Currency plays a peculiar role in economic activity. Classical economists are fond of claiming “money is a veil”; it abstracts away the underlying economic activity it helps coordinate. However, we know all too well that money is only a veil until it’s not. Monetary economics is justifiably a subdiscipline, so it makes sense for “tokenomics” to emerge as something similar to blockchain. And like early monetary economics, tokenomics finds itself suck in a strange mercantile stage of development wherein a token’s highest order is to appreciate rather than facilitate transactions. Something akin to increasing net exports and not letting money “leave the system.” But more specifically, modern tokenomics falls prey to three problems:
- Fixed Supply & Fixed Supply Schedule
- A Means, Not an End
- Make-Believe Ownership
Fixed Supply & Fixed Supply Schedule
Price stability builds trust because it is predictable. A fixed number of tokens and a fixed schedule in which those tokens enter circulation handcuffs the ability of monetary policy to respond to inflation or deflation. When stability collapses, so does trust; look no further than the recent wave of stablecoin disasters.
In the spirit of considering money as a veil, consider the effects of fixed supply and supply schedules on something like Magic the Gathering. In this parable, imagine Wizards of the Coast announcing a fixed number of card packs for the next set and a schedule to sell those very packs (ex., one-hundred packs for sale one week after release, three-hundred the week after). If there were many players and thus high demand, prices would be prohibitively high. Without the ability to purchase cards at a reasonable rate, players might churn to other games; a high price isn’t always the profit-maximizing price. On the flip side, too many packs for a given number of players could mean low prices. It’s hard to imagine Wizards of the Coast maximizing profit if they “minted” cards at the cost of production rather than exploiting their monopoly on card supply; P doesn’t equal MC outside of perfect competition.
Optimal monetary policy adjusts based on the conditions of growth and contraction, while most tokens prevent any such possibility.
A Means, Not an End
Economy designers generally model currency as a medium between activities rather than an end to itself, and economists do the same. Instead, however, cryptocurrency white papers spend more time on token distribution and allocation than redemption, ignoring that a currency is only as valuable as it can purchase.
Packy McCormick, an equally entertaining and informative writer, deep dives into the business models of start-ups in his weekly newsletter, Not Boring. In Braintrust: Fighting Capitalism with Capitalism, he chronicles the model of Braintrust, a talent platform. Late into McCormick’s explanation, he documents the cryptocurrency “twist” of Braintrust. By using and referring talent to the platform, users can earn tokens. It’s never clear, however, what these tokens gate or purchase. Users on the platform may price services in terms of the token, but they’d only do so if the token has purchasing power in real terms. Packy writes that Braintrust may offer “hints at future benefits for token holders; these might be things like educational content, free software, or coaching.” If so, the token’s price reflects the value of these services. I find it excruciatingly difficult to believe these services are worth much, so, in turn, the token shouldn’t be worth much. Starting a fiat currency from the ground up is a daunting task, but the most important precept of any token-backed project should be to grow demand for assets priced in the token.
Blockchain games do better here by exclusively first listing goods in terms of the game’s tokens; the token’s price reflects the demand for these goods. In the case of Braintrust, the token’s price reflects a future expectation that users or the firms will find a use for the token. Rather than composing a minority of a given whitepaper, explaining why there’ll be demand for assets priced in the token should be the analysis.
A stock represents both a governance right and a claim on dividend payments from a firm. More recently, markets segmented governance rights between Class A and B shares. B shares vote on governance issues while class A shares do not. Most blockchain games took note and immediately segmented governance rights into separate a token altogether. In this way, there is some sense of ownership. But so much of this token class stands on shaky legal grounds. Are blockchain governance votes legally binding? Over what issues do token holders have autonomy? Can they fire a CEO? Increase a token’s supply? Again, the entire issue of ownership is murky.
On the other hand, no form of token entitles an owner to dividends. If it did, tokens would fail to pass the Howey Test and be subject to SEC regulation. As mentioned above, a token’s current price represents present and future expected demand for the assets redeemable by the token. This is a wildly different value proposition from a traditional share which derives value as a claim to a stream of dividend payments. Far from “aligning incentives,” the different incentive structures result in different outcomes. Redemption incentivizes the price of the underlying assets to increase; this isn’t always in the best interest of the underlying product or service. However, dividends incentivize the growth of a firm’s profitability. Profit incentive finances and signals supply expansion. The supply expansion makes everyone better, whereas redemption results in something like what we see with the NIMBY’s homeowner movement. In translated terms, it might make sense for someone who holds a hypothetical governance token in Magic the Gathering to vote against issuing new packs of cards. It’s not hard to see why this would be destructive to the game.
As blockchain applications grow and fluctuate, monetary policy will increasingly come under a microscope. Vague regulatory guidance and short-run design decisions to build trust have forced awkward token design. Moving away from these constraints will produce sustainable applications while aligning incentives between token holders and users.