Designing an Open Game Economy (Part 1)

Uncharted Territory: Building a Sustainable World

In the last few years, we have seen many blockchain games come and go. Most of those that have survived suffer from dwindling player bases and floor prices, with a consistent leakage of value that seems to have no end.

Why is this the standard?

Zooming out, this doesn’t seem to be a new phenomenon. Even the most economically sophisticated traditional multiplayer game genre, persistent world MMOs, have long struggled with establishing sustainable currency valuations and population growth. When you introduce the pressure of real-world liquidity freely entering and exiting the game economy, it can bring forth a range of potential vulnerabilities and failure points that need to be carefully considered.

As of today, EVE Online from CCP Games boasts one of the most realistic player-driven virtual economies. Recently celebrating its 20th year in existence, it is the most frequently cited virtual economy in academic papers exploring the realm of online gaming. EVE has an effective taxation system, a trading market modeled after the NASDAQ, and a highly composable gameplay experience that empowers players to create a variety of dynamic and specialized careers. Ship destruction from Player-versus-Player (PvP) combat provides a massive sink for in-game resources (the largest in the game). Further, EVE is likely the only virtual game market where economic competition occurs that is comparable to that of the real world.

Truly, out of every traditional game right now, EVE’s economy would likely perform the best in a move to blockchain. However, even with their robust economic design, they have had to deal with problems like stagflation and a decreasing player count over the last decade.

Let’s discuss an example of a game which suffered from more severe economic issues. While not a persistent world, Diablo 3 experienced hyperinflation during the existence of its real money auction house (RMAH). In theory, the RMAH was a good attempt at addressing the gray market loophole of secondary trading found in Diablo 2.

However, it ended up causing significant problems. Diablo 3’s economic design was entirely unprepared for gold farming profit maximalization, which led to hyperinflation and in short order gold was virtually worthless. Over the course of one year the value of gold dropped from 30 USD/100,000 gold pieces to 1.09 USD/20 million gold pieces, or about one six thousandth of its original price. Suppose we applied a similar rate of devaluation to the dollar; this would be akin to a loaf of bread that normally costs 3 USD soaring to a price of 18,000 USD — not exactly confidence inspiring.

Taking into consideration unresolved challenges such as outsized inflation, stagflation, and player emigration in traditional game economies, how can we navigate and resolve these issues as we venture into this new territory of open blockchain economies?

This is what we intend to explore over the course of this series of articles. While the value of economic insights derived from game design is acknowledged, they often revolve around modeling value flows within closed-loop economies managed by centralized companies. By introducing blockchain as a base layer for games, they are now exposed to open market competition at a level not seen in the legacy space.

This new form of virtual economy needs to incorporate more traditional economic frameworks in their design if they wish to survive outside of the walled gardens of the past.

Clearly, this is a complicated subject with still many questions outstanding. My goal is to start a conversation around how we can improve current and future blockchain based economies. Insight will be shared into what are considered important and foundational elements. Criticism and discussion are welcomed, the intention being for this series to evolve over time.


I. Reasoning

  1. Blockchain economies are not game economies

    1. Currency competition
  2. Is your game a developing country?

  3. Money isn’t magic

    1. Currency volatility

    2. Stability is key

II. Methodology

  1. Currency reserves

    1. Currency inflows

    2. Royalties as an export tax

    3. Stabilization practices

  2. Liquidity bootstrapping

    1. Liquidity as a scarce resource

    2. Liquidity as a charter

    3. Liquidity as infrastructure

    4. Liquidity driven by royalties

    5. Liquidity via proposal

    6. Liquidity or stability, which comes first?

III. Implementation

  1. Virtual worlds need an anchor

    1. Value entanglement

    2. Auction-based exchange rate

  2. Treasury bonds

  3. Taxes, innate costs, & entropy

    1. Taxes drive money
  4. Currency systems

IV. Review

  1. In closing

    1. Designing an Open Game Economy (Part 1) Recap

    2. Final thoughts

    3. Recommended reading

This framework is presented as a box of tools. It is the distillation of almost two years of research into the economies of games, blockchain ecosystems, and nation-states. This is a thesis for a new type of blockchain based game economy, one which is marked by its robustness, adaptability, and stability. Each section as written is meant to build upon those prior. However, do not feel pressured to read these ideas in a linear manner nor in one sitting, in fact, it may be best suited as a reference for when specific dilemmas arise in the development of your economy. May the insights delivered here spark new thoughts, visions, and dreams of what a sovereign blockchain game economy can be.

I. Reasoning

Blockchain economies are not game economies

Now, before you grab your pitchforks, stay awhile and listen.

Builders yelling at Heimdall (Colorized, 2023)
Builders yelling at Heimdall (Colorized, 2023)

Traditional game design does not account for extrinsic markets nor the behavior of players when they are exposed to a broader range of opportunity costs. The crucial difference with blockchain economies is that both the game currency and game assets will not only have to compete with the United States Dollar and ETH, but also with a multitude of emerging heavyweights in the space.

The question for each player quickly becomes: why would I hold your money?

“Everyone can create money, the problem is to get it accepted.”

—Hyman Minsky, an American Economist

Minsky’s words have never rung more true than today. With numerous websites available to help even the most technically unsavvy deploy stock token contracts and the DIY edition only being a YouTube tutorial away, truly anyone can create money. But should they?

Every game that enters the space wants to tokenize their currency. Some believe that the only requirement to sustain value in an ecosystem is to simply “make it fun" (despite their seeming lack of ability to do so). This is espoused to such an extent that it feels as though sustainability is being framed as a mere game design problem, rather than acknowledging the new economic challenges that arise when introducing blockchain to games. Fun is certainly the most important consideration when developing a game, because without it, no amount of esoteric economic magic will sustain value in your currency. Before you even set forth on the journey of creating a sustainable economy, you should first answer this question: Would players still enjoy your game without any token incentives?

In the blockchain space, your games do need both fun and a viable economic structure. Without both you will forever be trying to retain value in an economy with declining player interest and the economic equivalent of a leaky ship. The goal should be to maintain a stable or growing player interest, while constructing your hull with the strongest material you can muster.

Now, it is doubtful that a monolithic definition for fun exists, i.e. you will need to define what fun means for your particular game. I recommend utilizing player feedback throughout the development cycle before you have launched any sort of asset that could illegitimize play testing. That way you can be sure the players are there for the game.

With that said, let’s get on with the hull construction.

In consideration of the medium we are working with, and the technological advances since Minsky made that statement, I propose a slight update:

Everyone can create money, the problem is to make it competitive.

Currency competition

Blockchain games shouldn’t have a currency unless the developers intend to make that currency competitive. I define a competitive currency as having five attributes: a relatively stable value, deep liquidity, transparent distribution, broad acceptance, and high velocity.

  • Stable Value — This does not mean perfectly stable, the value can still increase or decrease over time. The value of the currency should stay within a relative range of an asset that its user would consider an effective store of value. For example, consider ETH (Ξ) as the effective store of value, if a currency were to stay in the price range of .095Ξ - .105Ξ over an extended time period, then it would be relatively stable in terms of ETH. Further, the currency should maintain its value in terms of other ecosystem assets such as in-game items.

  • Deep Liquidity — Liquidity refers to how easily a currency can be bought or sold without affecting its market price. You should be able to make large transactions without inducing volatility in the currency. The liquidity is not deep if there is potential for it to reach an amount that lets transactions become volatile in the near future.

  • Transparent Distribution — The method of currency distribution is publicly understood and reasonably fair. Reasonably fair meaning that there is no singular entity receiving an outsized portion of the new currency. If you sold some of your currency to investors, it’s no longer a currency, it’s an equity token.

  • Broad Acceptance — Another individual (outside of your project) would accept payment from you in this currency. This individual having received payment feels no need to immediately convert it into another currency. If I’m in Mexico and pay a storekeeper with US dollars, he will likely be okay to hold those dollars.

  • High Velocity — Velocity of money is a metric that can be used to gauge the health of an economy. It measures how often money changes hands over a given period of time. Essentially, it is a measure of demand for a currency within a given ecosystem. The faster the turnover of money, the more trade is occurring, and the more effective mechanics like transaction fees become. In a blockchain ecosystem this can also contribute to more currency swaps on a decentralized exchange, which in turn generates fees for liquidity providers. In combination with a relatively stable currency price (which would reduce impermanent loss), high velocity can act as a natural incentive for LPs.

There are no live examples of what I’m proposing here. Most of the current game tokens are examples of “value-accrual” tokens rather than competitive currencies. They are designed for the number to go up rather than to be stable, and thus behave more like equities. A value accrual token generally offers a player pseudo-equity in the game ecosystem. The developer drives demand to such a token through various in-game utilities and/or its varying level of control over ecosystem funds that accrue to a treasury. It is thought that these attributes can elevate such a token to the status of a store of value, however, this has also not been observed in any of the currently available iterations. The issue is that these two very different concepts, value accrual tokens and currencies, are easily conflated because both are units of account.

The volatility of these tokens is incompatible with the framework of Automated Market Maker (AMM) liquidity, as evidenced by the numerous unsuccessful efforts to encourage sustainable liquidity provision. A more stable nature is appropriate, as can be seen in the inherent liquidity accumulation of stablecoin liquidity pools. If a token is relatively stable (in terms of its pair), it requires no incentive in addition to LP fees (more on this in the Liquidity or stability, which comes first? section). Thus, it can be said that volatility disrupts the potential for deep liquidity. Further, the initial distribution is generally centralized to the developer and their investors, so it is not transparent. And neither is it broadly accepted: a value accrual token tends to only be accepted within the bounds of its own ecosystem. Lastly, velocity will be lower as the potential for upside leads to hoarding instead of spending. Taking all of this into consideration, a value accrual token cannot be a competitive currency.

Now, it can be argued that the success of your game hinges on the viability of its currency. If the currency can’t sustain any semblance of stable value, it could undermine your game's potential. Developers might fare better focusing solely on other game assets if they can't establish their currency in a competitive manner.


In the blockchain world where currency conversion is virtually frictionless, it only takes moments for a user to act on lost confidence in a currency’s stability. A short jaunt to Uniswap and they have converted [insert game] token into USDC or ETH. This behavior can become contagious, accelerating as the price decays. If this occurs on a macro scale, the currency rapidly becomes an invalid store of value.

There’s a number of factors that can contribute to the collapse of a game currency. Some would like to blame the speculators, value extractors, the prisoner’s dilemma, or even the tragedy of the commons. It's more likely that developers’ are simply overlooking the fundamental needs of an open economy… or rather a developing country.

Is your game a developing country?

Let's start with a comparison Edward Castronova made in his seminal paper that explores the early society of Everquest and its residents.

“In March 1999, a small number of Californians discovered a new world called "Norrath", populated by an exotic but industrious people. About 12,000 people call this place their permanent home, although some 60,000 are present there at any given time. The nominal hourly wage is about USD 3.42 per hour, and the labors of the people produce a GNP per capita somewhere between that of Russia and Bulgaria. A unit of Norrath's currency is traded on exchange markets at USD 0.0107, higher than the Yen and the Lira. The economy is characterized by extreme inequality, yet life there is quite attractive to many.”

—Edward Castronova, Virtual Worlds: A First-Hand Account of Market and Society on the Cyberian Frontier

This distinction, which was certainly wild at the time, becomes even more prescient for blockchain virtual worlds that intend to be more than mere entertainment products. Viewing a game through the lens of a country can clue us into what might be missing in the equation of economic value. While there are certainly significant differences between a virtual and national economy, the similarities are striking and instructive.

Let's discuss the main types of comparisons we might draw:

  • Currency Volatility   Fluctuations in currency exchange rate

  • Currency Reserves   Utilizing foreign currency for economic stability

  • Property Rights Legal ownership and protection of assets

  • Governance   Management of decision-making and authority

  • Social Institutions  Structures shaping social interactions

  • Economic Mobility Ability to improve economic status

In this article, I’ll cover why reducing currency volatility is important, what’s stopped projects from achieving it and how to do it. Additionally, we will discuss foreign currency reserves, what they are and how to structure your economy to accumulate them.

In future articles, we will explore what qualifies as meaningful digital property rights, why governance is a critical piece of the economic equation, how to structure social institutions to ensure the long term sustainability of a community, and designing for economic mobility in eternal games.

