I have been thinking a lot about what a token is, and what it should be. There is a constant evolution of token models and designs across all different ecosystems, it’s almost impossible to stay up to date. However, as I continue to read and learn, I have curated some of my thoughts below, and full disclosure I am sure these will change over time!
Tokens as Equity
It’s really interesting to think about a token as equity, especially DeFi protocol tokens. Let’s think about a DEX. A DEX collects revenue for each swap in any liquidity pool. This revenue goes to the treasury, which then is used to pay the protocol expenses. I imagine the largest expense tends to be team member salaries, but there are plenty of other expenses as well. Once all of those expenses are paid, any assets left over are profit to the DEX. What should that DEX do with those profits? Protocols early in their lifespan, especially in the ever-evolving space of DeFi, should be reinvesting in themselves and marketing. They should be willing to spend on new features (a CPMM DEX looking into stableswaps and CLMM and new evolutions), new integrations, marketing across the ecosystem, research, etc. But as time goes on, there may be less need for this constant reinvesting in the DEX, and profits may be large enough to distribute to token holders, preferably not just in the DEX’s token (I like the idea of whitelisting a handful of tokens that the DEX collects as revenue, especially L1 tokens and stables)… This looks like an equity dividend.
However, the main difference between this model and a public equity model is ‘trust’. Token holders have no actual legal claim on the protocol and these profits. Its initially completely up to the team to do what they want to do with the protocol’s profits (and assets for that matter… rugs happen). DAOs and multi-sigs help alleviate this a little bit, but each comes with its own set of challenges. DAOs could be great, but do you really need individuals to vote on every parameter of a protocol, people are going to get ‘vote fatigue’ very quickly! Many of the small decisions of a protocol should be made by the team. They are the experts here, they understand how and why they built the protocol like they did, they should be in charge of these parameterizations and smaller decisions, the same way you hire a management team at a company.
All of this is great, but maybe public equity shouldn’t be the ideal for a token. Who is the management team of a public company required to manage the company for? Its the equity holders. The management team should be optimizing the performance of the company to extract every last profit from the market, their customers, their employees, etc. for the bottom line; so that the equity of the company has a higher price and can distribute more to equity holders. In my opinion, this is not wrong (maybe ethically, but not practically…). This is how the structure is set up for public companies. Managers doing this are literally doing their jobs. But maybe we need to come up with a better structure, where we can reward token holders, but not at the expense of all stakeholders (especially protocol users, partner protocols, team members). Given this space is so new, we have the opportunity to do that now. One of my current favorite structures in TradFi is the Mutual Insurance Model, especially in an Asset Management company like Vanguard (see a quick description in the appendix below).
Some things are public goods, other’s not so much
There is a lot of great information out there around public goods in crypto. I highly recommend people read about retroactive public good financing that Optimism is working on, based on Vitalik Buterin’s idea.
I think it is easier to see a Layer 1 and Layer 2 protocol as a public good. These are necessary goods that we should all strive to make available and useable (read as cost efficient) for every individual across the world. I don’t know that I think L1s should be profit making machines. Granted, much of the activity on L1s right now is degening (either in DeFi or NFTs). But as time goes on, I hope that we see activity pick up in RealFi, gaming, socializing, and other activities people do in Web2. As people to move to more than just degening, will we need to subsidize transaction fees (the way governments subsidize some public goods)? The funding of public goods is going to be increasingly important as time goes on.
Many protocols that live on these L1s, especially DeFi protocols, to me are not public goods. These should be run more like companies. We need to figure out how to align all stakeholders in these protocols. Fortunately, this is a wide open field and if crypto is good at anything, its innovating and experimenting. Its possible the solution will look different for different types of protocols. Maybe a DEX should be looking at something like vote escrow tokenomics. Maybe even innovating on that vote escrow tokenomics by using Liquidity Pool tokens as the locking token (incentivizing users to participate in governance directly) and driving governance towards more revenue generating liquidity pools, not just liquidity mining. If you could combine some of the incentive structures of ve(3,3) with a good plan of distributing initial tokens (maybe making LP tokens the locked tokens like veBAL), that could be really interesting.
But you can see how this model wouldn’t work for an NFT marketplace, or a metaverse project, or a gaming project, etc. Each type of protocol will need to think about the right way to align the incentive structure of their tokens and their users. And, most importantly…. not all protocols need tokens…
Kind of a non-sequitur… but important point along the lines of incentive structures in Tokenomics… Teams should be paid salary in stables or L1s or fiat. Team members are actually people living in the real world! They have real expenses that they need to fund. These expenses will be in fiat (most likely). So it makes sense to pay team members in something that resembles the base currency that they need to pay their expenses in. I don’t think any team should be paid salary in their protocol token. Even with locks and vesting, team members will have to sell their tokens to fund their lifestyles. These people deserve to be paid, they are working hard, and they shouldn’t have to take on the massive volatility and basis risk between the currency their expenses are in and what they are paid in. There is nothing wrong with paying team member’s bonuses in the protocol tokens! This may even align the team members (think management team of a company) to drive value to the token. You could think of this as CEO’s getting stock options (though I have my own qualms with that model as well, but the ideal behind it is fair).
Overall, I think we as a community need to think through how we design tokens and tokenomics of different protocols. In my opinion, different types of projects should have completely different distribution models and incentive models. A DEX token should work and act differently than a gaming token. Some protocols should be thought of as public goods, and other’s closer to companies. We need to align the incentive structure to benefit everyone, users of the protocol, token holders, team members and the ecosystem as a whole. How we do this, I do not know. But I look forward to seeing what we all come up with!
Appendix - Vanguard’s Mutual Insurance Model
I wanted to give a brief description of Vanguard’s business model. Vanguard is one of the largest asset management companies in the world. They pioneered index funds and passive management of assets (versus active management). They tend to have products with one of the lowest expense ratios (management fees) out there. The reason they can do this is due to their structure. Vanguard is not publicly owned. Vanguard the company is actually owned by the mutual funds. The mutual funds own the ‘shares’ of the company (not exactly but easiest to think of it this way). So if you invest in a Vanguard fund, you are essentially also an owner of Vanguard the company. At the end of its fiscal year, Vanguard takes it net profits (revenue minus all expenses) and can distribute that back to all ‘shareholders’ (aka funds) by lowering their expense ratio. So as Vanguard becomes more profitable, it can lower the fees for its investors. This is a beautiful alignment of incentives for owners of the company and users of the company’s products.
For full disclosure I mostly use Solana, Aurora, Cardano, Polkadot for DeFi, because I don’t have enough assets to justify Ethereum gas fees.
I am in the Kitty Farmer Committee for Minswap Labs. I am actively involved in multiple Friktion volts and a contributor in their Discord, and am OG Dappio Wonderland. I am also an active community member of Optim Labs.
I am invested in SOL, ADA, ETH, DOT, ACA, NEAR, Aurora, ALGO, MIOTA along with plenty of other tokens.
This is not Financial Advice!
I would love to hear your feedback/questions/comments. Reach out to me on Twitter… Marco_112358, or Discord… marco_112358 in Wonderland#2400