Online communities and businesses transform into online economies via their natively issued tokens. In this article users are considered citizens. Trust still plays an important role in these developing online economies. Citizens have to trust the builders and creators who write the smart contracts, drive the vision and engineer the ecosystem. A properly functioning tokenized economy requires intentional design by its creators and highlights the importance of token engineering.
We are building new age business models that have the properties of online economies. Their intention is to use tokens that align incentives and drive specific citizen behaviour. It has created a plethora of design challenges that need to be addressed to be successful and sustainable. We can draw from best practices that have been battle tested for creating successful businesses, communities & economies, as well as experiment with new ones.
We are at the trial and error, experimentation phase of this new design space. We have old models to pull from and technology that enables new ones to be imagined & tested. This article is not exhaustive. In fact it might just be scratching the surface but I hope it is helpful to the community. It is built on the ideas of people smarter than I. Thank you to all who see their ideas reflected in these words. You played a part in building this. A big thank you to Machinations. I leveraged their latest article on building sustainable game economies as the structure for mine.
So let’s dive in.
Economic history tells us that an economy cannot prosper if its citizens are dissatisfied. No online economy will be successful unless it offers its citizens something of value in return for their time and energy. Value is not one dimensional. It is multi-dimensional. It is token utility but it could also be a sense of belonging. Human beings are like onions and onions have layers like ogres. So let’s peel them back.
Token Utility:
Utility is one dimension of value. It is crucial to the long term sustainability of your online economy. You can design utility into your token and it can also emerge from the culture that develops around it. Culture is the shared narrative/story being told that people align with. A strong story can drive demand. As demand increases so too does the interest to build utility around it. But if utility does not emerge then sustainable demand will probably not exist. So in the long run utility is King.
Here are some things worth considering:
How does your ecosystem produce and capture value?
What is the utility of the token? How does the token capture value?
Why do users want to own it, hold on to it, accumulate it or spend it?
What is the most important reason why people are in your ecosystem?
How does the token align the user behaviour with the action you want them to perform?
What does the token allow users to do that they could not do otherwise?
What should the properties of the token be to fulfill its desired function?
What is the cost of solving your tokenomics versus the value it is bringing to your project?
Tokens are Technology Products
Technology enhances a human beings ability to actuate (perform actions). In some cases the token may be the product, so we may ask
One of the strongest forms of “actuation enablement” will be ones that give your citizens a competitive advantage over others, to the point where if other people do not adopt it, they are at a disadvantage.
In other cases the token may amplify the product/service that you offer.
I’m sure there are circumstances where neither of these cases apply to your Token or perhaps it is more nuanced. That’s fine, this is an emerging design space
Battle Tested Wisdom
I’d like to propose that your online economy may first begin as a business. This is not a backward step but a first step towards building something greater. Battle tested wisdom can help.
Consider the basic business principles of team building, core problem/your solution, competitive advantage, market analysis, stickiness or moat, sustainability of revenue model, go-to market strategy, cash burn & runway, user research, operating frameworks etc…
Culture & Core Human Needs
Utility is multi-dimensional. Culture plays a huge role in how an economy manifests itself. So peel back the layers and see your online economy is suited to address. Maslow’s Hierarchy of Needs is a simple framework but not the only one. The more needs you can meet, the stickier your economy is.
Security & Safety Needs (Financial, Physical, Emotional)
Social Needs (Love, Acceptance, Belonging, Playfulness, Freedom)
Esteem Needs (Appreciation, Respect, Accomplishment, Personal Worth)
Self-Actualization Needs (Personal Growth, Self Awareness)
The Glue Between the Lines of Code
Many builders underestimate the role storytelling plays. It is our shared narratives that holds a society together and as they erode so too does the society. It is a shared vision that holds a team together. It is a shared identity that holds community together.
TLDR: Tell a compelling story, build an identity that your citizens can relate to and a vision of the future they want to be a part of.