Source: Trust me bro
Source: Trust me bro

Money Isn’t Magic

Money isn’t magic, nor is the value it represents. This fact can be seemingly lost in translation in the crypto space, where too many dog and pepe coins are speculatively valued at too many millions of dollars. True value does not spring forth from the abyss and anoint the fortunate currencies at random; it must be carefully designed and cultivated.

Currency volatility

Currency volatility is so common in crypto ecosystems it almost seems native to the tech (and in a sense it is). There's a lot of enthusiasm for placing hard coded caps on token supplies in service of establishing the scarcity needed for numbers to go up. Indeed, this does often work as intended as far as spurring on speculation goes.

The thing is, we don't actually want the number to go very far in any direction when we're talking about an actual currency vs. a speculative asset (e.g. value accrual token). Scarce assets tend not to absorb market fluctuations very well. With a hard coded max supply, there's no flexibility to respond to supply or demand shocks. This overall trend is a significant driver of the volatility that appears native to crypto.

Another motivation behind setting a fixed monetary supply is rooted in a desire to prevent privileged entities from arbitrarily creating money, thereby causing inflation and currency devaluation. While this feature has contributed to Bitcoin's success as a store of value, it may not be ideal for assets primarily intended as mediums of exchange. Even as an attribute of a token designed to accrue value for an ecosystem, it is still not the most effective framework. We will discuss how to use new “value accrual” asset supply to your advantage in the Auction-based exchange rate section, and go in-depth on governance asset design in a later article focused on governance specifically.

Now, if we're speaking specifically of a desire to make tokens on blockchains serve as actual currencies, it seems that the fundamental purpose of money is too often overlooked: to facilitate efficient transactions by maintaining relative stability.

So what do I recommend? A currency with an elastic supply.

Of course, it’s no simple task to distribute or modulate the supply of a currency as many persistent world MMOs and other multiplayer games with complex economies have found. Elastic supply currencies often face challenges related to inflation (e.g. devaluation of in-game currencies and assets). Inflation is often the result of unbounded player asset generation, ineffective in-game utility, and a general incongruence between the effort required and the reward earned. Developers will attempt to solve these problems by enticing players to spend their currency and resources on any number of elective sinks — with varying degrees of success.

Hopping back to the Diablo 3 example, originally there was only four gold sinks in the game: repairs, transaction fees, consumables, and forging.

“Most of us (probably including Blizzard) assumed that the Blacksmith [forging] would be widely used — he was, after all, the only major gold sink in the game … but dropped items alone selling in the auction house have been enough to satiate the appetite of players and crafting is … a waste of gold when one could easily buy an optimal item from the auction house rather than pumping 50 to 170K of gold into a Blacksmith-crafted weapon.”

—Peter C. Earle, A Virtual Weimar: Hyperinflation in a Video Game World

In the transition to an open market design, these types of elective sinks can falter as players begin to compare playtime to dollar values and optimize for more efficient or liquid results instead of using the currency for the utility that the developers intended.

Dollar value comparisons can potentially exasperate this problem by incentivizing certain segments of the player base to automate or maximize for currency generating tasks in order to profit off of the game, which further accelerates inflation of the monetary supply.

“Although its anonymity may make it subject to skepticism, several weeks after the game’s debut a source claimed that there were at least 1,000 bots active 24/7 in the Diablo 3 game world, allegedly “harvesting” (producing) 4 million virtual gold per hour.” cont’d (above)

The demand for in-game assets on the RMAH led 3rd party gold resellers to capitalize on the trivial nature of gold generating activities in Diablo 3. This rapidly increased the circulating supply of gold in game and ultimately led to hyper devaluation of the currency. In the Currency Systems section, we will discuss how to better design faucets making them less vulnerable to exploitation.

Another gold farming example is that of the Venezuelan Mafia in Runescape. During the Venezuelan economic crisis, many discovered they could earn money by farming gold in the game. At first they were a disorganized band of players, but as their numbers grew and skill increased they soon took complete control over one of the most profitable faucets in the game. Over 2,000 Venezuelans had fully secured currency generation at a spot known as the Revenant Caves across nearly 150 worlds, potentially creating an inflow of 72 Billion gold per day (more on this story here). While it’s great that they were able to make real money in a difficult life situation, this led to problems for the general player base and Runescape economy.

Lastly, as one might expect, EVE Online has among the most sophisticated approaches to battling inflation of its ISK currency. Here’s an image showing the many sinks and faucets that exist within the game:

Monthly Economic Report July 2023:
Monthly Economic Report July 2023:

By looking at this chart we can see the power of a market based economy. Transaction taxes in their various forms account for roughly 50% of direct currency outflows. Additionally, because EVE has a variety of viable careers which provide value-added services for other players, a more natural balance point tends to occur between new currency generation and other activities in the game.

However, there are still some concerns regarding EVE’s true inflation rate. A large bar left off this chart is the “Active ISK Delta” which is the amount of ISK removed from circulation either by players leaving the game or from banned accounts. A positive ISK delta corresponds to an increase in circulating monetary supply due to returning player ISK outweighing leaving players (this rarely occurs), while a negative ISK delta is the opposite. Counting this as a sink in a closed economy makes a lot of sense, but in an open blockchain economy Active ISK Delta won’t really exist. That currency gets sold into the liquidity pool before the player leaves the game.

It’s hard to tell exactly how much new ISK is being counted as sunk in this way as some player accounts could be returning after a few months in a revolving door fashion. Looking back through the last few years of reports, there are potentially hundreds of trillions more ISK in existence than is currently reported. With the current structure a blockchain based EVE economy would likely have much higher real inflation, which could contribute to the currency devaluing at an undesired rate. A caveat here, is that they may intentionally maintain a higher rate of inflation to counteract potential deflation caused by the reduction in circulating supply.

Schrodinger's Active ISK Delta
Schrodinger's Active ISK Delta

To circumvent these scenarios, developers should look to make their currency — and therefore their economy — more competitive.

  • Create confidence in the currency valuation — Currency reserves, stabilization practices, and liquidity bootstrapping.

  • Denominate valuable assets in your currency — Convertible to governance assets, treasury bonds, or similar.

  • Develop intrinsic demand drivers — Taxes, innate costs, and entropy.

  • Distribute your currency equitably — Competition, friction, activity, and risk.

Ideally, these frameworks would be implemented simultaneously to reduce volatility and stabilize ecosystem valuations. Before we dive in, let’s talk a little bit more about why stability is so important.

Stability is key

Reduce volatility? Don’t we want the numba to go up?

Nah man, we want the stability to go up.
Nah man, we want the stability to go up.

Economies that have a low volatility currency or one with a stabilized value require less incentive to attract investment. In more volatile economies, a higher risk premium is necessary to bring investment into a country. In the real world, this might look like higher yields on government bonds, subsidies to companies, or even land grants.

How does this apply to the blockchain space?

We are already well acquainted with risk premiums. Some examples:

  • The whitelist mechanic — Often offers a 50% discount on a public NFT mint.

  • Token sale tranches — Purporting to give investors a discount to later rounds.

  • High yield staking protocols — Lock up tokens in exchange for inflationary rewards.

  • Token and NFT airdrops — Pseudo promised future dividends.

They often are means by which projects incentivize investment into highly speculative and risky assets. While these incentives can be fun to receive in the moment they also can lead to inequity, dilution, and devaluation. There are positive ways to use these mechanics, but for the most part, the early participants who take profit leave someone who did not. A game of speculative hot potato is generally not the best way to start a fair and open economy.

This profit taking or removal of capital from an ecosystem can be likened to the following problem faced by Less-Developed Countries (LDCs).

“…Any savings that do exist among higher-income persons in poor LDCs are often invested in IACs (Industrially Advanced Countries). This phenomenon is called “capital flight.” These wealthy individuals are afraid to save in their own countries because they fear that their governments may be overthrown and their savings could be lost.”

—Irvin B. Tucker, Macroeconomics for Today

The similarity to taking profit in a blockchain project is uncanny. Early investors (higher-income persons) afraid that the value of their assets could crater, tend to convert to assets of more stable ecosystems (IACs). An example of this in a blockchain context, could be the conversion of a project’s governance asset or value accrual token into ETH.

In a Less-Developed Country this type of scenario leads to what’s known as a vicious cycle of poverty, where a country which is poor cannot afford to save, and poor savings lead to less investment. In blockchain ecosystems, declining valuations tend to lead to less new investment in the project. A major difference here is that individuals in an LDC are gated by geography, whereas in a blockchain project, users will simply leave once the value is depleted creating the equivalent of a digital ghost town.

Therefore, stability is the key which allows for capital to coalesce.

Before we proceed, we will define two terms in our blockchain context that will be used throughout the article:

  • Domestic — refers to all assets, currencies, and users which are within a particular project ecosystem.

  • Foreign (International) — refers to all value and investors that originate from outside of a project. This also includes current ecosystem users who utilize an exterior currency to purchase an ecosystem asset or currency. This would still be a “foreign” capital inflow or international investor in the traditional sense.

“Policies that reduce the riskiness of a country’s currency from the perspective of international investors reduce its risk premium in international markets, lower the country’s risk-free interest rate, and increase domestic capital accumulation, domestic wages, and the world market value of domestic firms.”

—Tarek A. Hassan, A Risk-based Theory of Exchange Rate Stabilization

In other words, stability increases the competitiveness of a country’s currency and therefore its economy. Foreign investors feel more comfortable investing larger amounts of capital into domestic assets. Domestic residents feel more confident staying invested in their assets or reinvesting their savings. This should allow for the opposite of the poverty cycle, or rather a compounding cycle of capital accumulation and prosperity for ecosystem participants.

In a virtual context, not only does the game do well, but the players do too.

Further, a reduction in riskiness unsurprisingly reduces the need for risk premiums like those mentioned prior, which means a project can focus on more sustainable methods of asset distribution (e.g. competition, contribution, etc.). This makes the project less susceptible to inflation risk in the future while simultaneously rewarding valuable participants instead of mercenaries.

The synergy of these factors can culminate in a more robust virtual economy, enhancing the value of domestic activities and potentially extending the influence of the currency beyond the game itself.

We’ve discussed why stability is important and its benefits, now let’s move onto how we can accomplish it. For the purpose of creating general economic stability in a developing country, it is critical to accumulate and preserve foreign currency reserves.

II. Methodology

Currency reserves

Currency Reserves are foreign currencies that a country holds in its central bank or other monetary authority. The size of a country’s foreign currency reserve is often used as an indicator of its economic stability and ability to withstand financial shocks.

Similarly, in a blockchain game, the safety of a currency and investing in a project is directly related to the depth of its liquidity pool and funds held in the treasury. For reasons I'll cover soon, foreign currency reserves for blockchain games will likely take the form of ETH. Other competitive assets such as USDC or DAI could fulfill this role, but without the benefits ETH provides.

So how does a game get currency reserves?

To start, a blockchain game has a huge benefit in comparison to a developing country: it’s a game. If participating in the game is perceived as valuable (monetary or experiential), then the game can bootstrap initial foreign currency reserves by selling citizenship. In the context of a blockchain ecosystem, the closest parallel to citizenship would be governance assets.

Using an example, with inspiration from Nouns DAO, let’s imagine a scenario where the initial sale of citizenship (governance assets) for a blockchain game directs 100% of the funds to the game’s decentralized treasury, which is governed by those same assets. We could reasonably view this as the game being fully backed by strong reserves from the start. This is a relatively safe way to bootstrap the economy as the risk of contributing is reduced for your player base. If the game should fail then players can collectively decide to liquidate the treasury and recoup a majority of their value.

Of course, it would be natural to wonder how the developer would obtain initial funding in this approach. The most direct method would be to submit a detailed proposal to the player base outlining development goals and deliverables. Developers would use a checkpointed fund distribution model. This model sets a lower voting threshold to disburse future payments for previously approved proposals, with major checkpoints on a yearly basis. This ensures that developers are held accountable, where their additional fund unlocks are predicated on tangible performance and deliverables.

Developers may also consider in their proposals to receive a portion of revenue from secondary sales of related assets, as well as fees generated from infrastructure and expansions they develop. This aligns the value that accrues to the developers with that of the ecosystem, where increased demand for project assets leaves players better off and generates more revenue for the responsible developer.

Suffice to say, in this approach players should always have the ability to remove or redirect these income streams if performance is lacking. Without credible accountability, it is easy to end up with no accountability, a common problem in the blockchain space.

Okay so we’ve secured the initial reserve, but how do we grow it?

