The Future of Cryptoeconomics
Key Takeaways
While replicating traditional systems remains valuable, the most compelling opportunities will increasingly arise from novel cryptoeconomic designs that leverage blockchain technology's unique properties.
Projects must strike a delicate balance between generating value and capturing a fair portion of it. Ensuring key stakeholders are rewarded commensurately for their contributions is essential for fostering long-term alignment and success.
When crafting token supply schedules and rewards, prioritise long-term sustainability across multiple product lifecycles. Anticipate future incentive requirements to avoid making myopic decisions that jeopardise the project's viability.
Investing in tools and processes to better understand and segment participants allows projects to cultivate more robust and engaged communities. Tailoring experiences to specific member profiles can yield significant competitive advantages.
Governance warrants far more proactive attention as a fundamental building block for decentralisation. Thoughtful governance design empowers projects to coordinate effectively and leverage their communities as a core strategic asset.
Introduction
As the industry onboards its next billion users, on-chain products and services will further integrate into the lives and finances of the global population. Whereas governments or international agencies can backstop traditional economies, blockchain-based economies will continue to rely on codified rulesets and robust cryptoeconomic design.
This path forward requires a more open and critical discourse, such that the trial-by-fire innovation that much of the industry is built on can continue. This final article of the introductory series highlights what makes the next steps for cryptoeconomics exciting and consequential. A focus on the future involves being able to remove the noise of short-term trends to focus on longer timeframes over multiple economic cycles.
The goal of this article is to provide an optimistic continuation of topics covered in previous articles, cast forward to highlight how the pressing issues of today may be resolved tomorrow. For the purposes of brevity, it is key to acknowledge that this article cannot offer a full scope of the future of even cryptoeconomics, much less the full industry. Ideally, this article serves as a jumping-off point for further attention from the broader cryptoeconomic and blockchain community.
Cryptoeconomics and Technological Innovation
Technological milestones often provide opportunities for interesting cryptoeconomic innovations. As discussed in The History of Cryptoeconomics, it was the ERC20 standard, borne out of a desire for standardisation amongst smart contracts, that enabled the advent of tokens as they are commonly implemented today.
With a pipeline of innovations in areas such as cryptography, artificial intelligence, and social graphs, it would be expected that cryptoeconomics will be able to take advantage of these ideas. One clear example of an emerging field is decentralised artificial intelligence. Many projects have explored introducing distributed networks that provide data, computation, and/or access due to the threat that centralised AI monopolies pose. Though there are an increasing number of projects successfully attempting one or more of the above features, a cohesive coordination layer that connects all three has yet to be accomplished at scale. Cryptoeconomics will play a major role in ensuring that the relevant AI marketplaces are decentralised and fair.
Ideally, cryptoeconomic practitioners will adapt to new technological developments, potentially through greater specialisation within the field. As the breadth of complexity increases, practitioners may benefit from becoming more domain-specific, whilst the industry will benefit from a greater range of subject-matter experts. It is crucial, however, that practitioners balance a narrower lens with an openness to more complex and interdependent solutions. The need for broader collaboration, as a result, highlights the importance of open discourse within the cryptoeconomics community.
Cryptoeconomics has also been applied directly to open new opportunities in existing technologies and frameworks. By utilising well-documented academic economic literature as the basis for experimentation, they can provide feedback to grow that literature through practical application. One great example of this has been the development of AMMs (automated market makers). Referencing this deep dive by Benny Attar, AMMs, in theory, have been discussed as early as 2004 and were commonly cited in studies around prediction markets. 2018 saw the unveiling of Uniswap and the constant product market maker (CPMM), and since then, research into this topic has been pioneered almost exclusively by decentralised finance (DeFi) projects.
Another analogue of an area where this type of innovation is common is with Maximal Extractable Value, or MEV, as highlighted in the preceding article, The State of Cryptoeconomics. The industry is currently in the midst of testing potential alternatives, such as enshrining MEV exposure in the protocol layer and distributing proceeds, creating alternative mempools to prevent it entirely or simply letting it remain as a feature of blockchain networks.