Whether you are aiming to appeal to people’s financial, social or esteem needs, in the end it’s about the way it makes us feel. That’s what drives most human behaviour. Might sound weird but:
Economic issues can make citizens lose faith in their government just like it can destroy a community and a culture online. Citizens may assume -justly or unjustly- that the economy is not properly managed and won’t be able to produce long-term value in terms of enjoyment, utility, or profit. This makes token engineering of utmost importance for communities wishing to tokenize. For all the advantages it offers, it also offers many new challenges.
Tokenizing provides many interesting features
They can facilitate fundraising and/or bootstrapping initial liquidity.
They can create hyper loyal users by giving them upside exposure to the success of the economy.
They can distribute ownership and governance of a network/application.
They can accelerate the growth of your network.
They are easy to transfer and trade.
They lend themselves very well to gamification.
They can align the user base and creator base.
They promise a world of interoperability between networks/applications.
They can facilitate coordinating groups of people and pooled resources towards a common goal.
They empowers a whole breadth of new business models yet to be explored and uncovered
Tokenizing also creates many challenges
Managing the supply and demand of the token
Insiders can pump and dump the token
As the token falls in price the community disperses
Increase critic from your community (building in public can be unforgiving)
Community management becomes increasingly important
Token price can distract core contributors and pull them away from their core mission
At the current stage, tokenizing your network exposes you to market forces that drive risk on/off behaviours that can be completely unrelated to your development
Unanticipated 2nd & 3rd order of effects we have yet to find out about
New attack vectors (RIP all of those projects building on-top of Terra)
Still want to Tokenize? Let’s keep going
Sustainable economies have three key features that designers should look for. Individually, each pillar is necessary but not sufficient for a healthy economy. Economic health requires all three.
The core issue when designing a token economy is not inflation or deflation per se, but rather the failure of its tokens to keep within certain bounds of value. Wildly rising, falling, or fluctuating currencies prevent almost any citizen economic activity from proceeding smoothly. A token is measured against another asset to benchmark whether it is increasing (deflating) or decreasing (inflating) in value.
Thus, value stability, rather than inflation or deflation, should be the true target of token engineering so that it can serve as a stable medium of exchange/ unit of account / store of value that sustains economic planning and activity.
By value stability, we refer to the rate of change of the value of your token in relationship to other assets. It is this second derivative that leads to chaos or stability in an economy. Not the fact that it changes in value but the rate at which it changes against the assets to which it is pegged.
The value of your token doesn’t need to remain the same. Logically it ought to increase as the value it captures increases. But large rapid swings can be detrimental to both the culture and focus of the online economy in the beginning.
Therefore the value of your token and its rate of change (2nd derivative) should be monitored and evaluated.
Arguably wild swings in value will be hard to avoid in the early days of online economies as market forces grapple with these new instruments. In this case, projects should apply proper treasury management and remain focussed on their long term vision. I do think this sort of value stability will better serve projects that are building for the long term.
Proper treasury management
This needs to be a separate article but here is one interesting mind puzzle… Imagine your token increases wildly in value, you liquidate it, supply hits the market, your treasury becomes stable-coin based (great for you right now), the market tanks, now there are a lot of people holding your token who are sellers. The market is over supplied, demand has not caught up and this period of depression extends for a while due to market conditions and where you are at in shipping utility to your economy. This sort of short term thinking can destroy communities. It is not wrong to diversify your treasury but it is short term thinking to oversupply the market and sacrifice the long-term health of your supply/demand curve as a result. Proper treasury management must evaluate short/mid/long term goals and consider 2nd/3rd order effects of how the choices they are making now, may affect them in the future. Proper treasury management is as much about mapping supply & demand projections as it is about diversification and measuring cash burn. It’s a balance that needs to be struck between multiple variables.