Currency inflows

Continuing with the developing country metaphor, there are a number of ways that these reserves can flow into the government’s treasury. We will focus on four that can be applied to blockchain game ecosystems: exports, foreign direct investment, financial instruments, and investment interest & dividends. These concepts will be woven into the rest of the article and used as mental models to adjust the way we view blockchain game economies.

  • Exports — When domestic goods and services are sold abroad to foreign individuals or countries. In the context of a blockchain game ecosystem, “exports” should be considered any product which is sold for any currency other than the one that is native to the project. The initial mint, sales on secondary marketplaces, or additional assets sold for non-native currency can all be described as exports.

  • Foreign Direct Investment — When foreign individuals invest into a country, building infrastructure, or buying local companies. We will discuss this inflow later on in the Liquidity as infrastructure and Liquidity as a charter sections. Since native currency is paired with a foreign currency (e.g. ETH) when creating liquidity, it can be considered “foreign direct investment” when that liquidity is used as payment for an ecosystem service such as the construction of infrastructure or the creation of an in-game corporation.

  • Financial Instruments — When the central bank creates financial instruments specifically aimed at accumulating foreign currency reserves. Similar to the previous inflow, “financial instruments” would likely capitalize on liquidity investments. In the Treasury Bonds section, we will discuss a novel approach to accruing liquidity through the use of liquidity bonds which pay out native currency from reserves held in the game treasury.

  • Investment Interest & Dividends — If a country has investments abroad, it might earn interest or dividends, which can increase its foreign currency reserves. The most straightforward approach to “investment interest & dividends” would be ETH staking. We will cover an example of this in the Value entanglement section, observing how Nouns DAO leverages their ETH treasury to create inflows. This type of inflow could further extend to governance assets, liquidity positions, or treasury bonds of other project ecosystems.

We’ve covered how the initial mint could be utilized to bootstrap reserves and how that can inherently reduce ecosystem risk, but how can we use secondary sales to capture more value?

Technically a secondary sale does not create direct value inflow to the ecosystem, but it can increase the general wealth of individuals who continue to participate in the economy. As I explained previously, the more competitive an economy is, the more confident residents will feel reinvesting their hard earned savings (profits) back into that economy. This reinvestment should spur more capital recirculation on local in-game marketplaces or back into the native currency which can further increase the velocity of the economy. However, to be certain that some of this valuable economic activity is directly captured we can implement an export tax, or, in blockchain lingo, a royalty.

Royalties as an export tax

Royalties, often perceived as an inconsistent or replaceable source of income for blockchain ventures, are in reality a critical revenue stream that’s been largely misunderstood. What many fail to recognize is the potential for this revenue stream to offer consistent financial inflows irregardless of hype driven events. To date, only the projects backed by intense speculation have succeeded in harvesting large amounts of royalty income. Yet, more often than not, the accrued value from these royalties bypasses the ecosystem, flowing straight into the coffers of the centralized developers. This, in essence, mirrors another form of value leakage.

Leakage can be defined as the removal of capital from circulation in an economy. In the context of a blockchain game economy, the developer can be viewed as an entity that is extrinsic to the game. The value of the royalties leaks from the domestic (game) economy to their foreign (developer) account (for clarification on the terms “foreign” and “domestic” return to the Stability is key section). Even if the funds were to be repatriated through reinvestment by the developer at a later date, in the interim, those funds are unable to directly reflect value within the ecosystem.

For example:

  • Project A has 10 governance assets which control the game treasury. 3 ETH of royalties accrue to said treasury.

  • Project B has 10 “value accrual” assets. 3 ETH of royalties accrue to the developer’s wallet.

All else equal, in this scenario, which project’s assets have more intrinsic value?

It’s reasonable to conclude that the answer is Project A. Whatever your thoughts may be about the amount of value attributed from that 3 ETH, value is reflected from the treasury to the governance assets. This sort of intrinsic value based on treasury control is a topic we will discuss in-depth later on in the Value entanglement section.

Let’s think about Project B: how often do developer’s misuse funds they have accrued from their player base? I’m sure we all have our own personal horror stories from the blockchain space, but even traditional game companies have been known to invest in misguided side projects at the expense of their core game. Without some form of accountability, there’s no way to be certain that this value will return to the game.

While larger real-world economies possess the resilience to offset such leakages with alternative inflows, the relatively limited avenues for a blockchain economy magnify the impact of such diversions. When value consistently exits without being replenished or reinvested, a gradual decline in the monetary worth of a project can ensue. This affects a further lack of confidence in the ecosystem, leading to the devaluation of the currency and consequently related assets. An intriguing observation here is that currency devaluation in a developing country actually boosts demand for their exports (assets), leading to an inflow of foreign currency reserves. This contrast between real-world and blockchain economies stems from the general lack of inherent demand for blockchain project assets. With no perceivable lower bound value, there is no clear reason to purchase either the assets or the currency as their value trends ever downward.

Why engage with an economy where a single entity holds the power to perpetually siphon off its value? How can one trust such an entity to judiciously reinvest without any tangible oversight or accountability? Conversely, wouldn’t an ecosystem that automatically redirects this value flow back into its economy be more appealing?

Let's leave the royalty enforcement argument in the past where it belongs.
Let's leave the royalty enforcement argument in the past where it belongs.

My conviction is that royalties, framed as an export tax, are indispensable to a thriving blockchain economy. Such a tax directly captures and monetizes ecosystem demand, benefiting domestic residents and effectively accruing value from those who choose to speculate. Rerouting this value flow to a treasury, governed by the players, should increase confidence in the economy and aid in bolstering asset valuations.

Contrary to the popular thinking that royalty inflows peak only during a project’s hype phase, I predict that a well-structured, competitive blockchain economy, characterized by high velocity, can ensure sustained royalty inflows. To actualize this, it’s imperative to emulate the inherent export demand seen in conventional economies. Developing this sort of demand hinges on stabilizing the currency and establishing intrinsic value in the ecosystem.

We’ve seeded our treasury with the initial mint funds and took the first step in the process of accumulating reserves by applying export taxes to our asset collections, what’s next?

Stabilization practices

Most traditional games do little to nothing to stabilize their exchange rates. If anything, developers go out of their way to specifically forbid any currency outflows from their ecosystem, a.k.a. real money trading. So for the traditional game developer, any question of “price” in terms of "foreign" currencies is irrelevant. While there are gray markets available, they are not officially supported and most players tend not to partake.

The only example of a traditional game that does manage their exchange rate effectively is Second Life with their Linden dollar (L$). The Second Life developers have managed to keep the price relatively stable in a range around 240 L$ per USD for over 20 years now. They have turned their exchange rate management into a monetization method, using company funds (reserves) to buy back the currency when its price goes too low, and selling when the price goes too high. I recommend checking out this twitter thread from Kiefer Zang on Second Life and stabilization regimes in general.

Another stabilization strategy is the adoption of a semi-stable currency framework. Unlike directly pegged currencies that mirror the value of an asset like USD or Gold, semi-stable currencies offer a balanced approach. They permit some degree of market-driven fluctuation, fostering organic growth and adaptability. Simultaneously, they provide a stability cushion that instills confidence in their valuation among investors and users.

An effective method for managing these semi-stable currencies is through the enforcement of a currency band. This strategy involves setting a lower and upper limit within which the currency can freely fluctuate. When the value moves outside this band, automatic stabilization mechanisms are triggered (like the Second Life example) to keep it within the desired range. This technique, prevalent in traditional financial systems, could be implemented in a decentralized way with a liquidity pool based two-tiered Tobin tax.

The Tobin Tax and Exchange Rate Stability
The Tobin Tax and Exchange Rate Stability

Proposed by Paul Bernd Spahn, a German Professor of Finance and consultant to the IMF, the two-tiered Tobin tax would work effectively as a decentralized currency band. In the image above, the blue line is actual price movement, the solid black line is a crawling peg (sort of like an average price over time), and the area between the black dashed lines is the non-taxed price range. The grey shaded areas show where the tax begins taking effect, coaxing the price back into the desired range. This tax was proposed to support currency stability while staving off manipulation and speculation.

Previously, Spahn’s version of a Tobin tax faced some practical limitations. It was difficult to identify taxable transactions, adjust the tax rate, distribute tax revenues, and generally to enforce on a broad tax base. Thankfully, these can now all be enacted with minimal cost and in a trustless manner using smart contracts.

“Ideally, this should induce markets to behave more smoothly, in their own interests, and the tax would seldom need to be activated.”

—Paul Bernd Spahn, The Tobin Tax and Exchange Rate Stability

In theory, having the price maintained via a tax enforced stable range should lead to increased confidence. Traders in the ecosystem would potentially front-run sells at the upper bound and buys at the lower bound leading to further stability. Liquidity providers would be more willing to participate in such a design as it would likely reduce impermanent loss. The high taxes outside of the range could also protect from currency manipulators, or even monetize those who make the attempt.

In our blockchain version, we can base the range around a Time-Weighted Average Price (TWAP) or Median Price Oracle. This is to set a relatively stable frame of reference to anchor the non-taxed range around, similar to the crawling peg. This desired range would be adjustable as a percent change or volatility from the oracle price.

Outside of the desired range a volatility based dynamic tax would take effect (aka price change too fast, tax increase also fast). If the price moves above the upper range, a buy tax would be implemented to stem currency purchases. Similarly, if the price is below the lower range, a sell tax would be implemented. The tax increase would be adjusted to preference and could have a maximum scaling such as 20%, or even go to 100% if the aim was to stop further price movement in that direction allowing time for the opposing market force to come in.

So what to do with the tax? Here is four potential reward structures:

  • Burn the tax — Provides another currency sink and more decentralized value across the user base.

  • Reward liquidity providers — Creates an additional incentive for liquidity to be provided and further subsidizes any impermanent loss.

  • Deposit to protocol treasury — Currency in the treasury can be used for other reward programs or economic instruments such as treasury bonds.

  • Lean into traders — Design a reward system for those who aid in bringing the price back into the desired range.

While any individual or combination of the above structures should work well, the last option is my personal favorite. The idea would be to create a metagame for currency traders whose transactions act counter to whichever tax direction the system is in currently. Their transactions could be scored with a point system based on volatility reduction and rewards would be distributed periodically based on point weighting (your points/ total points) * (total rewards). This reward program is probably the most sure-fire way to compound the stabilization provided by the tax system. In effect, it acts as a player ran market maker — we could call these players “stability providers” as the fee reward structure is reminiscent of liquidity providers.

Thus far, we’ve acquired an initial reserve, enabled a velocity based reserve inflow to the treasury, and established a way for the currency to maintain a stable range. However, without deep liquidity, any transaction might slam the price into the upper or lower bound. This would cause the volatility based tax described above to trigger more often than might be desired. How can we further reduce price volatility so that this currency band mechanic can be more effective?

Liquidity bootstrapping

Here I will deviate from comparisons to the gaming ecosystems of the past, as there is no apparent parallel that we can look to.

Before diving into this topic, I would like to acknowledge Treasure DAO for pioneering the approach to gamifying liquidity. After reading through their novel conceptualization, I was inspired to think about liquidity provision in new ways. In their article, Founders’ Long-Term Vision for Treasure Project, they proposed framing liquidity as three different metaphors: Liquidity as Weather, Liquidity as Time, and Spatial Representations of Liquidity.

On Weather:

”Low liquidity is akin to extremely bad weather. Volatile, cruel, literally an existential threat to the protocol (or civilization).”

Presenting a lack of liquidity as an existential threat paints a visceral image of just how important it is to the survival of a project; something that all participants of an economy should band together in defeating — a sort of cooperative financial metagame.

These metaphors all share the underlying philosophies of incentivizing cooperative behaviors, establishing liquidity provision as a core aspect of economic design, and fabricating a world where liquidity is a force of nature.

We can expand on these metaphors, grounding each of these ideas around liquidity provision in the language of economic primitives rather than an immersive narrative. While the following may share similarities with current mechanics in some respects, I have defined them to fit within my own conceptualization of an open blockchain game economy. I present my own four frameworks: liquidity as a scarce resource, liquidity as a charter, liquidity as infrastructure, and liquidity driven by royalties.

Liquidity as a Scarce Resource

Treasure DAO developed the notion of a token as a natural resource with $MAGIC. However, their Balancer Crystals are a bit closer to actually implementing that idea. Framed as a power source, Balancer Crystals are an asset that can only be minted with liquidity pool tokens made of the MAGIC-ETH pair.

“Instead of using MAGIC as the ecosystem’s core token, the project could transition to using LP tokens as the power source. Ideally, the user wouldn’t even know that they’re using a LP token because it’s called a crystal or a chalice or some other item related to the metaverse.”

