Why Cryptoeconomics Matters
Acknowledgement
We wish to acknowledge the impact that our time at Smith + Crown had on us as cryptoeconomics researchers and practitioners. All three of us learned and developed our foundational cryptoeconomics knowledge, expertise and skillsets while at Smith + Crown, and if it were not for the organisation and its exceptional people, Just Cryptoeconomics would not exist.
While independent from Smith + Crown in our ideas and organisation, our work, here in this article series and elsewhere, is embedded with much of those ideas we learned and contributed to while at Smith + Crown, and readers will frequently encounter citations, glossary entries and other references to the organisation throughout our content. It is with gratitude that we reflect on our past association with Smith + Crown, and with excitement, we look forward to contributing novel ideas and advancements to the field.
Key Takeaways
Cryptoeconomics is an interdisciplinary field combining technology and economics to develop blockchain-based economies with aligned incentive structures.
It enables active participation and addresses challenges traditional systems struggle with by leveraging programmable software and economic rules.
It facilitates equitable governance and ownership of digital and real-world systems through combined access, governance, and ownership rights.
Cryptoeconomics provides a framework for innovative, participatory, accessible, scalable, and efficient alternatives to existing economic systems and organisations.
It can help accelerate growth and development by balancing incentives for both supply-side and demand-side participants.
Introduction
The blockchain industry, often referred to as crypto or Web3, encompasses a wide range of domains and subject matters, each contributing to its overall development. These domains can broadly be classified into two categories: technical and social sciences.
The technical sciences, such as cryptography, computer science, and engineering, provide the foundational infrastructure for blockchain-based systems, collectively referred to as blockchain technology (although technically imperfect, 'blockchain' is used to refer to the broader set of distributed ledger-based technologies.)
On the other hand, the social sciences focus on understanding decision-making in the context of these blockchain-based systems, particularly economic behaviour and motivations. Cryptoeconomics lies at the intersection of these two categories, grounded primarily in the economically-oriented social sciences.
Cryptoeconomics is an interdisciplinary field at the intersection of technology and economics that concerns the development of economies underpinned by blockchain technology. It focuses on the use of incentive structures to align individual actions with the goals of entire systems and effectively manage digital rights and resources, all without the need for central intermediaries.
The distinction between blockchain technology and cryptoeconomics highlights the interdisciplinary nature of the broader industry and the complexity involved in designing blockchain-based systems that integrate components from both fields
The industry has often focused more on the technological side, often at the cost of vitally important economic considerations. For example, despite Bitcoin's robust technical foundation, including its consensus protocol and communication layer, it faces challenges in becoming a widely adopted monetary asset due to some issues with its cryptoeconomic design, such as the long-term incentive for miners as the BTC issuance limit approaches and transaction fees become the primary compensation.
Blockchain technology affords valuable features and benefits to the systems it powers, enabling opportunities such as:
The capacity for scalable sovereign systems, enabling democratic and decentralised decision-making.
Trustless disintermediation, eliminating the need for middlemen.
The ability to create resilient and tamper-resistant systems, ensuring reliability in operations.
[Please see here for a full account of the valuable features of blockchain technology.]
While these technological advantages are powerful, when paired with the economic logic made possible by cryptoeconomics, it is possible to go further, creating systems that:
Enable active participation from all those involved.
Are sovereign and confer ownership to those participants.
Are genuinely novel and revolutionary.
Can grow at significantly faster rates.
The rest of this article will explore these four attributes that make cryptoeconomics, as a study and practice, especially important.
1: Active Participation
Cryptoeconomic systems offer solutions to challenges and opportunities that traditional economic systems built on laws and geopolitical relations struggle to address effectively. By leveraging programmable software secured by blockchain technology to encode and enforce economic rules and logic while preventing centralised entities from controlling said software, it is possible to create systems that are inherently more versatile, flexible, efficient, and innovative than traditional models allow.