Outside the box
All of this being said, I hesitate to say other possibilities do not exist. I think experimentation should be welcomed as long as we are intellectually honest about the risks involved. After-all, we have the opportunity to turn economics into an experimental science with token engineering. Experimenting with short term models and a variety of other frames could prove to be interesting, fun and dangerous. All in all, great data for the future AI managing the parameters of your online economy (half-joking).
Control Nodes
If we look at the global economy, it has various points of control. Centrals Banks, Government Treasury Departments, Swift Banking System, OPEC, UN, IMF etc… It is imperfect and unjust but that is not what we are here to debate.
Their attempt to control the economy by adjusting various levers is humanity’s best attempt so far to maintain a stable growing interconnected economy. We can imagine a future where AI optimizes design choices for the economy alongside certain parameters. I also believe that these mechanisms will be present in online economies. We are already seeing it in the early days of EIP-1159 and algorithmic burning mechanisms.
We don’t need to shy away from controlling input and output functions of our online economies. It may be required to maintain a proper balance of both supply and demand in the face of changing externalities. Rather we should experiment with how we can create equitable parameters and decentralized systems that maintain economic balance in a transparent and optimized way for the wellbeing of its citizens. Looking to remove any adaptability to our online economies makes them less resilient to external forces. Anti-fragile isn’t unchanging, rather it is adapting to stressors and becoming stronger due to them. Our online economies will require a similar type of adaptive mechanism.
Control the Release of Wealth
Token supply growth vs demand is the primary lever for achieving token stability. Pay attention to:
The Demand
The # of users
Rate of change in # of users
The utility of your token
How much it is being used for its designated utility
How much is being hoarded (potential future selling pressure)
The supply
Circulating supply
Maximum Supply
The emission rate of your token
Lock-up & vesting periods
Your cash burn and the need for your treasury to liquidate to fund its activities
Liquidity mining programs
Important considerations
Distribution of token (Percentage owned by founders, investors, users etc)
Fair and just lock-up/vesting periods
Plans for future distribution
Intention of large holders (whales)
The following may discourage community engagement
Unfair token distribution & lock-up periods
Non transparent tokenomics
Unlimited supply, no control parameters
No token utility
Whales with predatory reputations
Control the rates of draining and destruction of assets:
Implement mechanisms to control inflation by the burning of assets (money consumption): token burning helps with stabilizing the value and is used to:
Decrease the # of tokens in circulation
Adjust supply and demand ratios
To make the asset less inflationary
The price of goods should match what the citizens want them to be
A system for establishing fair prices and figuring out how much everything in the economy is worth is necessary for a well-balanced economic design. An item (product or service) should be expensive if it is thought to be very valuable, exclusive, scarce, hard to come by, etc…. An item should be cheap if it is thought to have no value, should be open to all, unlimited in supply, have no barrier to entry etc…
If the pricing system is inverted, the economy will be unable to function. It will show signs of breakage and create an environment of uncertainty that frustrates both citizens and builders while paralyzing economic activity.
Is the price of goods going up or is the value of the US dollar going down? Value is always relative to something else. Therefore it is not just the stability of your token versus a currency but also the stability of your token versus the services and products it can be redeemed for that is important.
Instability as a Feature
For all our talk about stability and control my hope for Web3 and this new design space is that we experiment outside of what is known. My intuition tells me new working models for human collaboration are possible. Hidden gems lie in both obvious and non-obvious behaviour economics. Perhaps chaos is attractive in certain contexts. Therefore I strongly feel that what we need is a testing ground for things we are not familiar with to see what works and allow for creativity to blossom in the field of economics.
We do not need to rework the wheel, there is a ton of data on what drives human behaviour. But we can create a sandbox that allows us to compile these (technological and social) modules into different structures and to test them.
We can simultaneously explore the unknown while surfing along the traditional. We are in a new era of experimentation. Trial and error is the norm. Failures are to be expected but so too are discoveries if we create the safe environment for them. For that safe environment intellectual honesty about the potential risks involved should be clear and transparent.