—Treasure DAO Documentation

These assets were the first example of liquidity abstraction, a novel idea which wrapped the liquidity token in the form of a game asset. By minting a Balancer Crystal a user would send their liquidity pool token to the DAO treasury and receive this asset in return which could be used for various utilities within the ecosystem. This idea was a move in the right direction in terms of how to accumulate Protocol Owned Liquidity: the holding of the ecosystems native token liquidity within its own treasury. However, that design faltered in one aspect: its lack of scarcity. Balancer Crystals can be minted at will and have an unlimited supply.

This lack of scarcity means that players will almost always be the one to create the asset, and therefore they will know that it is LP token based. If anyone can go make one at cost at the point of demand, then it is unlikely there will be secondary market purchasers. The only scenario where there is secondary market demand is when the seller is at a loss, or the buyer is acquiring a discount to the mint cost. Consequently, we can see that there has been a decline in the desire to mint the asset here, which can be attributed to a general absence of sinks and positive expected value from generating the asset.

But what if Balancer Crystals were scarce and limited to batched releases? Further, what if we made them integral to the structure of the game? We might see each new allotment minted out quickly, consistently and predictably injecting liquidity. Demand would be higher on secondary marketplaces and they could even trade at a premium to their underlying cost. The treasury would receive tax inflows based on this trade volume, which would establish a stronger incentive to invent new use cases for this scarce resource.

An interesting mechanism for modulating the supply of scarce liquidity-based resources could be allowing the token liquidity in ETH to determine new supply. As liquidity increases, the new supply offered would decrease on a decaying curve. This would incentivize minting the asset in the beginning stages of the liquidity pool, accelerating the exit from the bootstrap phase. Automatically reducing the offering of new assets in this way lends some confidence that there will be a premium for them in the future. Conversely, if the liquidity level decreases, there will be a discount to the previous batch of minters which is also an incentive. If we wanted to enhance this effect, we could increase the cost to mint this scarce asset in LP tokens as the liquidity level grows.

For the following examples and implementations, let’s refer to these scarce liquidity-based resources as “Aether Cores”.

Figures and chart are purely demonstrative.
Figures and chart are purely demonstrative.

Let’s say that once a week a batch of Aether Cores will become available to be minted. The quantity available is determined by the existing ETH amount in the liquidity pool. The price to mint an Aether Core (in LP tokens) increases linearly when the number of Aether Cores in a batch is reduced. To illustrate, consider that each LP token is initially backed by 0.1 ETH. It's important to note that each LP token is made up of equal portions of ETH and the native token; in a live environment this ratio adjusts dynamically based on trading, but for our example it will remain static unless stated otherwise.

Illustrating Aether Core Supply Dynamics

Figures are roughly demonstrative of the previous chart.
Figures are roughly demonstrative of the previous chart.

To understand the interplay between liquidity and the release of Aether Cores, let’s walk through a hypothetical scenario spanning five weeks.

Week 1: At inception, the ecosystem has no liquidity. To remedy this, 1,000 Aether Cores are released. Enthusiastic participants mint all of them at the rate of 1 LP token per Aether Core. This influx translates to 100 ETH being added to the liquidity pool, given each LP token embodies 0.1 ETH.

Week 2: In response to the initial liquidity addition, the available Aether Cores for this week drop to 900. Yet, a mood of hesitation sweeps the market; no Aether Cores are minted. Some players, perhaps skeptical about the future value of the token, decide to liquidate, leading to a sell-off and a reduction of 30 ETH from the liquidity pool. This results in each LP token representing a reduced 0.07 ETH.

Week 3: The liquidity pool's shrinkage triggers a compensatory mechanism: the supply of Aether Cores increases slightly to 925. Spotting an advantage in the diminished price of LP tokens (now at 0.07 ETH per LP token), a consortium of players decides to capitalize on it. They mint the entire batch, pushing the liquidity pool to approximately 140 ETH.

Week 4: The renewed player confidence and increased liquidity from the previous week sees a contraction in Aether Core supply to 850. As the ecosystem matures, the utility of the Aether Core asset expands, leading to the minting of all available units. Concurrently, the token's increasingly stable value attracts liquidity providers.

Week 5: Starting off with a robust 400 ETH in total liquidity (amassed from prior Aether Core mints and fresh LP contributions), the system automatically curtails the Aether Core issuance to 750. This scarcity, paired with heightened utility within the ecosystem, positions Aether Cores as an enticing asset.

In this design, a virtuous cycle of liquidity accumulation emerges. A dwindling new supply of Aether Cores would see faster minting of each batch, augmenting total token liquidity. This burgeoning liquidity enhances price stability, mitigating potential impermanent loss, thereby enticing players to contribute liquidity to earn fees. More liquidity translates to scarcer Aether Core supplies, so on and so forth.

This design ensures that there's never an Aether Core surplus. If demand weakens, fewer Aether Cores are minted in new offerings, reducing supply until strong demand returns. However, this whole approach hinges on Aether Cores being in demand in the first place.

With a game currency crafted to enable trade over utility, the focus would be towards Aether Core centered utility. This approach kickstarts the asset's early-stage demand, powering our liquidity accumulation engine. The subsequent sections delve into potential implementations for such an asset, contextualized within a hypothetical version of the game, The Citadel.

Liquidity as a charter

A charter can be described as a written grant by a country’s sovereign power, by which a body such as a company or city is founded and its rights defined. A charter can give the purchaser the right to establish a business endeavor or a new municipality, however, this framework could have much broader applications in a blockchain ecosystem.

Aether Cores, used for this utility, represent one of the currency inflows I described earlier: foreign direct investment. As we have defined foreign to mean any value from outside the ecosystem flowing into it, technically any liquidity position supplied for a return of ecosystem utility would serve this purpose. This is superior to denominating the cost in the native currency because we can transform what would be a one time fee into demand for an asset that helps stabilize the ecosystem. Further, any liquidity position which is exchanged for the Aether Core asset is contributed to the game treasury, increasing foreign currency reserves. Rather than trying to “sink” currency we should focus on ways to stabilize its value.

In The Citadel, each type of charter could be purchased for a certain amount of Aether Cores, this utility would build in a primary source of reoccurring demand for the asset. The Aether Core cost (think liquidity) adds the right kind of skin in the game that should be necessary for any enterprise which operates at scale within an economy. On this line of thinking, any utilities like a charter should require the ownership of the game’s native governance asset in order to participate, as this further increases their stake in the game’s well being.

A corporate charter could be purchased from the game’s governing body for a cost in Aether Cores. Once a player has acquired the charter, they would be able to start a company and issue shares as they wish. I won’t dive deep into the mechanics of such a construct here, as that would be better served with it’s own article, but in this system they could act as a way for players to fund ventures or pool assets within the game world.

Interesting to note, the scarcity and increasing cost of Aether Cores would provide an incentive to takeover defunct corporations, adding a source of intrinsic value. For example, if a corporate charter costs 10 Aether Cores, the market capitalization will likely have some lower bound value in reference to this cost. This is not too dissimilar from the way that defunct corporations in the real world are acquired to avoid the hassle of going through the registration process and other costs associated.

This framework positions the financial sector as an inherent pillar of stability for the game. The larger the player base gets, the more corporations are created, and the deeper the liquidity becomes.

A city charter could be purchased similarly, but at a much higher cost. This kind of charter would be best served by a reputation gate of some kind. In The Citadel, we could call it a station or an outpost charter. A player could travel to a coordinate on the map and deploy their outpost charter, beginning a cooperative process of building out the outpost.

An outpost would likely require a certain amount of resources to be constructed and in addition, a number of Aether Cores. Ownership of the outpost would be distributed pro-rata based on Aether Core contributions. If a corporation wanted to take sole control over an outpost they could do so by having the requisite materials ready at the start of construction. The outpost governance would have the power to elect representatives, set taxes on local marketplaces, and have its own treasury.

As more outposts are created, there will be more local markets, allowing for an increased amount of arbitrage opportunities. This allows for the velocity of economic activity to develop in the game, as well as viable play patterns. Further, these outposts should have to pay a tax to The Citadel in order to maintain their charter status, this should discourage wanton placement and incentivize players to deploy competitive outposts which fill a market demand.

Liquidity as infrastructure

Infrastructure refers to essential systems that serve a country, city, or area, which generally include the services and facilities necessary for its economy to function. This includes things such as public services and facilities necessary for the economy to operate, including physical structures like roads, bridges, railways, and airports, which I'll refer to as hard infrastructure. Soft infrastructure, on the other hand, can include institutions like the police force or emergency services.

Continuing to use the game The Citadel as an example, the player government could propose the implementation of infrastructure in heavily trafficked areas or for long-range travel across the game's universe, similar to the Warp Gates in Cowboy Bebop. However, before players can use and interact with these infrastructure points, they would need to be activated with Aether Cores. In this model, liquidity plays a crucial role in constructing these decentralized systems, as players collaborate to build them.

These hard structures would not be locally owned like the charter implementations, but would levy a fee paid to The Citadel player government for their use. They would function as public goods, addressing a problem discussed in Treasure's article on decentralized governance.

“How does one balance the need for a quadratic design (so that whales can’t own all of the new world) while preventing people from free riding and only contributing the minimal amount necessary to join other settlers? We solved this issue in the initial farm through centralization — specifically, being very opaque about the criteria — but this solution would not be possible in decentralized governance.”

For an example of soft infrastructure, let's reference EVE Online's CONCORD system, which serves as an automated police force protecting beginner player areas and critical high-security space star systems such as the main trade hubs. To achieve a similar effect and simultaneously encourage deep liquidity, we could envision a comparable scenario in The Citadel. In this system, areas of space (e.g. new player zones) are also safeguarded by security enforcement, except the security itself is enabled by Aether Cores, which experiences a form of entropy necessitating replenishment. Players would be incentivized to contribute to a public starting area security system, as these zones are likely to become trade hubs (you wouldn't go to the grocery store if it wasn't safe to do so). Expanding this further, as players venture out beyond these starting areas, areas of space could require exponentially more of the liquidity assets to enable security enforcement.

These are just a few ideas, but as we know, infrastructure exists in both the real and virtual worlds we inhabit and as a game world expands, much like the real world, opportunities for new infrastructure applications will increase accordingly. The potential applications in a blockchain game ecosystem for gamifying liquidity are limitless, so when designing new systems for your game, it's important to consider how this type of asset could be integrated.

Liquidity driven by royalties

Here we will digress from providing implementations for the Aether Core asset.

Liquidity driven by royalties is about directing the economic activity of trade volume denominated in ETH directly into stabilizing the ecosystem currency. We discussed the importance of Royalties as an export tax and this flow can also be utilized as an automatic liquidity provider. I call this idea “The Forge”.

The Forge is nothing special, it’s a smart contract with one function: to mint liquidity tokens. As new asset collections are added to the project ecosystem, a minority royalty flow can be directed to this contract from each of them. When the contract has accumulated a set threshold amount of ETH, it can be triggered to purchase half that amount in the game’s native currency from a liquidity pool. It then pairs the native currency with the remaining ETH, minting liquidity pool tokens that are transferred to the treasury. This further establishes Protocol Owned Liquidity. The interaction can be triggered by anyone; this might be best served by an offchain service, but it could also be fulfilled by a user based incentive program.

Example diagram of token flows and interactions in The Forge contract.
Example diagram of token flows and interactions in The Forge contract.

With this design, you can technically direct ETH flows from anywhere. It acts as an automated modular LP token generator. When the demand for ecosystem assets increases on ETH based marketplaces or swaps, it fills up faster and allows for more liquidity tokens to be created. Leveraging royalties as a stabilizer creates the potential for interesting value feedback loops. For example, the higher the asset trade volume, the more liquidity is minted, which creates more currency stability. More currency stability, should lead to higher asset demand, so on and so forth.

Liquidity via proposal

When suffering from a cold-start, the liquidity pool can be bootstrapped with funds from the treasury. A proposal for an initial liquidity seed can spur further confidence from current and potential players, as they see that the protocol is willing to back its native currency.

This is similar to the way that a government in a developing country would directly stabilize their currency with reserves. In a game governed by the players, they can make a proposal for either broad range or concentrated liquidity.

Broad range liquidity refers to liquidity that is available across all price ranges, and is denominated in fungible ERC-20 tokens. This is the type of liquidity referenced in the creation of Aether Cores, or in The Forge idea.