Not only is it important that cryptoeconomics remains on top of emerging innovations that allow for a broader design space, but cryptoeconomics can also spearhead the product designs that make existing technical infrastructure more effective. This creates positive reinforcing feedback loops that allow both it and other practices to grow off of one another.
This section is also an important departure from token-centric approaches, which constitute most of the remainder of this article. Due to its specialised nature, the topics covered here are less generalisable and warrant separate, in-depth studies. Future research from Just Cryptoeconomics and contributions from other experts in the field will be crucial in further exploring these areas. Tokens are a key but not exclusive manifestation of cryptoeconomic design, and understanding what works best beyond tokens can help practitioners design better economic systems that incorporate tokens.
Philosophy of Token Design
Tokens are, among other purposes, an investment tool that holders speculate on or projects use to raise capital. Though these remain valid reasons why a project may issue a token, they are not reflective of the full scope of the benefits afforded by blockchain technology and cryptoeconomics.
Token design has, similar to cryptoeconomics in general, taken inspiration from traditional industries. A compelling use case for tokens has come in the form of replicating financial instruments such as tokenised debt, digital commodities, and real-world assets (RWA), propelling decentralised finance to be a dominant sector in the industry. Tokens have, however, also taken inspiration from other digital assets such as air miles, in-game currencies and loyalty points. Part one of What is Cryptoeconomics defines token utilities as the ways that tokens can be used in a system, and that is representative of the current application of tokens in the industry. This set of utilities itself should evolve and may even grow over time.
Going forward, token designs should continue to expand far beyond that of investment vehicles. The adaptation of traditional instruments as tokens is useful, and should be seen as an opportunity to bring other traditionally non-financialised assets, such as professional accreditations or retail receipts, into an on-chain environment.
Beyond replicating traditional systems and assets, the ability to create previously unimaginable systems (as per our first article, Why Cryptoeconomics Matters) through novel token designs will be another major tool for industry innovation. An example of this type of evolution has been demonstrated well by the stablecoin sector:
BitUSD launched in 2014 as the first stablecoin backed by a basket of non-stable tokens but struggled to maintain its peg. [Further Reading]
This was quickly followed by Tether (USDT), which is backed by various traditional cash reserves, bonds, and debt instruments and is always redeemable for a dollar through Tether’s corporate entity. These stablecoins stored dollar-like assets off-chain and issued a proxy on-chain equivalent. [Further Reading]
MakerDAO was one of the first projects to successfully create a stablecoin using overcollateralised on-chain assets. This included not only on-chain debt but also traditional debt, such as in the MakerDAO HVB bank partnership. This represented a successful replication of a type of fractional reserve banking while using overcollateralisation as a means of managing volatility and liquidations.
It was as these foundations were set that new, more experimental forms of stablecoins emerged.
As discussed in The History of Cryptoeconomics, algorithmic stablecoins such as Basis cash (eventually Terra/Luna) utilised a dual-token seigniorage model.
Recently, Ethena released a new type of stablecoin that creates stablecoins based on delta-neutral hedges by shorting users’ ETH deposits on derivatives platforms to collect funding rates.
However, as designs get more experimental, certain risks will emerge and compound. One risk, especially from a project’s point of view, will be regulatory uncertainty. Even jurisdictions considered more progressive, such as the EU and its upcoming Markets in Crypto-Assets Regulation (MiCA) standard, only provide minor differentiations between tokens based on their functions: asset-referenced tokens, e-money tokens, and others. As discussed in part one of What is Cryptoeconomics, this covers just a few of the existing set of utilities, much less those that might exist going forward. As the design space gets more complex, most token holders will not be able to adequately evaluate the specific compliance and regulations criteria for each of the tokens they hold. In this instance, sensitive regulation can provide necessary assurances. The industry should continue to push for clarifications so that innovation can continue without the threat of retroactive punishment.