The problem of launch pricing is particularly thorny. User Research and simulating your economy can play a large role in making sense of these and other ongoing design choices.
Simulation
Machinations is a new tool used in economic game design that can also be used to simulate incentives within tokenized online economies. Simulations can help us understand if our design makes sense, anticipate issues and generate new insights. It is a visual language for economic design. We will dive deeper into the tools that make up Token Engineering in a future article.
User Research
User research is an underutilized tool for most founders. It is the practice of understanding the needs, pains, behaviours, motivations, and decision-making processes of your target audience. It is like the US census, the CPI, the ISM manufacturing index, the polls etc…that we see in modern economies. In a company or new online economy it may look like user testing, (un)moderated studies, card sorting, surveys, deep interviews and more.
User research is helpful to answer question such as:
Who are our citizens?
What can we learn about them that will inform our business, product and marketing strategy?
What market or citizen profile should we be targeting?
How do citizens use our product?
How does our product stack up against competitors?
Why are we not achieving adoption and retention?
What features should we prioritize in the backlog?
The allocation function of an economy refers to the way your online economy distributes tokens to its citizens. A successful online economy distributes tokens to its citizens in a way that seems reasonable and fair to everyone involved.
In an online tokenized economy, important consideration are:
Maximum supply of tokens (market cap)
The circulating supply
the % distributed between core team, company treasury, investors, community/users
Airdrops, liquidity mining programs and other distribution mechanisms
Requirements for staking, securing the network (if applicable)
Governance & voting thresholds (if applicable)
Lock up periods, emission rates
Present and future utility, mapping the projected supply vs the demand
Present and future incentives, how much are you giving away to your early contributors vs your time horizon
The cash needs of your treasury vs incoming revenue, how much you will have to liquidate to keep operating
“The allocation process will need to be fair and just. Economic history shows that when people believe a system is unfair, pressure and crisis often result.”
Research shows that citizens of an online economy will consider it fair if it has:
Equality of Opportunity - citizens are given to the same opportunity set for an equal amount/quality of time & energy
Equality of Return - compensation is distributed in a fair and just manner for similar time, energy & outcomes achieved
We are talking about compensating your citizens in an equitable manner and providing them with the same sort of opportunities. An example is the Uniswap airdrop to its users. It is a significant improvement in distribution of wealth and control for an economy to airdrop property rights and financial upside to its citizens. It is not perfect. VCs and early stage investors may still get outside returns. Perfect execution of this ethos is probably not realistic in the beginning but this is the direction many online economies in Web3 are heading.
Positive Sum Economies
Positive sum economies are one of the most fascinating and hope giving business models appearing out of Web3. That is to say, mechanics that allow every stakeholder involved in a process to win and benefit. Distributing ownership and profits more equally amongst citizens, aligning incentives for each of its members and experimenting with new governance models. It is a fascinating design space and one that gives me hope that we may be able to become proper stewards of all of these incredibly powerful exponential technologies coming out if we get the incentive structure right. Topic for a future article.
Exploring Inequality
Personally i think inequality is also a design space worth exploring. Conflict and competition seem to be genuine aspects of human beings who experience themselves as separate from the world and others. This is the present reality of the consciousness on our planet. To see ourselves as connected to everything is not a belief. It is a lived experience very few of us have had and I think where we are at in our journey of evolution as a species should be honoured and not shamed. Ideally we can create safe and creative spaces for the expression of these things rather than repress them into boxes in our subconscious minds.
Much as pain enhances the experience of joy and sickness the experience of health, playing with these ideas, like the blockchain game Dark Forest and building an economy with unique parameters outside of equality is worth exploring. If we limit ourselves to what we think is right, especially in a place of experimentation, we may gloss over truths that lead to better outcomes for our species. Autonomous Worlds is a great podcast episode with Justin Glibert that discusses some of these ideas.
