Nearly all the crypto-assets currently launched by web3 companies suffer horrible tokenomics design. In this blog post, I will be discussing the importance of revenue streams into tokenomics design as a part 1 of a complete series. This work is a follow up to a previous blog post “How to Design Web3 Tokenomics”. Web3 founders are the main target, but crypto investors in general might find the content interesting to help them make investment decisions.
Let’s first compare US currency to crypto-currencies. Almost all crypto-currencies value is based on some sort of either scarcity or utility mechanism. Meanwhile, US currency is entirely based on its utility as a mode of exchange and as a store of value. However, US currency suffers devaluation every year which implies that while it can be good for short term value preservation, it is not really that great for long term value preservation. In simple terms, if you keep $100,000 in the bank, your purchasing power decreases over time as the price of goods and services keep increasing due to inflation. In the crypto-industry, many currencies get labeled as shitcoins for their lack of utility and devoid of perceived long term value, and one could wonder why US currency doesn’t get perceived as a shitcoin as well. The truth is US currency is built on a backbone of a large number of businesses operating in the US and abroad that rely on US currency for settlement with their customers, suppliers, and as treasury, creating a powerful sustainable baseline demand for the currency. As well, US currency is so widely accepted that it has circular economy status, meaning that most participants do not need to convert US currency into other forms of currency, preventing large selling volume. As well, the US government has the power to “force” participants within its border to continue operating in this currency, at least for the foreseeable future. Other governments such as El Salvador were not so fortunate in enforcing the use of their currency, which led many individuals and businesses to rely on US currency as well, and more recently in Bitcoin for common day transactions. Overall, the value of US currency, or that of crypto-currency mainly exists because people and businesses believe in its long term preservation of wealth, but let’s make no mistake, there is no perfect mechanism of preserving wealth, and a certain amount of risk exists for all currencies, assets, or commodities.
When it comes to crypto-assets, scarcity alone is a very unreliable method of preserving wealth given that it relies on either growing user adoption, or at least maintaining it across time. Most of the participants are not there to be collectors, and if a large number of users decide they trust another mode of wealth preservation more, a collapse could occur at any time. Collapses can occur to both government backed currencies (Venezuela Bolivar, Egypt, Lebanon, etc.) and crypto-currencies alike (too many of them lost more than 99% of their value in 2022 for example). For crypto-currencies to become more stable, they will eventually need to reach a circular economy status where most participants accept to receive them in exchange for services and goods. More importantly, any crypto-currencies need to identify a use case where they become the ideal mode of exchange or store of value to increase their level of utility and eventual long term demand.
Equity traded on the stock markets follows a standard model. The stock price is correlated to dividends, and financial strength of the underlying company. Companies can sometimes be available on the stock market without revenues during their launch phase, but only for a short time, if they fail to eventually produce revenue from selling products, services, or growth potential from assets, they will eventually spiral down to $0 and get delisted from the market entirely. Meanwhile, crypto-assets exist mostly devoid of any revenue streams, entirely valued based on their tokenomic model or utility. However, very few such crypto-currencies can sustain growth for many years, most of them experience a pump and dump lifecycle which leaves long term investors wondering why they invested in the first place. Until crypto-currencies reach a circular economy status as an acceptable widespread mode of exchange, we can consider that crypto-currencies are more akin to stocks, except for those crypto that have a real defined utility such as Ethereum. Ethereum can be seen as a decentralized operating system that powers thousands of other crypto-assets.
For these reasons, just like for the stock market, it makes a lot of sense to integrate revenue streams into the economic model of crypto-currencies.
Revenue Streams for Crypto-Assets
There are few examples of web3 ventures that have incorporated reliable revenue streams into their tokenomics model, for example GMX, a decentralized crypto exchange (DEX) has dedicated a percentage of the trading fees on the exchange to be given to stakers through a process very similar to dividends of publicly listed companies on the stock market. It is the hope that more such web3 ventures will incorporate revenue models in order to rely less on scarcity of their tokens for growth potential. With thousands of crypto-currencies on the market, relying on scarcity alone is simply no longer viable unless there is a strong utility to the token used by large amounts of real users, which is often not the case either since speculators vastly outnumber real users when it comes to crypto-assets.