Concentrated liquidity is the provision of liquidity over a defined range, and takes the form of a non-fungible ERC-721 token. This type of liquidity would pair well with the two-tiered Tobin tax proposed earlier as it tends to maintain a relatively stable range. A further improvement on this would be the use of something like Gamma Vaults which are automated concentrated liquidity managers. They actively adjust the position given a specified strategy. In our design, we could create a strategy that matches our defined range from the two-tiered Tobin tax, therefore making the position always in range.

If all this liquidity talk is over your head, Gamma actually has a great history of liquidity types that you can read here.

In combination with the Aether Core supply structure we discussed earlier, providing a large amount of liquidity via a proposal would create a supply shock of sorts in the asset. Since proposals can take up to a week or more, this may cause an arbitrage opportunity, where players front run the liquidity provision from the treasury in expectation of a reduction in new Aether Core supply. This front running would increase the amount of liquidity quickly, further reducing the new supply of the asset.

Liquidity or stability, which comes first?

Is it a chicken and egg problem? I would say no: assets with more stable value in the real world tend to have higher liquidity by default. Does cash need an incentive to remain liquid? No, it only needs to have the confidence that others will accept it in exchange and that the government will accept it for payment of taxes.

As I have stated previously, the issue with tokens is that they tend to be highly volatile, further, they are lacking in any sort of intrinsic value. Without one or both, it’s unlikely that a token can expect to garner liquidity in a meaningful way. Centralized projects which distribute a majority token share to the issuers are destined to see said token diminish in value as users expect them to sell overtime. Decentralized DeFi protocols which lean heavily on a singular mechanic as their modus operandi are expected to face a similar fate, prioritizing distribution of inflationary token rewards in exchange for mercenary liquidity that flees at the slightest sign of weakness in the token value. Both hope that demand can somehow outstrip the consistent selling that is incentivized in these approaches, but in practice we have seen that this never comes to fruition. No one likes to be exit liquidity.

Rather than trying to bootstrap stability through incentivizing liquidity, I argue that liquidity is drawn to stability. Further, I predict that the first relatively stable ecosystems will be so powerful in their draw of liquidity that the primitive protocols of the past, lacking any intrinsic value, will be left barren. This is not too dissimilar from the wealth accumulating effects of Industrially Advanced Countries in comparison to Less-Developed Countries as we mentioned previously in the Stability is key section; the draw to safely invest savings in lower-risk, prosperous economies leads to capital flight.

This stability first approach has led us to the development of strategies such as the decentralized two-tiered Tobin tax. Another strategy for increasing stability we’ll talk about is asset correlation. Positively correlated assets have been shown to reduce impermanent loss, this can be observed in some of the largest liquidity pools such as stablecoins, which base their value around a stable dollar denomination. For example, USDC and Tether both trade within a tight range around the value of a United States dollar, this increases the incentive to provide liquidity as potential loss from price volatility between the two assets is mitigated (barring extenuating circumstances e.g. bank failures, insolvency) which is further incentivized by the demand for these stable mediums of exchange and the ensuing trade volume (this generates liquidity reward fees). If we can model such asset correlation, we can likely receive similar liquidity provision demand for a currency.

This begs the question, what do we correlate to? Additionally, how do we design for intrinsic value?

III. Implementation

Virtual worlds need an anchor

Most small countries choose to stabilize their currency against the largest and safest currency in the world, otherwise known as the “anchor currency”. In the real world that is the United States Dollar. In our world, that would be ETH.

“In other words, we argue the US dollar may be the anchor of the world monetary system because smaller countries are optimally trying to attract international investment by reducing the risk associated with their currencies.”

—Tarek A. Hassan, A Risk-based Theory of Exchange Rate Stabilization

Blockchain projects are even more dependent on foreign investment than most developing countries, as they tend to lack resources and industry that are inherently valuable. In order to be competitive in attracting foreign investment they should anchor their currency. I propose The Ethereum Standard™.

The Ethereum Standard refers to anchoring the value of an ecosystem in ETH holdings, with its currency maintaining a relatively stable value in terms of ETH.

ETH possesses exceptional qualities as an ideal reserve commodity. It was designed with characteristics similar to gold such as credible neutrality, scarcity, and utility. Gas fees operate comparably to the taxation system of fiat currencies that drive intrinsic demand. The staking function enables it to mimic a treasury bond while approaching a Risk-Free Rate of Return. Finally, ETH’s burn mechanism mirrors the equitable value distribution achieved through stock buybacks in traditional firms. Who wouldn’t want to hold this asset in their treasury?

Some may argue that “ETH is not stable.” But what they’re really saying is that ETH is not stable against USD, which ignores the extent to which ETH is quite stable against the most important crypto native assets and protocols. What are NFT floors priced in? What backs a majority of liquidity pools? 1 ETH = 1 ETH. Others might suggest USDC or another peripheral dollar based currency as an anchor, but these introduce unnecessary counterparty risk by using a centralized intermediary. And while a dollar coin is stable — that’s all it is, in an onchain treasury it is effectively dead money.

If the currency can be considered as good as ETH, then that removes the immediate desire to convert it into one of the most competitive assets on the blockchain. I predict that most successful blockchain game ecosystems will have a relatively stable ETH-backed currency within a few years.

The accumulation of ETH reserves amongst high velocity blockchain game economies could lead to an accelerating scarcity of the asset. As more ETH is captured into treasuries and staked for interest, the value of ETH itself should grow and become more stable. This could lead to positive sum value accrual amongst these projects, likely at the expense of projects that don’t implement a similar risk reduction strategy for their currency. Those that attempt risk reduction through utilizing dollar based stablecoins are at increased risk of being uncompetitive due to the appreciation of ETH aligned ecosystems.

So far, I have proposed direct stabilizations and the holding of ETH as the reserve standard, these both serve as the basis for accomplishing the goal of asset correlation. When a project is designed in this manner, we can observe a form of intrinsic value that occurs.

This intrinsic value can be likened to asset valuation in the traditional space. For the expanded connections between assets in a blockchain ecosystem I propose a new term: Value entanglement.

Value entanglement

There seems to be a strange phenomenon when it comes to blockchain ecosystems where projects tend to ignore traditional corporate valuations. In corporate valuations, shares derive underlying or intrinsic value from statistics such as asset valuation, cash flow projections, and goodwill accounting. A governance asset can be likened to the share of a company, and similarly it can garner intrinsic value from assets held in the treasury, predictable revenue inflows, and intangibles like ecosystem provenance. What would it look like if we didn’t ignore this powerful source of value? What if we instead designed for it and cultivated it?

In this section I will make the case for framing your entire economy around this sort of intrinsic value. I propose the term value entanglement because blockchain ecosystems are more expansive than corporations. As I’ve said previously, they are more like developing countries. This simple fact can be observed in the ability for blockchain projects to issue currency, whereas corporations are only currency users. Additionally, they have a liquidity pool for the currency, a native population of players, and a variety of assets that will trade on in-game marketplaces. All of the assets within an ecosystem will benefit from implementing this type of robust valuation framework as the foundation.

Value entanglement refers to the interconnected value between the different components of a trustless ecosystem. The value of two assets are entangled if the value of one asset is influenced by the value of another without frictionless convertibility between them.

Value Entanglement can be considered a form of positive asset correlation. As the value of one asset increases or decreases, the other does so in tandem.

Let’s start with an example derived from asset valuation to give this concept some tangible context. Bear with my usage of “entangled” here, as we will adapt this to serve the blockchain-based example later on.

A company’s stock could be considered entangled with the value of the company’s assets. The stock doesn't have direct fungibility with the company's assets, but its value is influenced by the value of the underlying assets.

Company A has no debt, $5m in assets and cash on hand, and 5m shares outstanding. Company A will likely have a price in a relative range of $1, exceeding this depending on cash flow, market, etc. If Company A were to be liquidated today each shareholder would receive $1, less legal fees and such.

Another example might be the way real estate derives value from the neighborhood it resides within. If a neighborhood becomes trendy or undergoes revitalization, individual property values would increase in tandem, even if nothing about the individual properties has changed. In a sense, these individual properties can have an intrinsic value that is entangled with its neighborhood. This example serves as an interesting parallel for the goodwill method of accounting, and can be integrated in our approach to value entanglement.

A frame of reference for this value might be the average home value of the entire city. If City Z has an average home value of $1m, but Neighborhood X has an average home value of $1.5m. We can see that the people, businesses, location, and other amenities have increased the average value by $500k. In contrast, if Neighborhood W has an average home value of $600k, then those same factors have contributed to a decrease in home price.

In the context of a blockchain based virtual economy, an analog to the company example would be the relationship between a protocol's governance asset and the treasury it governs. In this case, the "value entanglement" can be understood as the correlation between the value of the governance asset and the value of the underlying assets in the treasury.

The governance asset of a protocol, in this case, doesn’t have direct fungibility with the assets in the treasury. You cannot directly exchange the asset for its percentage of the value contained therein (barring a rage quit function), however, there is a perception of linked value similar to the company example. In a scenario where a majority of governance holders vote to liquidate the treasury, all participants would receive their equitable share. We discussed this elective liquidation as a way to reduce risk for your player base earlier in the Currency reserve section and I contend that this possibility imparts intrinsic value on the governance assets.

Observing our previous real world examples, we can come to some conclusions:

The positive performance of a company, its product, and dividends could drive an increase in share price above that of its entangled value. Conversely, if the company’s performance drove losses, products were ill-received, or showed an overall incompetence, then the value might be at a discount. This concept is called cash-flow based valuation in traditional markets, however, the validity of this type of analysis seems to have been ignored in the blockchain project example we will discuss momentarily. Such a clearly understood valuation principle should not be discarded simply because “blockchain”; instead it should be integrated as part of our overarching theory of value entanglement.

Using the other example, if a new home were to suddenly pop into existence in an up and coming neighborhood, that new home’s value would be consistent with those that are nearby. This is like saying that the value is not dependent on the individual quality of the home, but more so the actual land, the community and the utility of its proximity. The minor variations in price are due to the home itself, and the difference in the acreage of the land. Of course this scenario is an impossibility in physical reality, but in the virtual space, the potential for spontaneous land creation is high.

In both cases, we might say that a blockchain based project’s governance asset would behave similarly, and this is in fact what we see in practice.

Nouns is an NFT project and Decentralized Autonomous Organization (DAO) which auctions off one generated governance asset (a new Noun NFT) every day in perpetuity. Every tenth Noun is distributed to the project’s founders. This protocol can run persistently with the only human input being that someone needs to trigger the settlement of the winning bid for the next auction to begin. Noun holders can govern the protocol and make proposals on how to use the accumulated funds.

At the time of writing (pre-fork), there are currently just over 800 Nouns and the treasury contains more than 28,000 ETH. The “reserve-backed” value for each Noun should be approximately 36 ETH. Interestingly, we see that the new Nouns are being sold for 30-32 ETH per day or roughly an 11-17% discount. In the context of a company, we could say that the DAO is perceived as underperforming in revenue generation or effectiveness of monetary outflows.

Additionally, we can compare the Nouns auction to our magical neighborhood that spontaneously generates new homes. Each new Noun receives a bid that is consistent with the previous bid and is related to the individual percentage ownership of the treasury. The variation in price which is generally 1-2 ETH, can be chalked up to the differences in traits and the visualization of the Noun which is analogous to the minor difference in the price of homes which are in the same community.

To clarify, I know that the Nouns mission is not to make profit, but rather to “proliferate the meme”. I only make use of the Nouns example to explore this theory of value entanglement.

I have made the case that a majority of the Nouns bid value is based on the intrinsic value derived from treasury holdings and the environment of the protocol. So why the large decrease in bid value from the end of 2021 to now? Well, a lot of ETH has been spent, to the tune of ~22,535.

As ETH is spent, this reduces the future revenue generation potential of each individual daily auction, that is until the perceived performance of the DAO is positive, allowing auction revenues to exceed their reserve-backed value. We can see that the discount mentioned previously is likely due to a perceived negative future cash flow.

They are taking advantage of the interest bearing benefits of Ethereum, mobilizing their reserve they have staked ~24,995 ETH, which theoretically at a 4% APR could generate around 1,000 ETH per year. While it is a great example of the foreign currency inflow, investment interest & dividends, this covers less than 2 months of approved proposals at current rates of expenditure. A more concentrated and sustainable budget could increase confidence in the DAO, and thus increase auction bid amounts.