“The randomness observed in online economies is of two types: risk is the randomness in a die roll. We know what the probabilities are, but we do not know the outcome.
The other type of randomness is uncertainty. Uncertainty is a random situation where the probabilities are not known and it is much harder to deal with uncertainty than with risk. Facing risk, one can develop rational strategies for dealing with it. With uncertainty, no one has any idea what will happen, making rational preparation impossible.” ~machinations
We want to aim to create economies where the risk is calculable and the uncertainty minimized. Consistent and extreme token value instability creates environments of uncertainty. Breakdown in shared narratives and culture that binds a community, creates environments of uncertainty. It is much harder to operate in these environments versus one where risks are pragmatically considered.
To minimize uncertainty I think the space overall requires more intellectual honesty about the risks involved.
Like a public companies Q10 report, I hope online economies would strive to provide their citizens with some measure of honest risk assessment.
My own inclination is towards radical transparency and the power it holds to build social trust and resilience in communities.
Engagement is the use of one’s own time. One way of looking at it is: the online economy is buying the citizen’s time with its products, services, culture, in other words its value proposition. Money can arguably be thought of as crystallized human energy and time. Your citizen’s time and energy is one of the most important components leading to the growth of the online economy. Whereas real economies are limited by both physics, a lack of imagination and entrenched in old ways of operating, online economies can engage people in a wide range of tasks in a variety of creative ways.
What are the levers in your economy that drives engagement from your citizens?
What are the unpleasant, tedious, time consuming levers?
How are you allocating the time they are giving you?
How can you gamify their involvement? (NFTs, rewards, acknowledgment & appreciation, on chain credentials that build up)
How can you transform the unsatisfying mechanics within the economy?
Perhaps it sounds abstract but it can be as simple as making waiting for transaction confirmation a fun experience by providing an animation that is insightful, funny or culturally relevant. Once again I suggest we experiment.
It strikes me as peculiar that most societal structures we are familiar with today were established during a time of vastly different technological and informational capabilities. Our advancements in technology and knowledge of ourselves has created a plethora of innovative opportunities for those willing to be brave to try, and fail, until they succeed. I’m not saying to disregard the accumulated body of knowledge science has acquired. I’m saying use it and experiment with it and beyond it. Science only moves forward by exploring what we don’t know but the human tendency is to stay within the realms of what is known and familiar. It is usually up to the conscious effort on the part of a creative minority to pioneer new ways. To advance the plot rather than just have a step increase in productivity or some other metric.
Do you want to be part of the creative minority?
You do not need to be. The design space is vast enough that simply building online economies within already established and acceptable parameters is quite a feat. It’s just not the whole pie that’s available. Choose your slice wisely and be honest with yourselves.
It Takes Data to Manage an Economy
The economy is in good shape when specific data points falls within reasonable bounds or are moving in a reasonable direction. Monitoring economic data and raising alarms when a number enters the danger range are part of economic management.
In traditional economies there are standard metrics like GDP and CPI and also non-standard ones like Gross National Happiness, Human Development Index and so on. We will look at what metrics make sense for online economies. The databases for collecting and managing this data should be designed early on in the life cycle of your online economy so you can learn and adapt accordingly.
What is Token Engineering?
A multi-disciplinary science whose goal is to apply the tools of engineering (analysis, design and verification) with practical tools to simulate and verify theories of token ecosystem design. Tokenomics has turned economics into an experimental science and token engineering are the professionals looking to formalize it. We will dive into the theory, tools and other resources available to learn and connect with people leading this frontier.
New Models & Tools for Building Tokenized Communities
We will take a look at emerging models from different projects. Web3 tools for building online economies (bonding curves, platforms, DAOs, etc…). Ways for coordinating and creating online economies.
Thanks for reading! I know it was long, but I hope it was useful :). Once again thank you to Machinations.io for helping me overcome the potential inertia of my first article by providing a useful template I could follow.