However, contrary to publicly listed companies, web3 ventures can also benefit from implementing exotic features into their assets because crypto-currencies are programmable money essentially (i.e. new functionality can be built in). For these reasons, crypto-assets can be very difficult to evaluate with standard financial valuation techniques, which often leads to extreme growth potential from the fear of missing out (FOMO). FOMO is a very powerful driver for the crypto-industry given the historical growth of the early crypto-currencies such as Bitcoin (~100% yearly average return since 2009 — $1000 invested in 2009 would be worth $1.3M by January 2023), and Ethereum(~128% yearly average return since 2015 — $1000 invested in 2015 would be worth $447K by January 2023).
Implications of Revenue Streams
The implications of revenue streams into the tokenomics model is that web3 projects can now become more sustainable over the long haul and less reliant on scarcity of the tokens. However, most revenue streams are likely to be tied to real utility of the token, i.e. to real users. Unfortunately, real users are usually only a very small fraction of total users when it comes to crypto-assets given the speculators involvement. This implies that web3 ventures need to design token economies that protect their real users from the volatility created by speculators. Most speculators are unlikely to lock (stake) their tokens for a long period of time (as they most likely will sell their token the moment they are satisfied with their returns or expect a plateau to be reached), which is most likely why GMX (mentioned above) took the decision to provide dividends/rewards to stakers only, which is a good choice. However, that mechanism alone is most likely not enough since speculators may still jointly induce loss of value that can be very significant (more than 50%) upon a market downturn or large sell volume, and this will lead to leaving real users suffering massive losses. In the case of publicly listed companies, they sell their products and services through standard government backed currencies, and their stock is not used as a mode of exchange by their users. This way, customers are unaffected by the volatility and fluctuations of the company’s stock price. Essentially, they separate speculators from customers. Web3 ventures would be advisable to design similar models that separate the two types of users, while still maintaining some level of inter-relations.
Ideal Type of Revenue Streams
Since crypto-currencies are built on a peer-to-peer decentralized backbone, it makes it often difficult to integrate into physical products or services, however they can be ideal for digital products, for example video games. Readers may review projects such as Illuvium (a web3 videogame), they created a strong economic model where even teddy bear sales can feed back into their token economy.
Real Estate tokenization is also another example of tying revenue streams obtained from renting property back into the token economy. However, since most of the renting revenue will come in the form of government back currencies, web3 real estate tokenization projects need to also integrate on/off ramps to convert crypto-currencies back and forth into standard currencies, making those revenue streams slightly less ideal than digital products/services.
Note that for digital products and services, depending on the customer’s segment, requesting payment in crypto-currencies can be a significant friction factor for customers. Services like Moonpay can be quite beneficial to reduce friction with customers.
SaaS and Ecommerce companies can also become ideal candidates for web3 economies.
Revenue Streams Uncorrelated to Crypto-Industry
Currently, nearly all the entire crypto-industry is highly correlated to the US stock market, except for stablescoins which are often peg on US currency. Any financial asset manager in the stock market knows that a diversified portfolio is composed of as much as possible of uncorrelated assets to make sure that in the event of a market downturn of a specific industry, not all the entire portfolio suffers. For example, fast food stocks are known to be negatively correlated to the economy. Given these facts, it would be great to integrate revenue streams into crypto that are either negatively correlated or uncorrelated to Bitcoin (or the rest of the US stock market), this would enable crypto asset managers like myself to build diversified portfolios more easily.
Even if such a crypto-asset with a uncorrelated revenue streams would be created, chance are market makers in the crypto-industry would treat it like any other crypto-asset and would sell it when Bitcoin selling volume increase, rendering such asset correlated to Bitcoin as well. It would become critical for such a project to educate the market of that fact, as well as building up a treasury that enables them to offset the selling volume occurring when Bitcoin decreases to break the correlation. The treasury would have to be large enough to break the cycle.
I explained the importance of integrating revenue streams, ideally uncorrelated to the crypto industry into tokenomics models of crypto-assets. As well, it is critical to decouple speculators from customers (real users) to ensure sustainable growth potential while avoiding pump and dump. In the next blog post of this series on Advanced Web3 Tokenomics Design, we will cover the topic of “Pre-Seed Funding without Pre-Minted Allocation” to help web3 builders in designing better economies for themselves and their community.
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Keywords: #web3 #crypto #cryptocurrency #ethereum #blockchain #tokenomics