Although experimentation does not always succeed, such as in the case of Terra, significant opportunities exist beyond replicating what already exists. As the industry matures and foundational concepts are established, it is expected that the more novel methods without direct analogues start to become more common. This evolution necessitates cryptoeconomic practitioners to provide the right toolings and frameworks to ensure that users and markets can identify risks and circumvent vulnerable designs.
Value Accrual
The State of Cryptoeconomics describes an industry that has begun adapting existing value accrual frameworks when assessing tokens. These are often adapted from traditional financial modelling applied to tokens as investment vehicles. It is worth highlighting that this is an improvement over previous cycles where mechanisms like yield were viewed in a vacuum and seen as ‘free money’. Countless examples such as Wonderland (TIME) obfuscated the conditions under which these yields could exist, which was often only over very short periods of time. So, though the industry has made some positive steps, it is important to discern further how tokens are similar to and differ from traditional financial assets.
Traditional market bubbles form partly due to access to capital outpacing an investor’s need for value generation. In stock bubbles, for example, one might notice that the ratio comparing a stock’s price to its earnings (P/E) tends to be greater during bull markets. One interpretation of this is that investors don’t require companies to make as much money per dollar they invest. Importantly, this number falls dramatically when markets see large sell-offs.
For tokens, a similar relationship holds true. However, value fluctuations can be even more severe since ‘earnings’ are not necessarily captured by the token or, in certain cases, may not exist at all (akin to a startup that is ‘pre-revenue’ or ‘pre-profit’). As projects compete for market share, those with tokens should aim to create strong value accrual relationships between the token and project to retain a strong base of holders over multiple market cycles. The existence of both corporate equity and a token makes it increasingly important to identify the recipient of value capture. Token holders may incorrectly assume that tokens capture the value generated from the project, while projects use those revenues to argue greater private round valuations for a separate corporate entity. This results in an unsustainable double-counting of value that will eventually only hurt the token holder.
Projects may only distribute generated value to private shareholders.
Value Accrual requires a combination of value generation and value capture, but more specifically, the right balance of both going forward. Especially for the stakeholders who directly contribute to a project's success, imbalances between the value they generate and the value they capture (through the token or otherwise) can cause long-term strains on working relationships.
The scenarios above highlight potential long-term consequences for different stakeholder groups when value accrual is not carefully designed. While short-term token price fluctuations might mask underlying issues, the impact of imbalanced value creation and capture becomes increasingly apparent over longer timeframes. It is the goal of this article to emphasise that the value generated by a system is a scarce and finite resource; therefore, its distribution requires thoughtful decision-making to ensure the system's long-term sustainability and success.
Token Supply and Rewards
A project’s token supply and rewards decisions will continue to define the economic incentives for performing useful actions. As highlighted in The State of Cryptoeconomics, more projects are entering the later stages of growth in their product life cycles. Coming out of the ‘bootstrap’ phase, projects are tasked with finding a sustainable equilibrium for their operations that can survive and grow over longer timescales.
A large predictor of a project's ability to make this transition is highlighted in the earlier discussion about value accrual. For projects that have benefited from using token emissions to bootstrap the supply side of their economy (i.e., incentivising participants such as validators, data providers, and storage nodes) before the natural arrival of demand, the question will be whether they have been able to create the demand that generates value back into the system above the compensation these supply-side participants expect from it. Note that the definition of value may be evaluated differently from project to project and may not equate to revenue or profit.
Example relationship between value generated from demand vs. value paid to supply over time
Supply and rewards describe the management of how projects make decisions around incentivising both sides of the supply/demand relationship to reach a sustainable dynamic over time. In many cases, rewards represent the direct cost to a system, an increase in supply is commonly used as the source of tokens for the early bootstrap, and a decrease in supply may be used as an incentive to align all token holders by supporting value accrual.
As mentioned in The State of Cryptoeconomics, in 2018, towards the end of the ICO era, Multicoin Capital and other researchers proposed the idea of a burn-and-mint equilibrium (BME). This ushered in a wave of projects that designed tokens where usage of the project directly led to token burns. Once the project reached a certain usage threshold, more tokens would be burned from participants than the project needed to compensate its workers (some other independent emission requirement). Ethereum’s EIP-1559 is consistent with this philosophy.