Lastly, they have not taken advantage of royalty revenue generation which in this type of ecosystem is more like an export tax. This is a missed opportunity and presents itself as value leakage in the context of a DAO based project where that revenue would directly benefit holders rather than speculators. At a reasonable 5%, the trading volume of nearly 18,000 ETH would have contributed an additional 900 ETH to the treasury. Further, this could serve to increase confidence in the project and lead to more net inflows over time from the auction.

The connection of the treasury value to a Noun is an example of value entanglement. In this case, value entanglement allows the Nouns protocol to leverage the value of the treasury without having to spend it. Nouns uses this leverage to auction off a new asset and accumulate more ETH to the treasury at the cost of governance power dilution to current holders. The ability to create derivative value from assets held in a treasury (that are earning a yield) is groundbreaking in terms of its application to blockchain projects. Further, the market demand for such an auction in a positive future cash flow scenario would likely be very high.

The point is not that this is some esoteric or new fangled concept that never existed before. To the contrary, the point is to illustrate how something as simple as traditional asset valuation frameworks can be used to create intrinsic value in blockchain-based economies and extend that value in new ways. If you’ve reached this point, maybe you have recognized I broadly reinvented the wheel in this section. This is the case with most “tokenomics” mechanics, the difference is that I have shown how this circular wheel also works on a newer, more technologically advanced vehicle. Whereas many tokenomics ideas tend to be the process of figuring out why square wheels don’t seem to work (at the users expense).

But what does any of this have to do with currency stability? We can use this type of asset auction design to correlate the intrinsic ETH value of the treasury to the protocol currency through a process I call the “auction-based exchange rate”.

Auction-based exchange rate

Why does USDC stay in a tight range of $1 in liquidity pools? Because of the arbitrage potential with Circle (USDC issuer) or exchanges that redeem it at $1 on demand. Ah-hah! So it is the arbitrage to redemption and the intrinsic value that allows USDC to maintain the range. Without the arbitrageur, USDC would not stay in the $1 range. Yet traders are incentivized to do so because the trade is positive expected value.

We will rely on similar themes with this model. We’ve established that the intrinsic value of the ecosystem is the ETH held in the treasury, which is connected to the governance asset through value entanglement. Therefore, if we set up a redemption mechanic for the currency to the governance asset, the currency should receive a correlated value to the ETH held in the treasury. This part is important, as I mentioned in the Liquidity or stability, which comes first section, asset correlation reduces the risk of impermanent loss, which incentivizes liquidity provision for the pair.

Let’s try to state this as simply as possible. The currency price floats based on conversion to the governance asset whose value is derived from the treasury. In this design, if ETH goes up the currency value should too.

But when I say conversion what do I mean? We can’t expect to redeem 1:1 as Circle does, or even 1:1000, as direct pegs limit the ability to adjust monetary policy and also introduce the risk of bank runs. We saw this with USDC, when a single bank Circle used to hold a minority portion of its reserves went out of business. The stablecoin ran down to $.85 on the dollar before stabilizing again. This becomes a bigger issue when all reserves are held publicly onchain and thus a bad actor can clearly see that you are insolvent. We don’t want no mango man here.

So, by saying float and conversion what exactly am I getting at? An auction-based exchange rate.

An “auction-based exchange rate” refers to a currency exchange rate determined through a market-driven process, where the value of the currency is set based on competitive bidding. In this mechanism, buyers and sellers participate in an auction to agree on the price of the currency relative to another asset.

This concept is reminiscent of the semi-stable currency explanation from the Stabilization practices section. We want a currency that maintains a relative value to another valuable asset, in this case our governance asset which functions as the ecosystem store of value and value accrual asset.

At each auction the slack is taken out of the elastic currency supply, making sure that the supply left is the exact amount needed to facilitate trade in the economy and nothing more. If less of the currency is demanded in other parts of the ecosystem, more can be spent at auction. Conversely, if there is more currency demand in the economy, less will be spent at the auction.

But how can we ensure that demand for the auction is high enough to pull the slack out?

At the end of the Value entanglement section, we discussed the way in which Nouns DAO leverages the value of the treasury to create demand for new Nouns assets. We also discussed how players should contribute the initial reserve in the opening project mint in the Currency reserves section. This initial reserve can be leveraged to create demand for the currency through the auction.

Looking again at the Nouns example, we can see that there is approximately 210 ETH demand per week (30 ETH × 7 assets), which flows directly into their treasury. Let us say that our governance asset has a 1 ETH entangled value. If we target releasing 200 assets per week that would require about 200 ETH of demand. Since the only way to acquire these assets is through our auction, all demand is driven towards our currency. This would materialize as buy side orders at the liquidity pool, but also as a willingness to hold the currency earned in game. I will explain where this demand arises, but first let’s talk about the auction design.

Thus far, I like the general idea of the Nouns auction, but it isn’t as competitive as it could be. This is because all bid and outcome information is publicly available, which could also explain why VRGDAs haven’t been as successful as expected. For the auction-based exchange rate I propose a sealed bid uniform auction.

  • Sealed bid — Information asymmetry between auction participants using zero-knowledge proofs. As an additional layer of obfuscation, the auction should require that currency be deposited into the auction before it can be used to bid.

  • Uniform auction — An auction where there are multiple assets of the same type offered and all winning bids pay the clearing price. The clearing price is the lowest winning bid.

Sealed bid, because we don’t want users knowing what the current high bid is. In this system they can only see the amount deposited by each participant at the auction. This creates a sort of bluffing game that can lead to more competition.

Uniform auction, because we want the auction to be relatively fair for all participants. How do we stop whales from overbidding and taking over the entire auction? While it’s technically prohibitive price-wise and in terms of opportunity cost, we can also implement a bid tax to incentivize a sort of deposit game. The taxes from bids go to a reward pool, these rewards are paid back out to depositors based on deposit size. This should disincentivize gratuitous bidding.

Okay, so we’ve ensured that the auction is competitive, but what about demand?

There are two main reasons I expect strong auction participation: arbitrage and game access.

  • Arbitrage — The simultaneous purchase and sale of the same or similar asset in different markets in order to profit from differences in the asset’s listed price.

  • Game access — The ability to play the game, participate in governance, and earn the ecosystem’s native currency.

With arbitrage we can go back to the USDC example. If there is potential positive expected value from an activity then someone will exploit it. A game governance asset might have variable material stats that increase the utility of the asset within the game. This material difference would carry a premium to the asset floor on secondary markets. I refer to this phenomenon as a “random attribute premium”. An arbitrage opportunity arises here, where the native currency bid at auction on a game governance asset creates a potential for profit when that asset is sold for ETH on a secondary market place.

For example, imagine if an unrevealed Bored Ape was auctioned off in Ape coin. The floor of BAYC is currently 30 ETH (at the time of writing), the price of ETH is ~$1,800 and the price of Ape coin is ~$1.80. The bid based on these values, ceteris paribus (all else unchanged), would be around 30,000 Ape coin. However, we do have to take into account the premium for rarity, a rare BAYC might sell at 50 - 100 ETH or more, this means the currency bid value could exceed the ETH floor value on secondary markets.

In a rational sense, anyone can see that there is potential to arbitrage the value of the Bored Ape. If the bid value in native currency is equal to or less than the secondary market place floor price in ETH, then it is a clear arbitrage opportunity. However, whether they bid and win it for less than 30k Ape coin or pay a premium, the potential return is likely worth it. This arbitrage opportunity would drive competitive auction bidding.

Additionally, if access to the game is gated by the governance asset and participating in the game is positive expected value for players, then it is reasonable to expect greater demand for the governance asset. Since the asset cannot be listed while in play and there is a limited initial supply, listings on secondary will also be limited, which should drive the demand to the new asset auctions and therefore to the currency.

Interestingly, this can simulate the export demand mentioned in the Royalties as an export tax section. Where a developing country experiences increased demand for exported goods when the currency is devalued. Because the main ecosystem good (governance asset) is intrinsically demanded, the currency required to procure it is also demanded.

Theoretically, the game treasury could sell native currency reserves into the liquidity pool, prior to an auction, leading to a devaluation in the currency price. This presents itself as an opportunity for players to accumulate currency for the auction at a discount, which could bring the price back to previous levels. In practice, this sale could be another route to foreign currency reserve inflow to the treasury.

Potential benefits of this model:

  • New auction supply acts as an economic lever, can be increased or decreased to remove more circulating currency supply.

  • Removes a percentage of circulating currency supply each week.

  • Incurs a dilutive cost to holders, reducing the odds of players holding governance assets for pure speculation. E.g. they must play to avoid dilution.

  • Creates a relative peg to the governance asset without direct stabilization input.

  • Supports sustainable game population growth. The game grows at a measured pace, rather than a frenetic hype driven bubble.

  • Reduces pressure on the liquidity pool by giving players another way to exit value from the ecosystem.

  • New governance assets are technically at a discount for current players because they already earn some currency in game. E.g. they wouldn’t need to purchase a full bid amount from the liquidity pool.

  • In combination with the two-tiered Tobin tax, this model could potentially distribute demand across the entire week, as a rush to purchase currency prior to the auction could spike the price into the upper tax zone. Therefore individuals will be incentivized to accumulate and hold currency during the week to be competitive at the auction. In traditional economics, this can be considered the idea of money demand, where a certain quantity of money is held for its potential future use other than the transient consumption use-cases observed in most blockchain ecosystems.

Overall, the implementation of an auction-based exchange rate could serve as a keystone in the economic design of a blockchain game ecosystem. The creation of inherent currency demand and the reduction of slack in the supply allows for all of the previous mechanics mentioned to function more efficiently. This design has broad applications and could become the go to method of ensuring a relatively stable currency value.

Auction proceeds could be utilized in a variety of ways:

  • Burned from circulation — Remove a majority percentage from circulation to stem inflation as needed.

  • Recirculated to faucets — At some point the proceeds, accumulated to the treasury, could be redistributed to the game reducing or removing the need for new currency issuance.

  • Reward contributors — Through proposals, players could be rewarded with the native currency for valuable contributions to the game.

  • Sold into the liquidity pool — The proposed idea (from the paragraph prior the benefits” bullet point list) of selling the native currency from the treasury could be viable in this model. This would see the treasury accumulate ETH from the liquidity pool and establish further backing for the governance assets.

  • Interest payment on bonds — Something we will discuss in the next section. This recurring native currency revenue can be used to pay out interest on bond issuance in a sustainable manner.

In the past, native currency reserves have tended to be difficult to mobilize effectively. Generally, they have been used as ecosystem rewards or to pay contributors as suggested above, but let’s discuss a more effective use-case.

Treasury bonds

Or how to utilize illiquid native currency reserves. Gary if you’re here blink twice.

The third pillar of foreign currency inflows for developing nations are financial instruments. While there’s been plenty of implementations of different types of bonds in DeFi, we have yet to see any that offer low risk potential in terms of ETH. The problem with blockchain project bonds is that they inherently have to compete with the rewards of ETH staking, which leads to risky models that can dilute the value of the token over time.

This is similar to the way that developing countries might have to offer higher interest on their bonds in comparison to something like a US treasury. When US rates go up, smaller nations must increase their rates to remain competitive. However, as their rates increase this introduces currency inflation risk in the form of increasing monetary supply and a potential for the devaluation of the principal of the bond — counteracting the increased yield rate.

In designing a better blockchain bond, there are three main priorities:

  • Produce competitive returns in comparison to ETH staking yield.

  • Ensure the principal of the native currency maintains its value in terms of ETH.

  • Bonds should aid in stabilizing the native currency.

Here I will present a potential tokenized treasury bond implementation that draws inspiration from inflation protected treasuries, liquidity bonds, and the idea of abstracted liquidity. Let’s call these Inflation Protected, Liquidity Abstraction Bonds or IP-LABs for short.

This method of issuing bonds allows the game to obtain liquidity for its native currency, by offering bonds paid for in liquidity pool tokens. The bonds mature in the native currency and have an annual percentage yield (coupon rate) that is determined through a Dutch auction process. In the auction, the coupon rate starts at a base value and increases at set intervals until it reaches the reserve rate or until the total number of bonds available is bid. All participants receive the last bid coupon rate, also known as a uniform auction. This allows the game to gauge market demand for the bonds and determine an appropriate coupon premium for the current bond offering. The principal amount of the bond is also protected against inflation by adjusting in value along with the ratio of native currency to ETH. This offers a low risk way to provide liquidity.

