What is Cryptoeconomics Part 2
Key Takeaways
Cryptoeconomics extends beyond core areas to related areas such as technological choices, governance, stakeholder analysis, token investment analysis, and regulatory compliance.
Product design, marketing, sales, business development, and off-chain decisions, while interacting with cryptoeconomic systems, are not inherently within the field's scope and are categorised as excluded areas.
Cryptoeconomics benefits from insights from established disciplines and relevant fields like systems engineering, cryptography, game theory, and economics.
Ongoing research, experimentation, and collaboration are crucial for addressing challenges in the field of cryptoeconomics and advancing its study and application.
Introduction
So far in this series, we have explored the importance of cryptoeconomics and its core building blocks, establishing its role in creating novel, participatory, and self-sovereign systems by aligning incentives and enabling active engagement without central intermediaries.
This second part of a two-part article examines the fringes of cryptoeconomics, mapping its boundaries and intersections with other domains. It considers three categories:
Related areas within cryptoeconomics' scope
Excluded fields sometimes mistaken as part of cryptoeconomics
Relevant external fields that have influenced cryptoeconomics
Delineating these boundaries is crucial for clarifying cryptoeconomics' scope and its relationships with other disciplines, which is important for designing and analysing effective cryptoeconomic systems.
By exploring cryptoeconomics' boundaries and its connections to other fields, we aim to provide a comprehensive introduction, empowering readers to navigate the complexities of cryptoeconomic design and contribute to its ongoing development. Together with the rest of this introductory series, it lays the groundwork for a more informed and effective approach to cryptoeconomics.
Related Areas
The design of cryptoeconomic systems often involves additional contingencies and considerations beyond those outlined in Part 1. These decisions frequently overlap and can significantly influence the more familiar core areas, thus falling within the domain of cryptoeconomics as Related Areas.
Technological Choices
A project's choice of technology stack is a critical decision that impacts its functionality, security, access to capital, and community engagement. Economic viability also plays a significant role in these decisions.
Consider an Ethereum rollup facing a choice between using a centralised sequencer or a shared sequencer network. Each option presents distinct trade-offs:
Centralised sequencers offer greater flexibility and control but may limit interoperability. They are vulnerable to single points of failure but are more resistant to MEV attacks. However, reduced ownership over sequencing infrastructure could affect the rollup's ability to attract external capital.
On the other hand, shared sequencer networks provide better interoperability and faster pre-confirmations. They tend to be more decentralised, which can improve user experience and perception. Nonetheless, rollups can choose to reject the ordering provided by the shared sequencer. Adopting a shared sequencer network would mean forgoing proceeds from ordering and fees, necessitating additional incentives for sequencer operators.
These considerations highlight the importance of understanding the implications of technological choices on a project's cryptoeconomic design. Practitioners must ensure that the chosen stack aligns with the project's economic goals and that any additional mechanisms introduced are compatible with the existing infrastructure.
To create effective cryptoeconomic systems, designers must have a deep understanding of the capabilities and limitations of the project's blockchain infrastructure, ecosystem partners, and smart contract tools. By leveraging this knowledge, they can propose designs that are not only economically sound but also technically feasible.
The technological choices made by a project have far-reaching consequences for its cryptoeconomic design. A holistic approach that considers the interplay between technology and economics is essential for creating robust, secure, and viable systems.
Governance
In addition to the core cryptoeconomic areas covered in Part 1, governance also encompasses related areas that, while not explicitly economic, can significantly influence a system's overall health and sustainability. These include:
Governance structures and participation models: Designing chains of command, proposal processes, voting mechanics, etc., to suit the project's decentralisation goals and community engagement needs.
Technological decision-making: Coordinating protocol upgrades, new feature prioritisation, bug fixes, and other technical matters that impact system performance and usability.
Community management: Defining codes of conduct, moderation policies, stakeholder onboarding processes, and other social frameworks to foster a healthy, engaged community.
Ecosystem expansion: Making strategic decisions around partnerships, integrations, marketing initiatives, etc., to drive adoption and grow the project's footprint.
The specific approaches a project takes in these areas should align with its unique vision and needs. For instance, a DAO aiming for maximum decentralisation may implement flatter structures with more open participation, whilst one prioritising rapid execution may opt for tiered hierarchies with specialised subcommittees.
A project’s chain of command and needs for hierarchies may inform its governance structure.
Balancing trade-offs is key when designing related governance frameworks. Using third-party DAO platforms can speed up development and enable interoperability but may constrain customisation. Codifying too much logic on-chain promotes transparency and automation but can limit flexibility to adapt to changing circumstances.
