How does cryptocurrency reconstruct the native economy of the Internet?

Author: Patrick Rivera; Compilers: Wang Dashu, Gu Yu

An important and oft-discussed idea in the cryptocurrency space is to enable creators and communities to build their own internet-native economies. A key component of these economies are tokens, which got a bad rap during the ICO boom a few years ago but have remained the fundamental unit of value in the cryptoeconomy as an incentivizer for decentralized network participants (users, developers, investors and service providers) is considered a breakthrough in the design of decentralized networks.

On a simple level, tokens are just code that exists on a global peer-to-peer network called a blockchain, and unlike other forms of money, they are digitally native and programmable, secured by encrypted wallets and private keys.

There are two broad categories of tokens: fungible and non-fungible.As more creators and communities build their own crypto-economy, fungible tokens will be used to exchange goods, store value, and make collective decisions; non-fungible tokens (NFTs) will be used to create collectibles , rewards, achievements, etc. as the center of the new business model - to give people identity, status and a sense of belonging。

All the best crypto protocols, social apps, online communities and marketplaces need a deep understanding of the interplay between fungible and non-fungible tokens to create their own internet economy. Why do we need an internet-native economy?

Most traditional economies were not designed with the Internet in mind. As a result, there are many problems with the modern economy:

1) Restricted access. Globally, approximately 1.7 billion adults do not have bank accounts. This limits people's ability to start businesses, fund projects, and take entrepreneurial risks.

2) Inefficiency. High fees for credit card transactions and money transfers, as well as high-interest loans make it difficult for low-income communities to participate in the economy.

3) Low transparency. Banks operate under complex structures, and it is difficult for the outside world to understand their financial status and risks. Citizens are relegated to trusting that the government will preserve economic value through monetary policy, capital controls, and FDIC insurance, and we've seen that doesn't always work.

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01 Two forms of homogeneous tokens

Money has traditionally served three main purposes: a platform for communication to facilitate trade; a store of value to preserve wealth over a specific period of time; and a unit of account metric.

Economies invest money in productive assets such as factories, scientific research, technological development, and public infrastructure to drive economic growth. To make life more enjoyable, consumers also buy relatively “non-productive” items, such as flat-screen TVs and high-end wallets or sneakers.

The crypto economy follows a similar dynamic. Money circulates through issuance policies and is reinvested along a range of productive and non-productive assets. For example, the code that runs the bitcoin network plans to issue 21 million bitcoins, reward miners who secure the network, and allow bitcoins to be transferred directly between parties for use in various scenarios.

In the Ethereum network, tokens are mainly issued through the replaceable ERC20 standard; commodities are mainly issued through the non-replaceable ERC721 standard, and these non-fungible tokens issued through the ERC721 standard are usually called NFT.

In addition to being a form of internet-native token, the programmable nature of ERC20 tokens supports two other use cases: utility and governance. These use cases can be seen more clearly when we take a deeper look at the taxonomy of tokens.

1) Utility tokens

Utility tokens are fungible tokens that unlock functionality in smart contracts or off-chain systems such as Discord communities. Utility tokens are difficult to perform off-chain, so they tend to be most valuable when their functionality is performed entirely on-chain via smart contracts.

When designing a utility token system, it is necessary to consider the following questions: What is the core problem we are trying to solve? Who do we solve for? How can we help them address it in a positive way?

Some use cases for utility tokens, and the resulting cryptoeconomy, include automated and trust-minimized lending.

Executing trading strategies (such as short selling and leverage) in a decentralized/trust-minimized manner has not been possible in the past because traditional exchanges require a centralized counterparty to take credit risk and provide services such as clearing and settlement.

To enable decentralized lending on a blockchain like Ethereum, the protocol requires traders to deposit tokens into a smart contract as collateral to unlock lending capabilities. Tokens used as collateral for decentralized lending are examples of utility tokens, as they unlock automated functionality in smart contracts.

Compound is an example of a lending protocol built on Ethereum. In order for a user to take out a loan, they first need to deposit one of the approved collateral tokens that have been voted on by governance. Currently the protocol supports tokens such as ETH, DAI, USDC, BAT and UNI. By depositing collateral, borrowers unlock the ability to lend.

Traders use Compound to take leveraged long positions on ETH. For example, they will deposit ETH as collateral, borrow stablecoins like USDC or DAI, and buy more ETH. You can do something similar for short positions. If loan interest payments are not made on time or the value of the underlying collateral drops below a certain level, automated bots called Keepers will incentivize them to liquidate positions by taking a cut of transaction fees.

