the team) to deliver on governance decisions.
They have no legal obligation to deliver. Instead, you expect the team will honor a social and economic “contract” if governance votes a certain way.
You’re basically betting (hoping) the team will deliver, even if the vote is not in agreement with what they want so they can maintain trust with their community/investors and not have people sell.
Because of this weak relationship between governance tokens and economic value, at best these tokens trade on future hope that some value capture will be possible and at worst they get sold and dumped to death.
The best tokens are directly linked to value creation by the protocol. These tokens have a real reason to exist and incentivize people to hold.
Here’s a four-part framework to analyze tokens:
- Reasons to exist
- Reasons to hold
- Supply dynamics
- Value accrual
Reasons to exist:
Why does this protocol need a token? Does it serve as an important input? Does it provide holders with a return? Is it there for farm and dump? Insider exit liquidity? How does the token fit into the ecosystem?
Reasons to hold:
Why should anyone hold this? Who are the target buyers? Will they buy and hold more tokens or is it purely on reliant on hype and narrative? If inflationary, as most tokens are, are there good reasons for stakers and LPs to hold rewards?
Supply dynamics:
What is the supply schedule of the token and what does it imply for selling pressure? What creates and removes supply?
Who has most of it? When are they likely to sell? When do they have to sell (e.g. VC fund unlocks)?
Value accrual mechanisms:
How does the token accrue “value”? Meaning, how does the token benefit when the protocol benefits? How do the various interactions within the protocol impact the price (buying/selling/minting/burning) of a token?
Here’s a simple example of value accrual from @perpprotocol v1, a derivatives exchange.
People trade on their platform, half of the trading fees go into a pool which is then paid out to stakers.
Protocol value capture 🤝 token value capture
Before we move on, I’d like to dispel the idea that tokens should just be number-go-up only. I fundamentally disagree with this mentality. Tokens should benefit from a successful protocol, NOT try to fool people.
Instead of spending $ to set fake floors on your token price, the focus should be:
- Set up the right tokenomics to benefit from growth
- Allocate all efforts and resources to growth
No one token model works in every case.
Here are 5 examples of tokenomics I like
$LUNA 🌕
LUNA is the Terra blockchain’s native token. UST, a stablecoin, can be minted by burning 1 LUNA. When there’s more UST demand, more LUNA is burned which reduces its supply and increases the price.
Regardless of your view on UST-Anchor and the rest of Terra, the key takeaway here is that if there is demand for the core products (UST, the Terra network), the LUNA token has a flywheel that captures demand and increases token value.
$CVX
CVX is a great example of tokenomics that make use of game theory, supply curve management and revenue share while also built on top of a protocol with a strong economic moat (Curve = best-in-class stablecoin DEX).
CVX is a black hole for $CRV, a token that incentivizes liquidity on Curve and helps stablecoins maintain peg. CVX’s emissions decline as more CRV is earned, meaning the ratio of CVX emission to CRV farmed will continue to decline (each CVX becomes increasingly valuable).
After CVX hits its max supply of 100M, each CVX will represent more CRV meaning more rewards and in turn, more revenue shared with stakers.
The complete CRV/CVX dynamics are beyond the scope of this thread but you can check out our free post on it here:
$TOKE ☢️
When I first came across Tokemak, I was really intrigued by the tokenomics.
Think of Tokemak as being a giant pool of capital, and your share of TOKE lets you vote on where to direct that capital.
Meaning (simplifying here) if I own 1% of the TOKE supply and Tokemak has $500M of TOKE TVL, I can provide $5M as one side of a liquidity pair of my choosing + reallocate w/ no fees/gas.
Inflation is high, but if Tokemak is successful there should be organic demand for TOKE.
TOKE is a good example of a token that represents a unit of value. Your token is like a “share” that has direct control over a specific set of assets.
Plus, TOKE doesn’t just have a reason to exist, it’s a necessity – Tokemak needs the token for the protocol to work.
Dual-tokens: DPX/rDPX 💎 and RAIDER/AURUM
I find dual token models interesting because you can split incentives and de-risk dumping of the “main” token.
I know what you’re thinking – wtf does that mean?
In the case of Dopex, $DPX serves the purpose of governance and fee share, while $RDPX is issued as a rebate for option writers who lost money on expirations.
rDPX helps bootstrap Dopex early by being the reward token w/o hurting the main token's value. And has its own utility.
Similarly w/ @crypto_raiders, $RAIDER is a profit share token, while $AURUM is an in-game currency + paid out to RAIDER holders as rewards.
Cheap AURUM is better bc it lowers the game’s cost of entry but it’s still used to buy things which helps maintain its value as a reward.
I like the dual token model for gaming in particular b/c it gives optionality. You could add ETH, USDC, etc. to your game in the future without having to rip up your entire token model.
Also, IMO bootstrapping in-game currencies is hard so dual token = good downside protection.
There is far more that goes into a holistic analysis than just tokenomics, but tokenomics are an essential component.
Me and the DeFi Ed team dive deep on all aspects of Defi. We don’t shill or cut corners and built our rep solely through content quality and word of mouth.