5 things to look for in tokenomics (No. 4 is controversial but important):

Most fungible tokens can be classified into 3 types according to their purpose:

1. Quasi-equities

These tokens give holders a share of project profit, often w/ some sort of voting rights, which make them similar to stocks, except:

Shareholder rights are protected by law. Quasi-equity token holder rights are protected by code. Projects tell you code = law. But code can be much easier to update than law.

’Tis not obvious when everyone’s making money. But when time is tough incentives change. Example. Some deFi projects w/ liquidity problem recently withheld revenues it owed to LP token holders. You can’t get away w/ reneging on shareholder rights this easy.

Don’t get me wrong, quasi-equity tokens make a lot of sense.

They allow you to invest in early stage projects esp those that are actually decentralized & thus aren’t fit to be corporate entities. Your rights are transparent & programmed. Value creation-to-distribution loop is tighter than traditional equities.

Still you may have little legal protection so keep eyes wide open.

2. Quasi-currencies

These are utility tokens that serve clear functions in project operation, for example as medium of exchange for goods & services the project provides. paying for txn fees, redeeming for discounts.

Imo utility tokens have the biggest room for innovation in crypto esp if integrated w/ real life products & services:

3. Betting tickets / memes

These tokens are linked to a project in name only. They have non-zero price b/c of tacit agreement among mkt players that if project does well, price goes up, in same way that betting tickets in a horse race for horses w/ prior winning streaks are more expensive.

Categories are not clear cut, as in all financial mkts participants are playing against other players. In this sense all assets, w/ utility or not, are betting tickets if they’re traded in a mkt. That include the quasi-equity & quasi-currency tokens.

Next let’s look at 5 features to look for in project tokenomics. All of them apply to quasi-currency / utility tokens. Some apply to quasi-equity & memo tokens too.

1. Sustainable spending utility from uncorrelated demand

Weakest point of any crypto token today is to have strong spending demand not correlated w/ speculative motives.

Many web 3 projects attempt to solve spending demand problem either w/ high yields on staking to temporarily absorb excess supply, or relying on endless new inflow of speculative users to pump demand.

These approaches are highly reflexive, feeding on existing price trend. In bull mkt they accentuate upward momentum in price. In bear mkt they exacerbate downward volatility & leave behind a trail of cynical investors wary of ponzi-nomics.

That’s why imo web 2.5 projects, combining web 2 products of real life use cases w/ tokenization biz model, may have biggest potential to solve this challenge while crypto adoption is low, as they introduce possibility to have token demand uncorrelated with state of crypto mkt.

2. Holders benefit from project growth

Holder benefits can take many forms.

Some direct: e.g. via revenue shares for quasi-equity or debt tokens, or via token repurchases using project profits.

Some indirect: if the token use case is to redeem products/services from the project, token price would tend to appreciate when demand for said products grows.

The latter’s not that different from what happens w/ real life currencies. When a country’s economic growth is strong, demand increases for its currency as economic txn volume grows, which leads to exchange rate appreciation.

Another type of indirect holder benefit: strong spending demand + project growth can allow project to allocate additional token supply to holders w/o excessive impact on price, similar to stock splits from well-to-do companies.

3. Mechanism to stabilize token price

Most central banks use whatever tools they have to curb excessive exchange rate volatility, as the latter increases txn cost for trade & commerce while undermining long term trust in the currency.

Quasi-currency/utility tokens should think abt price stabilization for same reasons.

Projects that allocate a portion of profits towards token buybacks, preferably in a counter-cyclical manner, tend to see less volatile price movement. So do projects that systematically allocate profits to support liquidity in LP pools of their own tokens.

Example: utility tokens from FTX & Binance both have regular buyback mechanism in place. Both have outperformed large caps (BTC, ETH) in current downturn.

It also helps that these tokens have clear spending utility in products the demand of which is less cyclical than most web 3 projects of today.

(BTW, like this so far? I help you get smarter about web3 & macro. Subscribe to my newsletter for updates.)

The other side of stabilization— increase token supply when there’s excess up move in price— is less popular, but equally important if a utility token wants to have long term price stability.

This doesn’t have to hurt holders if new supply is allocated to existing holders or if profits from project’s “open mkt operations” are shared w/ holders in some way.

4. Non-rigid emission schedule

Many projects try to model token supply after bitcoin w/ fixed emission schedule, capped final supply & even a “halving” scheme.

This sounds good on paper but in reality has many problems.

For one, finite supply cap is typically only binding many yrs down the road. It does nothing to countervail demand shifts in short to medium term. Hoping the supply cap would shore up price is more a psychological illusion than reality.

Secondly, fixed emission schedule unnecessarily ties the project’s hands in responding to rate of project growth & general mkt conditions.

’Tis especially true for quasi-currency / utility tokens, the supply of which would ideally be contingent on how fast the project grows & associated increase or decrease in txn needs.

It’s sheer insanity to have fixed token emission rates for 10 yrs out before project gets any traction w/ no historical data to base growth projection on. Yet that’s what most projects today choose to do for a fake sense of certainty.

Same issue applies to final supply cap. If project outgrows its current stage, token supply increase would eventually be an important lever to stabilize token price. Giving up the option in exchange for a limited-supply meme is vastly short sighted.

5. Design simplicity

Complexity in token design is often an attempt to fix problems w/ project profitability or sustainability. But those aren’t problems tokenomics can fix.

Some projects keep inventing new “user cases” for tokens, e.g. new metaverse land or NFTs to buy, multiple levels of staking, etc. These merely obfuscate underlining ponzi-nomics & don’t change the fact that user base consists mostly of speculators w/ little actual adoption.

A real *use case* is one that doesn’t positively correlate w/ reflexive price moves of crypto mkt. If after reading a tokenomics doc, you can’t explain to someone else in 5 mins how the design works, ask yourself what the project’s actually trying to accomplish.

TLDR: 5 features to look for in tokenomics–

  1. Sustainable spending use cases uncorrelated w/ crypto mkt cycles
  2. Holders benefit from project growth, directly or indirectly
  3. Mechanism/plan to stabilize token price
  4. Non-rigid emission schedule
  5. Design simplicity


1 Comment

  1. Thank you for your very interesting post. Can you please share more on the 4 and 5 , what would a simple design use case be like? Any examples out there that follow your methodology ?

    Love your work and would love to connect and share thoughts 🙏🏾