2) Governance Tokens

Governance tokens represent percentage ownership of voting rights. It is difficult for most community members to keep up with the latest developments in a particular protocol, so most protocols allow token holders to delegate their votes to trusted representatives.

When designing a governance token system, it is necessary to consider the following questions: What public goods should our community manage? How should governance tokens be issued? How do we design fair, flexible and transparent governance systems?

Next, taking parameter setting and upgrading as an example, let us review some cases of governance tokens.

Cryptonetworks are powered by smart contracts that execute logic responsible for calculating interest rates in lending agreements, implementing policies for automatic issuance of stablecoins, or determining exchange rates for token transactions.

When a smart contract is first deployed to the Ethereum network, it may contain multi-party administrator permissions to limit the risk of vulnerabilities. Once a smart contract has been tested enough in prod, admin privileges are usually removed to ensure that the core team cannot update the protocol at will.

However, many times the protocol still needs to be upgraded and improved. In Uniswap, UNI holders can vote to open a protocol fee proposal that redirects 0.05% of transaction fees to UNI holders instead of LPs. In Compound, COMP token holders can vote on the collateralization ratio of new tokens.

Recently, the YFI community has proposed the most advanced decentralized governance system, and the latest proposal is to recommend that YFI holders elect committees for specific areas such as budget control, development roadmap, and investment strategy.

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02 Non-fungible Tokens (NFT)

NFTs are unique digital tokens stored on the blockchain. We're seeing a lot of activity and excitement in this space, but in order to focus on the bigger picture,People value virtual goods for six main reasons: identity and belonging, status, personal meaning, relationships, collections, superpowers。

Let's take a closer look at how each approach works for NFTs in the cryptoeconomy.

1) Identity and Belonging

A sense of identity and belonging is fostered through a sense of shared history and storytelling. Religious groups are masters at creating a sense of identity and belonging.

CryptoPunks are a quasi-religion in the crypto community. By owning a CryptoPunk, you're showing that you're willing to hold onto the artifact and be part of the CryptoPunk community, rather than sell it for a premium. HODLers identify themselves by changing their profile picture to their CryptoPunk. Some will even delete their CryptoPunk profile pictures after the sale to show a loss of identity.

2) status

Status is driven by price and scarcity. Whether it's a Louis Vuitton bag or a Lamborghini, status signals are a central part of being human. On social media, status is often derived from follower counts and engagement metrics such as likes, shares, retweets, etc.

These metrics are really just virtual currency that exists in the company's database. But they are inefficient because it is difficult to convert likes and followers into cash. As a result, business-savvy creators use social media as leads for their actual businesses, such as branded electronics stores, merch drops, courses, and more.

But what if you could just exchange likes for money?

I believe crypto-native social apps will create a new form of "irreplaceable likes" that feel like badges and in-game items in video games. For example, Snap's Spotlight program pays creators for popular content. But it's an opaque process.

Instead, crypto-native social apps could let consumers vote on their favorite content, reward the highest-voted creators with NFTs, and allow those NFTs to be redeemed for a percentage of the prize pool. The process will be community driven and independently verifiable as it is done on-chain through encrypted tokens and smart contracts.

Today, top creators receive inefficient virtual currencies (e.g. likes/follows) and cash rewards from centralized platforms. In the future, creators will build a new form of identity through these community-driven NFTs, which they own through their private keys and can be exchanged directly for money.

3) Personal significance

Personal meaning is driven by sentimental value and customization. Many people have a baby toy, trophy or ring that holds special meaning because of the story behind it. Fasting app Zero offers users badges to reward certain milestones, such as fasting for 24 hours or doing intermittent fasting for 5 consecutive days.

Likewise, crypto protocols can commemorate milestones and achievements by issuing NFTs based on on-chain activity. For example, Rabbithole has partnered with leading DeFi protocols to create tasks that people can perform to receive special NFTs or protocol tokens. This helps provide a fun way for people to get involved in the crypto industry by performing on-chain tasks on special NFTs.

Another example is Uniswap's v3 protocol. Whenever a liquidity provider (LP) deposits into a pool, the protocol transfers an auto-generated NFT to the LP based on a number of factors such as which pool they deposit into and within which range of the liquidity curve.

4) Relationship

In Japan, business people exchange gifts to build trust and show respect. On Twitch, viewers send tips and buy gifts to show their affinity and hopefully create a buzz. In the cryptoeconomy, tipping and gift-giving may become core primitives for building online relationships.