A key distinction is the ability for participants to benefit financially from a system's growth through incentives that promote long-term, active participation. While blockchain projects are often overshadowed by short-term speculation, thoughtful cryptoeconomic design can create complex roles where participants earn by actively contributing work or resources, fostering true ownership and involvement.
Active participation is essential for all participants in a cryptoeconomic system, including users, token holders, service providers, but also project owners. When a project issues a native token, it enters a dynamic relationship with the public market, requiring the team to actively engage, adapt to market trends, and make strategic decisions. This level of involvement is more demanding than in traditional economic systems. For example, if airline miles were traded like tokens, their value and utility would constantly fluctuate, requiring the airline to manage its token economy proactively. This complexity and the need for active participation from all parties distinguish cryptoeconomic systems from traditional models.
In summary, cryptoeconomics transcends traditional economic models, enabling democratised participation and inclusive growth and redefining value creation by aligning incentives for productive, active involvement. The economic engagement mechanisms inherent to cryptoeconomics can empower participants and groups to shape public goods and shared systems, presenting genuinely unique opportunities for collective prosperity.
2: Sovereignty and Ownership
Inequitable power distribution has troubled societies throughout history, whether due to the outsized influence of wealth over merit and ability or other systemic imbalances. The theme of concentrated power persists despite novel political and economic models aiming for more equitable structures.
Cryptoeconomics, enabled by blockchain technology, offers a potential solution to governance challenges. It enables the equitable governance and ownership of digital and real-world systems, products, services, and organisations by their participants. Developing these decentralised, self-governing 'sovereign networks' or 'network states' owned by users is a significant goal, though still more ambition than reality for the industry currently.
At its core, cryptoeconomics allows combining access rights, governance rights, and ownership rights, typically through tokens. Unlike traditional equity or debt instruments solely representing financial claims, tokens grant holders rights to access and govern shared digital resources and communities. This blending of usage and ownership empowers participants as primary stakeholders and beneficiaries. The transparent nature of smart contract-based software encoding these rights and rules, coupled with the ability to distribute control over this software, strengthens this value proposition.
Projects have adopted various approaches toward this participatory ideal. Ethereum's proof of stake transition shifted network control from miners to ETH stakers. Projects like MakerDAO opted for decentralised autonomous organisation (DAO) structures, conferring governance rights to token holders. While no governance design is perfect, cryptoeconomic principles provide the tools and opportunity to build sovereign systems where ownership and control reside with participants, underpinned by transparent, collectively managed rulesets.
However, ensuring fair, accessible participation requires addressing barriers like the digital divide, technological complexity hindering involvement, and the potential for wealth concentration distorting token-based voting. Proposed solutions include user-friendly interfaces, educational resources, mechanisms for equitable token distribution, and safeguards against vote-buying.
For designers, balancing financialisation with product needs presents trade-offs. For example, an immutable, hard-coded social media platform may struggle to adapt to evolving user needs. Conversely, enabling frequent modifications via token voting could compromise core principles like censorship resistance over time.
Cryptoeconomics introduces novel governance and ownership models by aligning incentives and distributing control. These frameworks enable all participants to collectively steer the formation of shared digital and real-world resources—from protocols to economies—in a decentralised manner, minimising trust in single entities. While implementation challenges exist, examples across sectors like upgradable protocols and self-governed DAOs demonstrate the potential.
3: Enabling Novel Systems
Cryptoeconomics marks a significant departure from traditional economic and governance structures, offering a pathway to disintermediate and replace existing systems with more participatory, accessible, scalable and efficient alternatives. This shift provides a broad canvas for innovation, challenging conventional practices and paving the way for projects with unique missions and structures to emerge.
Unfortunately, a notable trend is a tendency to simply replicate existing models within cryptoeconomic frameworks, overlooking the opportunity to critically reevaluate and adapt these models to leverage blockchain technology and cryptoeconomics' full potential. This ‘copy-paste’ approach leads to missed opportunities for genuine innovation by failing to utilise cryptoeconomics' inherent unique capabilities.