This bond, which is procured with liquidity pool tokens, will exchange that liquidity position for the equivalent value in a time locked redemption of the native currency. Inflation protected, liquidity abstraction bonds (IP-LABs) would be released through standardized auctions which could be initiated with a vote, via a treasury oriented working group, or set to recur on a certain timeframe. The auction is denominated in fungible liquidity pool tokens in the native currency + ETH pair. The value of the LP token position is converted into a native currency total, which is then considered the principal amount of the bond.

Both the number of bonds as well as the bond price would be set at the beginning of the auction and remain static. This auction would be based on the coupon rate rather than the price in LP tokens. Utilizing a Dutch auction, the coupon rate would start at a base value and increase by a percentage at timed intervals until it hits the reserve rate. The auction would end when the quantity of bonds was bid or when the reserve rate time interval was complete. Again, using a uniform auction mechanic, all bidders would receive the highest last bid coupon rate.

Example 1

The game issues an IP-LAB offering of 1,000 bonds at a price of 500 LP tokens per bond. The starting coupon rate is 6%, increasing by 2% every 30 minutes. In the first 30 minutes only 100 bonds are bid, the coupon rate increases to 8%. In the second period an additional 300 bonds are bid, but since there are still 600 left available, the coupon rate increases to 10%. In the third period, 200 more bonds are bid, bringing the total to 600. After the next increase up to 12%, a frenzy of bids comes in to snatch up the remaining 400 bonds. Since all bonds have been sold, the auction concludes. The 12% coupon rate is locked in for the offering and all bidders are issued bonds with that rate.

In this example, the game would be successful in releasing 1,000 bonds and gathering around 500,000 liquidity pool tokens at minimal cost to the game treasury. If each LP token were to cost around $1, this would be equivalent to $500,000 in new liquidity contributions for stabilizing the native currency.

Since the auction was fully subscribed, it was successful in gauging the appropriate risk premium for current bond demand at a 12% interest rate.

Example 2

Using the same figures from Table 1, the game issues an IP-LAB offering of 1,000 bonds at a price of 500 LP tokens per bond. The starting coupon rate is 6% again. The first five periods see no bids. As the sixth period begins we see sporadic bids come in for the 16% coupon rate totaling 100 bonds. The rate increases to 18% for the seventh period, and another 150 bonds are bid. In the final period, an additional 250 bonds are bid at a 20% rate which brings the total to 500. The auction expires with only 500 of the total 1,000 bonds bid. The 20% coupon rate is locked in for the offering and all bidders are issued bonds with that rate.

In this example, the coupon rate auction was unsuccessful in gauging the appropriate risk premium for bond demand as it was not 100% subscribed even at the reserve interest rate of 20%. However, all 500 bidders received the highest coupon rate possible for that release of bonds.

Utilizing the coupon rate as the demand metric will enable the game to release bonds in a healthy and measured way by allowing the market to decide the risk premium based on current conditions. Market demand is important in accurately gauging the health of an economic instrument such as a treasury bond. A similar method is used to auction US treasuries.

Inflation protection

Another important goal with the bond is that it should protect the principle from inflation. This means that if the value of the native currency (NC) reduces in terms of ETH the principal amount of the NC will adjust up to compensate for the price differential. If the value of the NC returns to its original ratio, the principal will adjust back down, however it will not reduce past the original ratio.

Example of the order of events during a quarterly period principal adjustment.
Example of the order of events during a quarterly period principal adjustment.

At quarterly intervals the price ratio will adjust the principal, then the interest rate is paid out based on the new bond principal.

The bonds will have a set lockup period (12-24 months), at the end of this term the principal amount in the native currency is adjusted at the final quarterly checkpoint and is able to be redeemed.

Let’s look at an example of an IP-LAB over a 24 month period.

Example 3

The game treasury issues the IP-LAB offering from Example 1, which was fully subscribed at an annual coupon rate of 12%, let’s say that this bond matures in 2 years. We’ll also take some liberty in saying that 500 LP tokens was roughly equivalent to 1,000 of the native currency as the base bond principal. The table below shows the changes to principal and the amount of interest paid based upon changes in “inflation”, which for our purposes is defined as the change in price relative to ETH.

In quarter 1, there was no inflation and the bond paid a total of 30 NC over that period. In the following quarter, inflation increased 15%. The principal of the IP-LAB increased by 15% as well to 1,150 NC and the 12% coupon is applied to the increased principal amount resulting in a payment of 34.5 NC for quarter 2. In quarter 3, there was similar inflation causing both the principal and interest payment to increase again. In quarters 4 and 5, there was deflation and the principal of the IP-LAB was reduced resulting in a lower interest payment. In quarter 6 and 7, inflation increased again increasing the principal and the interest payment. With a final quarter of deflation the 24 month term is complete and the bond holder is able to redeem the principal. At maturity, the bond holder would receive the inflation-adjusted principal amount of 1,304.03 in the native currency. Additionally, over the course of the bond term they yielded 298.73 NC in total interest.

Thoughts on this design:

  • Treasuries need to compete with ETH staking — These examples use a baseline 6% starting coupon to account for the opportunity cost of ETH yield. However, this could be more dynamic adjusting for a more precise base premium to current ETH yields.

  • Relatively low risk — Low in comparison to past bond implementations in the blockchain space, but there is still risk if for whatever reason the economy is unable to maintain the liquidity pool or a relatively stable currency value.

  • Designed for currencies which correlate strongly with ETH — If the native currency is not ETH correlated, divergence to the downside would make the bond redemptions unsustainable as the principal of the bonds balloon in size leading to a form of sovereign debt crisis. E.g. if the liquidity pool is too thin to accommodate the sale of massive redemptions, or the treasury does not hold enough native currency to facilitate them.

  • Reduces impermanent loss potential — It is unlikely that the native currency will increase in value in terms of ETH because its inflation rate will be higher, and the downside risk is mitigated through the inflation protection mechanic. There is one scenario where the native currency may experience outsized appreciation: when the governance asset they base their exchange rate on is valued much higher than the asset’s ETH-backed value. In such a scenario, it would be recommended to adjust the currency faucet and increase the inflation rate to bring the currency back into the desired price range.

  • High quality asset — Since the principal is likely to maintain its original value in terms of ETH and it offers a reasonable rate of return, this kind of treasury could potentially become an example of a low risk blockchain native asset.

  • Collateral as export demand — Being high quality could contribute to broad use outside the ecosystem as a collateral asset thus increasing demand. This would further guarantee low interest rates at auction and maximal liquidity provision for each offering. Demand on ETH-based marketplaces or swaps could provide an additional stream of income for the game treasury through an export tax (royalty).

  • Native ecosystem demand — With the existence of in-game corporations and cities, it is likely to see initial demand arising from these entities as a way to diversify their own holdings. This should further establish the financial sector of the game as a pillar of stability.

  • Potential for bond token utility — Another benefit of a token-based bond is that it could have utility in a blockchain ecosystem. However minimal the cost, future redemptions are still a form of debt. “Bond sinks” could be designed in order to reduce the amount of circulating bonds if the number outstanding grows too large. They could be part of a crafting recipe, used for access to an event, or required in the construction of a city. This reduces native currency redemptions and leads to net positive liquidity gains.

  • Auction game theory — The uniform reward in the auction should encourage cooperation among participants to wait for the highest coupon rate. However, since all participants can receive the last bid coupon rate and there is a limited supply of bonds, some participants may choose to defect early. As the number of defectors increases, the likelihood of the auction being fully subscribed also increases. The goal is maximal subscription at the lowest potential coupon rate.

  • Minimal cost to the game treasury — The game accumulates its own native currency through the economic activity in its ecosystem. As long as trade is encouraged and reasonable taxes are implemented, the treasury should be able to afford the payout of interest and principal redemptions.

As with everything proposed in this article, these tools work better when implemented in tandem. We seek to mimic the successes of more traditional real world economies. In order to accurately simulate such ecosystems, we need to think about how they work at a foundational level.

Taxes, innate costs, & entropy

Previously, we discussed how the currency of a blockchain game ecosystem becomes exposed to competition with the global financial system. Consider this: the currencies of developing countries have the added benefit of a captive audience. They have a population who needs to use their currency to buy food, water, gas, and pay taxes. Further, many items in the physical realm experience decay requiring spending in the form of upkeep, this contributes to additional currency demand and economic activity. Games don’t have the same kind of luxury by default — these elements must be designed.

Of course, we don’t need to worry about many other costs that a developing nation would experience such as a standing military, health care, or education; however, it’s useful to consider obligatory spending when creating an open economy. This drives an inherent demand for the native currency, causing individuals to hold a necessary level of savings in order to function in the society. I.e. they can’t just dump it all on Uniswap, if they do, they’ll soon become buyers when they need to “fill up the car”.

Taxes drive money

To start, I’d like to talk about a concept derived from Modern Monetary Theory:

The "taxes drive money" concept posits that the demand for a state-issued currency arises primarily because the state requires taxes to be paid in its own currency. This obligation ensures the currency's acceptance and value within the economy.

Wait, weren’t we just talking about reserve-backing with ETH? Now we only need taxes to bring demand to the money?

These two theories are not at odds with each other, as it might be argued in traditional economic discourse. In fact, this combination might be necessary for virtual worlds, which we’ve said need some type of anchor. This is mainly due to the ability for players to migrate at will, rather than being captive to their government’s discretion. If a player does not want to pay a “tax” in a game then they can easily move to a new world.

The taxes drive money approach is actually similar to the way that traditional games drive their own currencies; in a way, any in-game spend is a tax. The developers are taxing you in the game currency to use specific utilities, thereby removing currency from circulation. In a sense, the virtual currencies of past traditional games are not much different than real world fiat currencies, they are only backed by the acceptance of the developer for core utility and content. Some blockchain game currencies add an additional layer in the form of scarcity through a hard coded maximum supply, but the overall design is comparable. The major difference between a virtual currency and a fiat currency is that virtual spends tend to be elective, rather than compulsory.

“…let us say [the] government monopolizes the water supply (or energy supply, or access to the gods for salvation, etc.); it can then name what you need to deliver to obtain water (or energy, religious dispensation, etc.). In that case, if it says you must obtain a government IOU, then you need the government’s IOU — currency — to obtain water… Of course it is not enough to merely impose the obligation (tithe, fee, fine, tax); the obligation must also be enforced. A tax liability that is never enforced will not drive a currency. A tax that is only loosely enforced can create some demand for the currency, but it will be somewhat less than the tax liability for the simple reason that many will expect they can evade the tax.”

—L. Randall Wray, Modern Money Theory

The game developer monopolizes whichever utility they use as their currency sink, however, since they are not enforced they only create some demand. This is not enough to drive a currency, or create inherent demand.

Taxes aren’t just the thing you see come out of your income, they can be more subtle. The auction-based exchange rate can be perceived as a form of tax. We levy a cost on governance holders, dilution, which can only be offset by participating in the auction with currency earned. This auction only accepts the native currency, in the same way that the US government only accepts US dollars for income tax payment. To avoid dilution, participation is obligatory, therefore it can be said that this tax is enforced effectively and “drives money”.

“An obligatory payment that must be made in the sovereign’s own currency will guarantee a demand for that currency. And we argued that even if one does not personally owe taxes (or fees, etc.) to the sovereign, one might still accept the currency knowing that others do have tax liabilities and thus will accept the currency.”

—L. Randall Wray, Modern Money Theory

When I said earlier that the currency is not utility focused, but rather trade focused, it was not entirely true. I only meant to impress that utility should center around non-elective spending. Players are obligated to spend in order to participate in the economy. There is a place for elective spending, but it should be used sparingly and as a minor source of currency outflows.

Here are four examples of obligatory taxes:

  • Taxes on infrastructure — Using an example from earlier, a Warp Gate tax could be levied on long-distance travel, barring entry to certain areas or introducing a cost on expedited travel similar to toll roads.

  • Taxes on marketplace trading — Looking at the results from EVE online, taxes on trade volume are highly effective at removing currency from circulation. A small tax levied on a high velocity economy can grow into a large sink.

  • Corporate taxes — A tax could be levied on the trade of corporate shares, or on the income generated in such a venture.

  • City taxes — Cities could have to pay a tax to the government in order to stay in good standing and continue operations such as running a local marketplace or a repair facility.

Two additional forms of obligatory spending:

  • Innate costs — Simulate the non-discretionary spending of the real world such as food, water, and fuel for transportation. In a medieval style game, this cost could be as basic as providing food for your horse.

