A brief analysis of token economics: how is good token economics designed?

Written by: Zach Zukowski

Compiler: Paul Zhang

In the past period of time, more and more projects are looking for economic models to guide the project, which is often called "tokenomics". We believe that tokenomics is the most important part of project design. In this article, we share our research with WEB3 entrepreneurs. After researching thousands of projects, we selected a few highlights to share:

1. Incentive design scores

Token economics is an important tool for aligning incentives for projects. In order to achieve a virtuous circle, the behavior of each participant in the ecosystem is very important. Equally important are well-designed incentives, through which the direction of market behavior can be brought back on track. Many poorly designed mechanisms are abused by project participants who sacrifice long-term benefits for short-term gains. Farnam Street Media Inc. published a case study of three pre-cryptocurrencies that had poor results due to poor incentive design.

2. Tokens can create network effects

Tokens are a powerful tool for incentivizing even small numbers of participants. Before the invention of cryptocurrency, internet businesses needed huge marketing budgets to attract users and in doing so create a network effect that attracted new users. Today's encryption projects can introduce token incentives to attract users and improve network effects. Chris Dixon, partner at A16z, has a wonderful tweet explaining the concept:

For example, Snapchat has a hard time accumulating active users unless friends are reading your posts. Projects like Snapchat can now use tokens to encourage users to continue creating content and expanding their circle of friends. Likewise, Uber would have few passengers without drivers, and few drivers without passengers. A similar program at Uber could use tokens to reward riders and drivers for participating or referring friends.

3. Ecosystem Incentives

Ecosystem incentives are one of the most creative parts of token design. Examples of ecosystem incentives include:

• Activity Award

• Contributor Rewards

• airdrop

• Staking Rewards

• Partner

• airdrop

The corresponding incentive token mechanism by the smart contract manager makes the management's exhaustion and fishing lose the soil. In the distribution of tokens, this smart contract should always have the largest share. To ensure the long-term effectiveness of incentives, we recommend that the token unlocking period should be 5-10 years.

We suggest that the allocation rate should be linked to the activity of the project, for example, increase the allocation when the transaction volume increases, and weaken the allocation when it decreases. Our favorite example is Helium (HNT) and the Planetwatch Recycling Bin, where Helium ensures that the protocol never runs out of HNT tokens by distributing the fees collected this week over linear hotspots over the next few weeks. Planetwatch Recycling Bin project, which puts all of everyone's unmined tokens into a pool, and the tokens in this pool will be used to increase the number of future participants.

4. Assign value

Every project must define the relevant path for sharing value to the owner. Protocol Owned Treasury (POT) is a way we like, where all revenue is shared between the project treasury and the developers. Governance token holders control the assets in the POT and can unlock them as needed. Therefore, governance tokens usually have a certain transaction premium.

We prefer POT to the model of distributing cake outside the project. POT enables token holders to enjoy compound growth while holding positions. If value distributions are required, then manual re-deposits will be required after each distribution to keep positions undiluted. In addition, previous allocations usually require increased related bookkeeping work.

We came up with a new method of value distribution called Automated Pre-Allocated Liquidity (APL). Initially this value assignment was done withMeld VenturesofMichael Cottonbrainstormed to come up with. APL has been deployed on Algomint. In this method, the token is sent to the vault, which is then paired with another token (ALGO or a stablecoin) and sent to the AMM. This allows POT to automatically generate income while increasing the liquidity of project tokens. The conversion of treasury assets into governance tokens increases liquidity and eliminates the squeeze on POT liquidity in direct redemption requirements. Token holders can get more value by selling their tokens on AMM. Compared with Olympus DAO, APL does not require the supply of external liquidity. In fact, POT has been providing its own liquidity to itself.

Algorand's native Atomic Transfer feature allows it to complete currency transactions while injecting proceeds as liquidity. This eliminates desynchronization of projects in trading and injecting liquidity.

Another popular model is the buyback and destroy model. He distributes the revenue into buybacks and burns tokens, which creates deflation and higher unit prices. We believe APL is superior to the above model because it leverages Web3 tools like AMMs to convert revenue into a decrease in tokens in circulation and an increase in liquidity.