Ultimately, related governance matters, whilst not as traceably tied to cryptoeconomics as core areas, are important to a project's long-term success. Effective governance involves carefully considering all relevant topics, and cryptoeconomic design connects these key issues with those most affected and those most capable of addressing them.
Stakeholders Analysis
Understanding how key stakeholders evolve is directly relevant to a system's health. Public blockchains can augment traditional stakeholder analysis by providing new tools to manage relationships, such as the ability to observe on-chain behaviour and distribute tokens or grants to reward participation and allocate ownership. For instance, projects can track token transfers and voting patterns to identify active and influential stakeholders.
Projects must be able to properly account for and represent stakeholders. For example, in systems that use token holdings as a means for representation in governance voting, investors with large token exposures have more influence than dApp developers who hold fewer tokens. If there is a proposal pertaining to developer experience, the project may want the latter group to have a larger influence on the outcome compared to the former. Future articles will delve deeper into specific stakeholder groups and common interests, including but not limited to:
Team: Ensuring alignment with the project's long-term vision and managing token-based compensation.
Builders: Fostering a vibrant developer community and providing appropriate incentives for contributions.
Equity and private investors: Balancing their interests with those of the wider token holder community.
General token holders: Engaging them in governance and aligning their incentives with the project's success.
Demand side participants: Understanding their needs and creating mechanisms for their effective participation.
Supply-side participants: Fostering a robust ecosystem of service providers and contributors.
By analysing the representation of these stakeholders based on token holdings, projects can gain valuable insights into potential imbalances or concentrations of influence. This information can help inform strategies for community engagement, token distribution, and governance design, contributing to the overall health and sustainability of the cryptoeconomic system.
Token Investment Analysis
It is erroneous to conflate tokens with traditional assets, such as securities. Tokens typically do not encapsulate the full scope of a project in the same way as common stock does in the case of corporations. However, tokens do often present an investment opportunity, and their holders typically want to see their value increase over time.
It is beneficial for projects to acknowledge this as an inevitable feature of having a publicly exchanged token. When applied correctly, the increased value provides projects with greater opportunities to grow their products and expand operations.
Investors can and have adapted existing valuation models, such as discounted cash flows and comparables analysis, to create investment theses about projects. However, there are often important limitations to applying these frameworks to tokens, given the scope of a token’s utility and rights, as discussed in Part 1. A cryptoeconomics-focused analysis may include studying the token's value accrual and distinguishing where value accrues back to the token, to a project's corporate entity, or to some other structure.
Having a private controlling entity and a public token pool is a further reminder that tokens should not be considered equity in the full project. As this can often be a point of friction, those expectations must be addressed and clarified before tokens are issued to the public.
Legal & Regulatory Compliance
All project operations and cryptoeconomics should comply with relevant laws and regulations. As regulatory scrutiny varies by jurisdiction, projects should always consult qualified legal counsel to navigate the regulatory landscape surrounding tokens.
The high-profile case of the U.S. Securities and Exchange Commission (SEC) v. Ripple Labs illustrates the nuances in regulatory views on token-related activities. A U.S. judge ruled that Ripple's public token issuances were not securities offerings, but its institutional token sales met the criteria for securities. This split decision underscores the importance of carefully structuring token issuance processes.
Regulatory considerations significantly shape cryptoeconomic design choices, especially token utilities and rights, distribution mechanisms, and governance structures. Projects must balance economic objectives with mitigating regulatory risks. Proactively addressing regulatory factors in the design phase helps create more resilient, sustainable cryptoeconomic systems.
Any considerations of how the companies behind projects are structured and incorporated are decisions best left to legal and other professionals in the relevant jurisdictions. Regulatory limitations may inform cryptoeconomic decisions due to how off-chain entities are set up, but that tends to be the extent of its relationship.
At a high level, projects need to consider where to incorporate as well as how. There are several jurisdictions that support Virtual Asset Service Providers (VASPs), with the ability to obtain a token legal opinion and create appropriate investor agreements being two key project considerations.
Future articles will cover the impact of regulatory limitations on cryptoeconomics practitioners.
Excluded Areas
Certain areas of operations fall outside the bounds of cryptoeconomics and are not considered part of the field.
Product Design and Strategy
The goal of cryptoeconomics is not to directly dictate product or strategic decisions. This typically includes most product ideation and creation, UI/UX considerations, core product infrastructure, technical audits, monitoring and compliance. Generally, these are considered fixed constraints for cryptoeconomic designers. However, cryptoeconomics can help choose between similar product design options, especially when considering user experience and journeys.
In certain cases, a core product's design is synonymous with its cryptoeconomics, such as with stablecoins, where the economic mechanisms are intrinsic to the product's basic functionality and stability. In general, though, these should be considered exceptions.
