This piece is a collaboration between Tina He and Packy McCormick. Tina is the founder of Station, which I was lucky enough to invest in via Not Boring Capital, and the author of one of my favorite Substacks, Fakepixels.  All the smart parts are hers.

When trying to understand tokens, it’s tempting to draw from what we already know. 

Sometimes, tokens function like equity in a company, and owning a token is akin to holding a stake in the project’s potential upside. Other times, tokens function like a “token-of-gratitude” and symbolize goodwill among close friends in the purest sense. The wide-ranging role isn’t a bug but a feature representing value in the most abstract sense, whose meaning is given by the system's very design.  In other words, a token doesn’t necessarily have any intrinsic value but relative value. It’s the encapsulation of a unit of value universally recognizable and enforceable by a system. 

Tokens are barely a new concept. Shells and beads were the earliest types of tokens as a medium of exchange. Others that we’re familiar with today — casino chips, credit card points, stock certificates, concert tickets, and club memberships – are all forms of tokens as they represent a unit of value universally recognized and enforced by the system that issues that token. When the respective systems fail to enforce and recognize the value of these tokens, the jurisdiction can step in to protect the token holders. 

Think about the last token you interacted with — What does it allow you to do that you otherwise cannot? Why are you holding it and want to own more of it? What happens if you discard or transfer ownership of your tokens? To many, the answer to these questions would be “getting even more tokens.” To others, holding tokens allows for participation rights in projects and communities that they care deeply about. The former speaks to the economics of holding a token, the latter to access rights. 

A token design is poor when there’s value misalignment between value accrual in the system and value accrual to the token. Gabriel Shapiro aptly describes tokens like UNI, COMP, and the recently launched APE, as “value by association,” as he acutely identifies the fragmentation in value streams for the protocols aforementioned — the prime slice has been preserved for the insiders, while the “illusion of power” gets distributed to the rest. 

One of the reasons that there is so much confusion around token design, and value accrual specifically, is that tokens, and the DAOs and protocols that issue them, are so multifaceted. Sometimes, the issuers want them to behave like shares in a corporation. Others issue “governance” rights to skirt regulations while insiders pump the tokens in the hope of getting out before the price tumbles. Others still want to build and unify digital nations. Often, even the issuers aren’t clear exactly what they want to do with the token, but they know that tokens are a great way to capture value.

While token design isn’t the only important aspect of creating a new protocol or digital economy – delivering value to users should always be priority #1 or else the token’s price will inevitably crumble – it’s a critical one. Just like a messy cap table can inflict mortal wounds on a startup or poor monetary policy can derail a nation’s economy, bad token design can doom a protocol before it even gets off the ground. The crypto graveyard is littered with examples of good projects whose token designs cemented their eventual demise from day one – maybe the tokenomics encouraged too much growth, too fast – and we’ll cover some of them here. There are others whose token designs allow them to do things that non-web3 companies can’t by properly aligning incentives in the system, and connecting the system to the larger ecosystem. We’ll cover those, too. 

Why does it matter? Everything is falling apart. Terra collapsed largely thanks to its token design. Projects that attracted millions or billions of dollars with the promise of absurd APYs are learning the truth of the old adage, “Easy come, easy go.” The regulators are coming.  Tokens that were worth a lot of fiat a couple weeks ago are worth a lot less today.

All of those reasons and more are exactly why it’s critical to understand good token design today. Not only because good token design can help avoid catastrophic outcomes, but because, assuming we’re entering a sustained bear market, now is the perfect time to experiment with novel token designs without the pressure of the expectation of high prices and “up only.” 

Tokens are naturally economic; they have a price attached from inception, and are instantly tradeable on liquid, global, 24/7 markets. But tokens can be much more than that. They’re programmable primitives that allow DAOs and protocols to signal what matters in their ecosystem, to reward good participation, to trade with each other and build interconnected webs of support, and to support new forms of digital organizations and nations. 

So what are you building? Are you building a club or a co-op, a corporation or a country? 

Protocols can be all of the above, so we’ll start by walking through how they compare to companies and countries, before laying out a framework for token analysis, and imagining what the world will look like when the dust settles. We hope that it’s useful to the builders, contributors, and investors alike. 

We know you wanted a break, anon, but it’s time to jump back down the rabbit hole.