5. Multi-token model

For the vast majority of projects, we recommend issuing only one token. Multiple tokens mean that there is no longer a clear target to invest in, which can overwhelm the market and reduce the brand value of the project. Governance tokens should usually be utility tokens. However, in some cases it may be necessary to issue a dedicated token for a specific activity.

Governance token + stable currency is a common model of the multi-token model. Examples of applications include: GARD, Algofi, and xBacked. In these models, governance tokens are used to distribute ownership of the project to its users, which increases the annualized rate of return (APY) of the project while incentivizing governance token holders to stake tokens for additional rewards. This creates a virtuous circle:

In order to achieve combined applications with other DeFi projects, governance tokens + proof of deposit tokens are used by many DeFi protocols including Folks.Finance, Tinyman, and Humble. In this model, projects provide depositors with newly minted tokens that prove deposits, and these proof tokens can be used as collateral for other DeFi applications. Governance tokens allow participants to share in the benefits of the governance treasury.

Fixed supply of governance tokens + variable supply of burnt tokens is another multi-token model often used by P2E games. We helped Alchemon design its model. Its governance token (AlcheCoin) needs to be obtained by staking Alchemon aNFT, which is attached with treasury management rights and hard issuance caps. Another of its tokens is burnable AlcheGold, which is minted during game play. AlcheGold can burn itself in exchange for strengthening characters or reducing waiting time.

6. Circulation supply

We found that the market will place a certain premium on projects that have a clear description of their token supply. We recommend creating a web page that provides a visual description of the supply. Circulating tokens are mainly affected by two factors: the unblocking timetable of development teams and investors and ecosystem incentives.

For the vesting schedule, we recommend that the team's cliff (that is, the time period before the token is lifted) be 1.5 times the length of the investor's cliff, and the team's Vest time be 2 times the investor's vesting schedule. This demonstrates the team's confidence in the long-term success of the project. The founding team should consider their tokens to be one of the best investments, and there is no reason to reduce their positions until investors are unlocked. Investors shall receive 50% of the tokens before the team vesting cliff begins.

Once the cliff is reached, we recommend daily vesting rather than monthly or quarterly. Mass unblocking after a long wait could trigger a Prisoner's Dilemma, as it would incentivize token holders to accelerate sales to secure the best price. Daily vesting allows parties to trade to eliminate the above risks, so there is no panic selling. Algorand's low transaction fees allow stakeholders to frequently sell tokens at low cost.

7. Governance

The design system we propose is as follows: in the first year, to allow a "founding team-based" approach (by issuing "team-aligned" tokens), the first two years are mainly operated by the founding team, and in the third year transition to a real Community management governance. Usually the founding team and strategic investors have invested a lot of time and energy into the development and success of the project, and have the ability to make decisions that maximize the long-term benefits of the project.

8. Token Distribution

Most projects mainly study the ownership structure table before creating tokens. In the initial stage of the project, it is usually unclear what the difference is between the value of equity and tokens (usually most of the value is generated by tokens). When creating tokens, we recommend that all stakeholders distribute tokens rather than raising them in multiple rounds. This aligns stakeholder incentives and prevents possible conflicts.

Because there are no "unissued shares" at the company's discretion, token distribution differs from traditional shareholding structures. The amount of tokens and the method of distribution are determined when the project is publicly released. In contrast, a company with a legacy can continue to issue additional shares, although this dilutes the ownership of existing shareholders. The Crypto industry standard is to allocate at least 50% of tokens to the community, which effectively dilutes the ownership that the founding team and investors are able to retain. Example: If the team has 100% control and distributes 50% of the tokens to the community, the team only has 50% control.

Below are our token distribution guidelines:

Token economics is a cutting-edge and increasingly important field in the crypto industry, after all, bad token economics can ruin an otherwise great project. The above is shared only as a preliminary suggestion during the design process. Each team will have to fine-tune these recommendations to its own idiosyncrasies.