Web 2.0 is all about being social—follow, like, comment. Web 3.0 is about the social + economic graph - NFTs you buy, projects you invest in, social tokens you earn. Company profiles on Crunchbase were an early example of economic charting. For most startups, you can see who funded them, how much they received, and when the funding round was.

Since all transactions on crypto networks are settled on-chain, we will be able to build rich economic relationships into social applications, online communities, and marketplaces. We will provide a crypto-native version of Crunchbase for creators, communities, and various creative projects. At Mirror, we demonstrate these economic relationships for tokenized crowdfunding that supports creative projects like novels, newsletters, and creator residency.

While there is certainly a risk of over-financializing relationships, many have spoken of the strong ties that develop through these economic graphs.

Another way NFTs enable new types of relationships is through peer-to-peer credentials. Today, the primary sources of certification come from college degrees, companies you've worked for, social media influence, and letters of recommendation. These are inefficient forms of authentication: they are either not very specific, or take a lot of time and effort to become clear (in the case of citations).

But what if you could send the "Top Backend Engineer" NFT to the best backend engineer you've ever worked with? Or a "Very Helpful VC" NFT for board members? The nice thing about these badges being NFTs is that you can prove they came from a specific person and that it's scarce (e.g. you're only handing out three of them). I'd much rather hire someone based on a recommendation from someone I respect than a fancy degree.

I believe NFTs like this will enable new types of relationship graphs that we can use to build better recommendation systems for job postings, content, dating apps, etc.。

5) Favorites

Whether it's Beanie Babies or Pokemon cards, collecting taps into our innate desire for status and competition. For cryptographic projects, the key is to make collections more legible. NBA Top Shot does this with their Showcase feature. They provide simple tools for creating collections and displaying them on your profile page:

One idea we're excited about at Mirror is the "digital bookshelf". What if you don't like the content, but instead collect it by buying it at different prices/rarity tiers (e.g. gold, silver, bronze) and then display your collection on your public profile? NFTs enable creators to offer digital goods at varying prices, which can lead to better monetization over time, as Chris Dixon mentioned in his article "NFTs and a Thousand Loyal Fans" .

In addition to helping creators improve their monetization methods (which many have talked about), I believe NFT collectibles will also usher in a curator economy.

What if Spotify listeners voted on playlists, and top curators got a mix of cash and Spotify stock? What if Pinterest compensated top users in the same way as top engineers?

As more and more digital media becomes NFT by default, I believe curators of top songs, videos, newsletters, podcasts, etc. will be able to package their NFT collectibles and earn royalties based on licensing and engagement. A whole new curator economy will be born.

6) Super power

Long ago, in a distant metaverse, the gaming industry realized that one of the most effective ways to monetize games was to give users "superpowers." These include skipping levels and improving your ability to win races faster.

Dating apps, consistently the highest-grossing apps in the world, follow a similar approach. Dating app superpowers include more swipes and greater visibility, which leads to more matches.

LinkedIn also follows this approach, offering premium subscribers more searches and advanced analytics to find jobs or hire the right candidates faster.

In crypto, NFTs can be granted to power users, granting them special abilities, such as serving as arbitrators in popular communities. So why make it an NFT? The benefit is that NFT owners cannot be pulled by centralized entities. Instead, smart contracts will enforce terms based on independently verifiable logic.

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03 Summary

All in all, encrypted networks support a secure, transparent, internet-native economy. The basic unit of value in these economies is the token. Fungible tokens can be used for currency, utility and governance. At the same time, non-fungible tokens are digital assets that enable new business models and can give people identity, status, and a sense of belonging.

There are still challenges to implementing a crypto economy anywhere, such as high transaction fees and cumbersome barriers to entry, but over the past decade, crypto has gone from a fringe activity to one that more institutions, technologists and entrepreneurs are starting to take seriously things.

Over the past decade, we have seen cryptocurrencies, crypto finance (DeFi), and crypto art. Soon, we could have encrypted social networks, encrypted commerce, encrypted companies, and more.

When thinking about how to design a crypto-economy, I often think of this quote from Ethereum co-founder Vitalik Buterin: “For me, the goal of encryption has never been to remove the need for all trust. Instead, the goal of encryption is to give people access to Encryption and economic building blocks that give people more choices about who they trust."

The next decade will be about using these economic and cryptographic building blocks to design a new generation of transparent and fair internet-native economies.