Projects like Helium adopted this philosophy but made a key modification: fix the supply by introducing diminishing emissions. Rather than allowing supply and demand to stabilise at an equilibrium that was roughly fixed or slightly deflationary, they chose to gradually reduce emissions until they neared zero, as outlined in HIP-20. This model was similar to Bitcoin’s halving design.
Although results may seem similar, this difference imposes time pressure on projects to be able to find another way to incentivise supply-side participants. The ability for a project to support these participants through emitting new tokens will eventually diminish due to the fixed supply and diminishing emissions schedule. As the emissions rate approaches zero, there will be fewer newly minted tokens available to incentivise network participants, necessitating a different source of token rewards. This may require implementing aggressive demand-side taxation or changing supply dynamics later on. The primary benefit of this approach is that a predictable fixed supply could be more beneficial to the token's price.
The industry should be advised against making supply and rewards decisions based solely on optics to investors, and it can be the case that a permanent supply budget paid for by the collective dilution of all holders is the economically viable solution. Having to make major changes in the future can work, but is not advisable since it usually involves trade-offs between different stakeholder groups. Projects should approach supply and rewards designs with their long-term ideals in mind and avoid following popular trends that don’t have a significant historical track record.
The importance of the trust and support from participants in systems with long-lasting rules is not yet fully understood. It is likely overlooked by projects that are forced into changes due to short-term thinking early on. Decisions around supply and rewards have some of the most lifelong ramifications and are, therefore, some of the most common places where these mistakes occur.
Token Allocation and Distribution
The increase in competition and number of projects vying for participants is just as relevant to the initial token strategy as it is to long-term viability. As a project’s most important go-to-market event, a well-coordinated token launch can single-handedly address the cold-start problem that all startups encounter in scaling their initial user base. The State of Cryptoeconomics described how airdrop strategies have become more specific and selective as participants become more aware and eager to farm engagement to speculate on token benefits. A further look, however, unlocks some aspects that need attention going forward.
The increase in complexity in airdrop qualification criteria is evident in the industry. This is largely due to the advent of airdrop hunters, participants who can maximise the number of actions that would likely qualify an account over multiple accounts. The need for complex entrance criteria, therefore, serves as both an anti-sybil mechanism and a means to reduce the number of qualifying participants. Running a successful airdrop campaign requires a sizable number of tokens that are distributed to its users, all of which come at the cost of newly minted tokens.
Over time, more genuine users who deserve rewards may not meet the metrics used to assess their contributions. Eventually, a situation will emerge where those who successfully qualify for an airdrop win at the expense of those who did not. On an aggregate level, participants will not be left better off—with a few specialised participants winning a disproportionate share of the initial allocation. The problem lies in a sufficiently large number of organic participants turning bitter to a system that rewards those better at gamification over honest commitment.
Eigenlayer’s airdrop campaign was met with resentment when stakers felt like they were inadequately rewarded due to how much the criteria preferred larger holders. As a result, Eigenlayer increased the size of the airdrop by 28 million tokens allocated evenly to all stakers. At a premarket trading price of around $9, a better allocation design could have nominally saved the project $250M to be allocated elsewhere.
Of the multiple paths forward for this issue, the core need is a better method of identifying meaningful participation and figuring out the best ways of including those users in a token’s allocation and distribution strategy. Airdrops, which reward an arbitrary amount of speculative contribution with free tokens, may or may not be the best mode of issuing these rewards, as discussed in The State of Cryptoeconomics.
It is worth mentioning that a better approach to genuine participation identification has implications beyond just airdrops. Much like how projects have increasingly included key opinion leaders (KOLs) in private investment rounds, projects may want to include their distinguished participants more intimately in various parts of the projects, such as investors, core contributors, or community leaders.