We encourage practitioners to engage with cryptoeconomic fundamentals deeply, envisioning novel models that not only adapt but also enhance traditional systems, closely aligning each project's specific functionalities and goals. True cryptoeconomic innovation is not just theoretical but practical, as numerous projects have demonstrated its transformative potential:
Bitcoin: The cryptoeconomic system underpinning Bitcoin's issuance of BTC plays a role in incentivising the participation of necessary miners, with the benefit of decentralising token ownership as miners sell tokens to realise revenue from their work.
Ethereum: Ethereum's cryptoeconomic system balances the supply of ETH based on 1) the amount locked and 2) network usage. Collectively, this aims to introduce scarcity, imparting money-like attributes to ETH.
Flashbots: The cryptoeconomic coordination system that Flashbots developed allowed Ethereum to mitigate the negative externalities posed by MEV and avoid centralisation of the validation process.
MakerDAO: The governance of MakerDAO is enabled by a cryptoeconomic system that provides token holders with governance coordination tools on changes to the entire system, both economic and technical. This allows MakerDAO to operate as a token-holder-controlled decentralised central bank.
NFT Communities: The rise of NFTs has seen the formation of vibrant communities that have collectively developed and steered brands. These communities demonstrate the power of tokenisation and community alignment but have often suffered from extreme speculation-driven price movements.
Cryptoeconomics expands possibilities for innovation, collaboration, and value creation beyond traditional boundaries. The flexibility of incentive design and token utilities enables the creation of systems and products that align more closely with the needs and values of a rapidly evolving digital world.
4: A Tool for Growth
Cryptoeconomics acts as a catalyst for accelerated growth, facilitating faster-than-otherwise development and expansion of products, services and ecosystems. This stems from cryptoeconomics' ability to balance incentives for both supply-side and demand-side participants, who are necessary for a holistic system, whether it be service providers, governance participants, developers or users, or any other relevant and necessary role.
Cryptoeconomic mechanisms are essential for the operation and growth of many decentralised systems. Bitcoin, for example, is deeply intertwined with its native BTC token. Without its incentive layer, Bitcoin would struggle to attract the support of miners and thus sustain itself as a permissionless and secure network.
However, cryptoeconomics' applications extend beyond just decentralised use cases. Tokenisation models can benefit centralised organisations by incentivising user participation and alignment, whether through tokenised airline miles rewarding customer loyalty or ride-share drivers earning tokens for completed trips.
Moreover, tokenisation represents a paradigm shift in go-to-market strategies akin to debt financing - it allows organisations to access or realise future value by incentivising early participation and adoption through token-based incentive models.
Through elegantly designed incentives and tokenised ecosystems, cryptoeconomics enables faster user onboarding, stakeholder coordination and network effects compared to traditional growth opportunities.
In essence, cryptoeconomics unlocks new levels of accelerated growth potential by aligning incentives, coordinating stakeholders and accelerating value realisation in ways that traditional systems cannot.
Conclusion
The combined use of blockchain technology and cryptoeconomics has great potential to help develop economies and organisations and the people who participate in them. Blockchain provides a trustless and secure infrastructure platform for connectivity, while cryptoeconomics defines the motivations and incentives that govern these interactions, all without the need for dependency or trust on central intermediaries.
The success of blockchain-based projects relies on well-conceived cryptoeconomic designs that balance technical innovation with a deep understanding of human behaviour and economic design. This balance is essential for creating self-sovereign systems, facilitating disintermediated participation, and ensuring the longevity of tamper-proof public goods.
Advancing cryptoeconomics as a field of study requires collaborative research and practical experimentation and making concepts accessible to a broader audience. The path forward is not merely technological; it is a step towards a more interconnected and economically inclusive world.
In summary, the fusion of blockchain technology and cryptoeconomics is critical to unlocking a new era of digital interactions and economic structures. By aligning incentives, facilitating active participation, and enabling the creation of novel, sovereign systems, cryptoeconomics can drive unprecedented growth and innovation.