Marketing, Sales & Business Development
Similarly, cryptoeconomics does not directly address how projects engage with users and clients commercially. The cryptoeconomic principles associated with commonly overlapping marketing events, such as airdrops or bounties, tend to focus on the fairness of distribution rather than their impact on adoption and engagement. While there is some overlap regarding user engagement, as token incentives can drive adoption, it is important to distinguish this from viewing token distribution events as a sustainable means of user acquisition.
Sales and business development expenses can fall into a similar category, where tokens may be allocated towards a budget for certain initiatives. However, this is generally to the extent that tokens are used as a cash-like instrument rather than being a core component of the token's design or cryptoeconomic considerations. Many projects mistakenly conflate a marketing event with a fundamental part of their long-term cryptoeconomic model, failing to recognise the distinction between short-term promotional activities and the cryptoeconomic design.
Off-Chain Decision-Making
Cryptoeconomics often focuses on capturing and representing on-chain decisions, but many projects also make off-chain decisions that are not represented on-chain. These off-chain decisions might include business and product choices or user preferences like software choices.
Projects should carefully consider the potential impact of off-chain decisions on the cryptoeconomic system, the necessity of on-chain representation, and the associated trade-offs. Establishing guidelines and frameworks for assessing these decisions can help maintain the integrity of cryptoeconomic systems.
As the field evolves, new technologies may emerge to bridge the gap between off-chain decisions and on-chain systems. However, a thoughtful and cautious approach to off-chain decision-making remains crucial for designing robust and resilient cryptoeconomic systems.
Relevant Fields
As a nascent interdisciplinary field, cryptoeconomics draws inspiration and influence from many established fields. These fields predate cryptoeconomics, offering more historical precedence and academic literature that can efficiently support its growth. This list is not exhaustive but is a useful starting point for readers.
| Fields | Description | Relevance |
|---|---|---|
| Systems Engineering | The design and management of complex systems throughout their lifecycle [source]. | Cryptoeconomics studies how to create lasting economic systems. While it primarily focuses on establishing sustainable initial conditions, it must also be adaptable to live tokens. |
| Cryptography | The study of secure and fraud-resistant communication through mathematical computation [source]. | Advances in cryptographic primitives inform cryptoeconomics by expanding the range of possible implementations, bridging theory and practice. |
| Distributed Systems | Systems where computation or infrastructure is performed and shared by independent nodes [source]. | Distributed systems with heavy computational loads on nodes are largely enabled by decentralised incentives. Cryptoeconomic implementations must maintain the decentralisation standards set by the underlying system. |
| Game Theory | The study of how agents make decisions in competitive scenarios based on their preferences [source]. | Cryptoeconomics often solves coordination problems, ensuring that the ideal action for each party aligns with the ideal action for the entire system. Game theory concepts help prevent the emergence of malicious dominant strategies. |
| Behavioural Economics | The practical study of why agents behave in certain, often irrational ways [source]. | Behavioural economics provides insights into the actual behaviour of participants in response to system events. |
| Incentive Design | Structures implemented to boost worker productivity and motivation, traditionally in corporations or social welfare initiatives [source]. | Cryptoeconomics draws from this to create supply-side workforces of distributed contributors. Understanding existing corporate incentive designs is a useful starting point for adapting them to an on-chain economy. |
| Economic Policy | Frameworks for understanding the role of managing an economy, including the circulation of money through inflation, taxation, subsidies, and interest rates [source]. | Traditional economic policy is valuable in understanding the value of designs that attempt to create internet-native money, including generalised money and tokens used to transact for specific products and services that integrate blockchain technology. |
Conclusion
This two-part article explores cryptoeconomics, highlighting its interdisciplinary nature and crucial role in designing and governing blockchain-based systems. Cryptoeconomics, at the intersection of technology and economics, extends beyond tokens or economic transactions. Its influence informs and is affected by technological choices, governance structures, stakeholder analysis, investment considerations, and beyond.
To fully realise cryptoeconomics' potential, ongoing research, innovation, and experimentation are essential. This requires addressing challenges like standardisation and potential regulatory developments while seizing opportunities for collaboration and knowledge-sharing within the cryptoeconomics community.
We encourage readers to engage with the material in this series, apply the concepts to their projects, and contribute to the field's ongoing development. By working together and building upon the foundational understanding provided, we can collectively shape cryptoeconomics' future and its role in the broader landscape of the blockchain industry and beyond.
As we continue with our introductory series, our next article explores the history of cryptoeconomics to help understand its current state and highlight remaining challenges and opportunities.