Progress in DIDs, reputation scoring, and social graphs are all positive signs that the industry is moving in the right direction. Hop Protocol’s campaign for Sybil-resistance remains a positive case study into an approach to airdrops that both improved the selection process and incentivised users to participate. Ultimately, it is how this selection process can positively inform allocation and distribution decisions that should remain a top priority for the industry moving forward.
Governance and Community
Technological innovations will continue to push the boundaries of the blockchain industry in all directions. It is the role of governance to not only chart the right course for this innovation but also to manage its growth over time. Tooling will continue to evolve so that projects will be able to implement almost any system of decision-making with codifiable rulesets. As a result, projects should put special emphasis on both the metagoverning decisions themselves and the ability to engage voters, which are key success conditions for governance systems going forward.
Approaches to governance will have to adapt to increasingly decentralised blockchain-based infrastructure. The ability for decentralised decision-making is a core benefit of the underlying technology. However, the current domain of understanding around governing social structures primarily revolves around centralised entities such as governments and corporations, with few exceptions (like cooperatives). Ideally, an industry that has the right mix of enabling technology and a philosophical desire for self-sovereign systems would have both the tools and ambition to innovate on these structures. The History of Cryptoeconomics described the period of DeFi’s experimentation with token governance models in 2020 through mechanisms such as vote-escrow and examples such as Compound. Future developments could improve some of the drawbacks of these token voting models, such as the inherently plutocratic nature of one-token one-vote models.
The role of the community within a project will also continue to evolve and differentiate between projects. In line with the better identification of communities, as highlighted in the previous section on Distribution and Allocation, projects with more ‘futurist’ philosophies should aim to involve their core community more intimately with governance. This involves blending the roles of participants and contributors. In a pseudonymous work environment, participants may be recognised for their reputable actions rather than being seen as individual actors. Conversely, certain voting procedures may prioritise identifying real human accounts amongst potential sybil ones. In both cases, better recognition will help better identify participants, creating a positive feedback loop that enhances how everyone is perceived and engaged.
Projects that navigate this dynamic will also likely see sustained competitive advantages develop as a result. Projects with stickier communities may be able to utilise more non-token and potentially non-financial rewards, such as additional rights. This makes them more competitive over other communities that would need to otherwise fund their own engagement and development to a community that is overall less sticky.
Governance, coupled with the ability for a greater interconnection between project and community, may ultimately be the catalyst for the blockchain industry to become a major part of its participants' professional and personal lives. The evolution of governance, though technological in part, will largely start to hinge on the collective socioeconomic metagoverning ideas of a project's constituent participants.
Conclusion
As this marks the final piece of the introductory series on cryptoeconomics, it is clear that the intersection of blockchain technology and economic principles holds profound potential for reshaping industries and societal structures. The evolution of cryptoeconomics not only challenges conventional financial systems but also redefines how value can be created, distributed, and preserved within digital economies more generally.
The road ahead for cryptoeconomics is marked by the need for continuous innovation and deepened specialisation within the field. As practitioners and researchers push the boundaries of what is possible, the integration of new technologies will further refine and expand the capabilities of blockchain-based systems. This includes expanding the known domain of token utilities and mechanism design.
Designing systems with long-term outlooks is useful when making decisions on token supply and rewards. This outlook similarly ensures that the balance between value generation and capture is sustainable over multiple product and market cycles.
Additionally, a more careful approach to how participation aligns with the success conditions of a project can aid in allocation and distribution decisions, as well as foster a community over time that all feel passionate about steering the project in a positive direction.
A combination of the long-term outlook and attention to participation creates an ecosystem where participants can truly dedicate their efforts to decentralised projects with the confidence that their contributions will be fairly recognised.
The future of cryptoeconomics lies in its ability to harness technological innovation for the betterment of all participants through the use of well-designed economic designs and mechanisms. As the industry continues to explore and innovate, it is the goal that this series serve as a foundation for further discussion and development within the cryptoeconomic landscape. Just Cryptoeconomics will continue to offer thought pieces and frameworks to serve as a reference or incite healthy debate in the space. There is reason to be optimistic that a resilient and adaptive industry can be developed that anticipates and shapes the economic paradigms of the future.