  • Entropy — A simple definition of entropy is the tendency of isolated systems to degrade over time. Many professions and industries in the real world depend on entropy. In the context of an open game economy it is worth considering. Without entropy, potential economic activity is significantly lower. Introducing a repair cost makes sense in this scenario. For example, if my armor is damaged in battle, it should require repairs. Another idea is that the equipment players use age over time and need replacement.

Is any of this fun? Some will argue that gamers dislike taxes or repair costs, but an even more detrimental expense is inflation. It is a hidden cost that affects everyone, particularly those who are the least financially secure. Many players may not realize that these types of expenses are necessary to prevent hyperinflation.

So we have clarified that obligatory spending is better at countering inflation than elective spending. This, however, can only get you so far. It is also important to consider and control how new currency enters the game. By addressing this fundamental issue at the source, we can prevent it from getting out of hand in the future.

Currency systems

The consensus seems to be that outsized inflation in games occurs because there is not enough sinks to remove currency from circulation. While this perception is not wrong in theory, it is an oversimplification. Balancing an economy in this way is akin to walking a tight rope: too many sinks and the currency appreciates causing hoarding; not enough sinks and the currency devalues leading to capital flight. The path in which the currency functions optimally is narrow and forever at the whim of any errant gust of wind.

Games do have an advantage though: the ability for any player to generate new currency from their own activity is an improvement on the unequal distributions found in the real economy.

So where does the problem arise?

We know that faucets are simply incentive design programs. Developers want players to participate in a particular activity, so they make that activity reward currency. However, as we discussed earlier, overly trivial and exploitable rewards will be taken advantage of by players swiftly and to the maximum amount possible.

“If you are rewarding an action in the game with value, could be tokens could be NFTs, and that action could be repeated en masse, for example, the value of that reward will fall to the level of difficulty of that action. And if that action, say, is relatively easy or repeatable the fundamental value of that action approaches zero in the long run… with crypto games, if you’re creating an action that is giving, say, token value, but that action is easily repeatable by a lot of people then the value of that action falls towards zero which means your token is going towards zero.”

—Nick Metzler, A Fundamental Approach To Designing Tokens In Games

I agree with Nick here, friction and time investment are important considerations when designing faucets. I would also add that real economies are inherently competitive systems. Without some form of competition for new currency and assets, the value derived will also be more fragile.

Let’s be honest, players are often able to outsmart even the best game developers. An activity that appears difficult will be picked apart by minds trained on decades of varied content. The gamer is truly a purpose-built value extraction machine. They will band together in the thousands as in the Runescape example, or develop programs to work for them as in the Diablo 3 example. Rather than faucets being a competition between players and developers, we want them to be a competition between players and other players.

As Bohdan from Mithraeum puts it:

“All your on-chain game mechanics must carry a non-trivial mystery that cannot be solved once and for all. The best source for such a mystery is the players themselves. That is why it becomes obvious that on-chain games are primarily PvP.”

—Bohdan Melnychuk, On-chain Gaming: Principles for Building Viable Systems

Further, we could let faucets take a backseat and design the economy in such a way that competition occurs over circulating currency. This would more accurately simulate a real economy, creating a higher velocity of trade and making all of our obligatory spending more effective.

As a final note, an economy where currency and assets are gained without friction or the possibility of failure cannot be sustained. Without losers, there can be no winners.

IV. Review

In closing

If there's one thing to take away from this article, it's that traditional game design principles must be expanded to consider the impact of open markets and the behavior of players in a broader economic context when applied to blockchain games. The competition faced by game currencies from established cryptocurrencies or even real world currencies highlights the need for developers to carefully design and cultivate intrinsic value in their game economies.

The way forward will be perilous and marked by many failed experiments. By utilizing these frameworks, we can more systemically contain value within our ecosystems, and thus protect players to the best of our abilities. The ideas posed here are meant to better align developers with their potential player bases. When developers deliver genuine value to players and foster a healthy ecosystem, that value can return to them in a multitude of ways — without the need for predatory tactics.

Designing an Open Game Economy (Part 1) Recap

  1. Currencies must be competitive — Defined by a relatively stable value, deep liquidity, transparent distribution, broad acceptance, and high velocity. A currency with these elements will be more able to withstand the pressures of a highly competitive crypto environment.

  2. Blockchain games as developing countries — When games become open economies they start to act more like countries than the MMOs of the past. We should consider the attributes of a developing country in the design of our economies such as: currency stability, currency reserves, property rights, governance, social institutions, and economic mobility.

  3. Avoid a pre-defined maximum currency capacity — Medium of exchange currencies need to be relatively stable to function correctly, developing a currency with a hard coded capacity will surely lead to volatility. Currency supplies should be elastic; able to increase or decrease the circulating supply to meet demand and ensure stability.

  4. Reducing ecosystem risk leads to capital accumulation — The more stable the economy becomes the safer it appears to current and potential players. This leads to confidence in leaving value within the ecosystem, rather than looking to place it elsewhere.

  5. Acquire an initial reserve and game population — This can serve as the foundational seed of confidence in the economy, paving the way for its broader possibilities. Further, limiting game population to the number of governance assets should lead to more sustainable growth trends and a healthier economy.

  6. Categorize potential currency inflows — These will most likely take the form of exports, foreign direct investment, financial instruments, and investment interest. Taking this approach, we can more clearly define avenues towards economic sustainability.

  7. Royalties as a critical inflow in the form of an export tax — While there has been much debate on this subject, we can be certain that this form of revenue will excel in propelling intrinsically valuable open economies. Are they difficult to enforce? Sure, but so are many taxes in the real world.

  8. Utilize currency stabilization practices — This can be a direct approach akin to Linden Labs and their Linden dollar or a more decentralized approach such as the gamified two-tiered Tobin tax implementation. Protocol backed stabilization will create an inherent level of confidence in the currency.

  9. Consider ways to design liquidity into the structure of the game — Framing liquidity as narrative elements — as in Treasure’s approach — or as economic initiatives can lead to the accumulation of the deep liquidity that is a prerequisite for a competitive currency. I propose liquidity as a high demand scarce resource, an opportunity to conduct business endeavors, a charter to create new cities, or even a component for building new infrastructure. The potential applications for liquidity based assets within an ecosystem are only limited by the imagination of the developer and community.

  10. Liquidity follows stability, not the other way around — Liquidity is naturally attracted to stability, with assets possessing intrinsic and stable value garnering more liquidity. Efforts to artificially boost liquidity without underlying stability are often futile and can lead to capital flight.

  11. The Ethereum Standard — ETH stabilized ecosystems reduce competition with ETH and inherently align themselves with the protocol. Anchoring the value of the game economy in terms of ETH should lead to capital accumulation at the expense of projects who do not. Such a standard should create positive-sum value accrual amongst projects who adopt its use.

  12. Explore implementations of value entanglement — Where the value of assets are inherently linked to a strong reserve commodity, such as ETH, even without direct convertibility.

  13. Auction-based exchange rate — As a way to reduce circulating currency supply slack through a market-driven process, and accurately gauge currency demand in the economy on a recurring basis.

  14. A novel treasury bond concept for stable ecosystems — Inflation protected, liquidity abstraction bonds can allow projects to utilize illiquid native currency reserves while at the same time building protocol owned liquidity. These bonds protect the value of the player, ensuring confidence over its term.

  15. The importance of driving inherent currency demand — Developing countries have the benefit of a captive audience, while blockchain games do not have the same luxury. Through a “taxes drive money” mental model we can simulate this demand with ecosystem taxes on infrastructure, local marketplaces, in-game corporations, and cities. Innate costs or “non-discretionary spending” can be simulated through mechanics like a fuel cost for travel. Entropy should be considered as its effects drive economic activity in the real world. Costs based on equipment decay or environmental damage can drive more demand for currency. Keep in mind, all of this is only sustained by the desire for players to participate in a valuable economy to begin with.

  16. Don’t neglect the design of faucets in favor of sinks — It is important to consider friction and time investment for mechanics that generate a currency. Additionally, competition should be a critical part of how assets and currency enter the ecosystem. Without these three aspects, it is more than likely your currency value will be unsustainable.

Final thoughts

This comprehensive framework outlines a potential roadmap towards crafting a robust open game economy that's both resilient and adaptive. By emphasizing the importance of currency competitiveness, intrinsic value, inherent demand, and self-stabilizing mechanics, we position our game economies to thrive in a dynamic crypto environment and avoid the pitfalls experienced by previous iterations of blockchain games and traditional MMOs. Anchoring these principles is the need for continuous evolution, ensuring we address challenges head-on and evolve with the needs of our player base. Only through a methodical and informed approach can we hope to redefine the standards of game economies and set a new benchmark for the future.

Imagine a future where game economies are crafted with such precision that they become the very pillars of stability for the Ethereum network. Picture efficient game treasuries amassing vast quantities of ETH and staking thousands or even tens of thousands of ETH each. Such a landscape could set in motion a virtuous cycle, fostering positive sum value accrual amongst these projects that technically compete with each other. This prospect isn’t just a distant dream; a single groundbreaking success might be all that’s needed to illuminate the path forward.

The overarching aim of this series is to guide the development of blockchain economies that uphold and preserve the value of their participants. If you’d like to offer feedback or believe that certain aspects of my writing could be refined, elaborated, or visualized, please feel free to connect with me on twitter/ X @HedgeEconomist or message me on Discord @0xHeimdall.

I’m also always hanging out in our project Discord, The Citadel. Ping me there in chat anytime. Thanks for reading!

In part 2, we will take a comprehensive look at governance, aiming to develop a democratic and decentralized approach for game economies. By incorporating key principles such as diminishing marginal utility, illiquidity, active governance, and lucid ownership, we can construct a robust framework that introduces friction in the accumulation of governance power and encourages meaningful participation. Through these factors, we will aim to tackle the inherent challenges faced by pure ERC-20 governance systems and pave the way for a more equitable decision-making process in blockchain games.

Be on the lookout for the next articles in this series:

Part 2: Embracing Friction for Governance Systems

Part 3: Solving for Tragedies with Ostrom

Part 4: Navigating Murky Ownership

Part 5: Upward Mobility in Eternal Games

Special thanks to the Citadel team for the help in making this legible and fleshing out the ideas presented here. Specifically, Phyzix Teacher as editor-in-chief, Emerson, Flam Sanct, and Fleet Commander. Many of these ideas have been co-discovered throughout the process of building and balancing our game.

Additionally, thanks to Dmitry Vinogradsky for your diligent proofreading and valued perspective, Apix for helping to ground several sections making them more concise and understandable, Nick Metzler for critical feedback leading to further exploration and substantiation of many ideas presented here, Alex Wettermann for pushing me to elaborate on the narrative through-line of game economies as developing countries, and Kiefer Zang for his welcome thoughts on the article which clarified that multiple sections required examples and further expansion.


  1. The Machinations Manifesto For Building Sustainable Game Economies – The Design Pillars by Machinations

  2. Crypto Gaming: A Most Practical Thesis by Arad

  3. End-Game Vision by Flam Sanct

  4. Founders’ Long-Term Vision for Treasure Project by Treasure

  5. The Barrier to Big by Ramin Shokrizade

  6. On-chain Gaming: Principles for Building Viable Systems by Bohdan Melnychuk

  7. Fun Games (alone) won’t Solve Web3 Gaming by Nick Metzler

  8. Play to earn economies as base layer protocols for games by Pet3rpan

  9. Sinks & Faucets: Lessons on Designing Effective Virtual Game Economies by Terry Chung


  1. Animal Spirits by Akerlof and Shiller

  2. Modern Money Theory by L. Randall Wray

  3. A Program for Monetary Stability by Milton Friedman

  4. Governing the Commons by Elinor Ostrom

  5. Virtual Economies: Design and Analysis by Lehdonvirta and Castronova

  6. Land is a Big Deal by Lars A. Doucet


  1. Virtual Worlds: A First-Hand Account of Market and Society on the Cyberian Frontier by Edward Castronova

  2. A Risk-based Theory of Exchange Rate Stabilization by Tarek A. Hassan

  3. Tangibility as Technology by JoĂŁo Marinotti

  4. Macroeconomic Conceptualization in EVE Online by Leonid Rempel

  5. The Tobin Tax and Exchange Rate Stability by Paul Bernd Spahn


The views and opinions expressed in this article are those of the author and do not necessarily reflect the views or positions of any entities they represent.

Further, the content of this article is not financial advice and does not constitute any offer or solicitation to offer or recommendation of any investment or product.

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