Decentralized Applications, or dApps, are an integral part of Web3, being the interface to facilitate transactions, investments, and various other activities for approximately 99% of users in the Web3 ecosystem. These platforms, powered by smart contracts on blockchains, offer permissionless and automated processes around the clock without the need for intermediaries.
Smart contracts serve as the foundation of dApps, so their security and reliability are of utmost importance. To ensure their resilience against malicious attacks that could lead to a loss of user funds, smart contracts get audited, sometimes even multiple times - true to the motto “4 eyes see more than 2”.
However, just as it has become standard practice to audit smart contracts, the auditing of tokenomics is equally important for the long-term success of the respective project. Nearly every blockchain project, beyond dApps, incorporates its native token, often placed as a central element of its business model or ecosystem. In this article, I will explain why tokenomics auditing is crucial, and why you should think about getting a second pair of eyes to look over your tokenomics..
Smart Contract Audits
Smart contracts serve as the backbone of dApps, enabling seamless platform functionality without intermediaries. The immutability and constant availability of these contracts on the blockchain ensure uninterrupted, permissionless, and trustless transaction execution, around the clock.
A crucial aspect amplifying the significance of auditing is that smart contracts, particularly in DeFi protocols like lending/borrowing platforms, hold user deposits. Take Aave and Compound, for instance, where billions of dollars are stored within their smart contracts. Consequently, the robustness of these contracts must be bulletproof to safeguard the funds.
Audited smart contracts bring several benefits. First and foremost, the confidence and trust of users and investors in the platform increase significantly. The stamp of approval from auditors often implies a certain quality standard for the protocol, depending on the credibility of the auditing entity of course. Furthermore, a commitment to conducting audits demonstrates the project's dedication to security and willingness to invest in fortifying its infrastructure.
Tokenomics Audits
Having gained insight into the significance of smart contract audits, it becomes apparent that for dApps embracing a token economy, tokenomics audits hold equal importance. If you choose to integrate a Web3-based token economy into your business model, its success depends not only on reliable smart contracts but also on the effectiveness of the token economy and how well it is aligned with the strategic goals of your business model.
Above all, it's important to recognize that not every Web3 project necessitates its token, let alone within established business models. Consider, for instance, whether your token predominantly functions as a medium of exchange within your platform. Reflect on whether this truly enhances your business model or if it inadvertently presents obstacles for both your current and prospective users. Tokens primarily functioning as mediums of exchange can easily be substituted with more fitting alternatives, like reputable stablecoins such as USDC or BUSD.
Your token should consistently provide value to your users, rather than hinder your scalability efforts. To gauge its value proposition, begin by questioning why someone should buy the token, and more importantly, why they should hold it. If you can address the first question but stumble with the second, your token may merely serve as a transaction facilitator—a medium of exchange without substantial substance. An answer to the latter question would reveal concrete value drivers that benefit token holders throughout their holding duration. And I don’t mean speculation.
Beyond that, a well-functioning token economy should comprise critical factors from the quantitative side of tokenomics like reasonable token allocation to avoid centralization, a carefully planned release schedule to prevent excessive inflation, and a reasonable valuation when aiming for a token sale.
To address these concerns, a tokenomics audit involves experts meticulously scrutinizing the tokenomics, both qualitative and quantitative, checking if the project's goals are aligned with the tokenomics. An essential aspect of this assessment involves employing game theory to understand how users will interact with the token and the project, thereby exploring potential unintended consequences and feedback loops that can quickly end in vicious circles.
By analyzing and optimizing these economic mechanisms, projects can enhance their value proposition and build trust among users and investors, fortifying their position in the ever-evolving landscape of blockchain technology.
The Benefit of Tokenomics Audits
Just as smart contract audits enhance user confidence and trust in the project, tokenomics audits ensure the viability of your tokenomics strategy within your business model. These audits assure users and investors that the token adds value and is thoughtfully designed, instilling further confidence in the project.
Moreover, a well-executed tokenomics audit goes beyond validating the token's basic functionality; it delves into the alignment of the token's utilities with the overall project goals. By examining the token's role in incentivizing network participants, fostering user engagement, and promoting long-term growth, the audit helps optimize the token economy for sustained success.
Additionally, tokenomics audits serve as a crucial risk management tool. By identifying potential flaws or vulnerabilities in the token's design early on, projects can proactively address and mitigate risks before they impact the platform or its users. This proactive approach not only safeguards the project's reputation but also reduces the likelihood of unforeseen challenges arising in the future.
Furthermore, the findings of a comprehensive tokenomics audit can be leveraged as a valuable communication tool. Transparently sharing the audit results with the community demonstrates a commitment to openness and accountability, which can lead to stronger community support and engagement.
Conclusion
Now you know why it's important to audit smart contracts but also why tokenomics should be audited. Smart contract audits serve as a foundation ensuring the security and reliability of dApps, while tokenomics audits play a vital role in validating the viability and value of the token economy within a business model. Audited Tokenomics can bolster user confidence, attract investors, and establish themselves as trustworthy players in the blockchain landscape.
How Phantom Blocks can help with your tokenomics:
Phantom Blocks provides free tokenomics reviews that help you identify areas of improvement, negative feedback loops, and more. If you are interested in a free review, reach out to us via lukas@phantomblocks.com or via LinkedIn.