Advanced Web3 Tokenomics Design — Part 6: Network Effects Design
Nearly all the crypto-assets currently launched by web3 companies suffer horrible tokenomics design. In this blog post, I will be discussing a core principle behind tokenomics design which are network effects as a part 6 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.
Network Effects — Metcalfe Law
Metcalfe’s law states that the value of a telecommunications network is proportional to the square of the number of connected users of the system (n2). This is also known as network effects, and is one of the most sought after competitive advantages in the tech world. Some investment funds even only invest in companies with strong network effects.
When it comes to crypto-assets, not only the value of the network grows with each additional user, but it directly affects the wealth generation potential of the early users, making these financial network effects even stronger for the growth potential and fear of missing out (FOMO).
The same network effects tied to the financial wealth brings all the speculators to join new crypto assets as early as possible to benefit from maximum financial growth, sometimes within a single year, some new assets can grow upward of 50,000% making the crypto industry one of the most scalable type of industry in the entire world. The growth is not only powered by real users, but also those speculators coming only for the wealth creation aspect.
Since positive network effects are so easily designed into tokenomics, we discussed previously that it makes sense to slow down growth potential by generating selling pressure to build a treasury while the growth phase is underway. Obviously, slowing down the growth will reduce adoption, but more often than not, a large portion of this growth is the wrong kind of adoption from speculators. While reducing speculators adoption, projects essentially improve the long term outcome and sustainability. A certain level of sustainable growth that is below your revenue generation capability is absolutely acceptable and favored in my opinion. If projects chose to allow a certain level of speculation-backed growth, I think it can be also acceptable, but managing this properly will become an art more than a science.
Negative Network Effects
Once the initial growth phase of network effects in token economics has dissipated, most often a negative network effect comes into play, which is that everyone needs to sell their assets before the collapse comes. This created pump and dumps as a standard lifecycle of crypto-currencies. This means the financial incentives become reversed, and traders start shorting these crypto-currencies, or at least sell them before the collapse starts to occur. Some of the early investors have generated so much wealth quickly by that point, that they have massive capability to significantly decrease the price of the projects, making tokens crash upward of 90% leaving the late adopters in ruins. These network effects become a game of chickens, of who will sell at the perfect peak of value. Lots of projects never fully recover after the initial collapse.
Network Effect Designed for Prevention of Attrition
The final type of network effect are those that can be engineered to prevent attrition of adoption. Since, most network effects can eventually reverse and cause a collapse, I find it critical to design a specific network effect that kicks in once a project has matured and rapid adoption is no longer possible. I have never seen such attrition oriented network effects in practice however, so let me explain.
As a treasury, and revenue stream are generated and fed into the tokenomics of a web3 project, it is possible to delay by a month or several months the reward back to the community. Essentially, if capital is being created and stored away for later, this means this pool of capital can act as a financial incentive to prevent attrition in the near future. For example, if 50% of a community sell their tokens trying to attempt to cash out before a collapse, this means the stored capital will be rewarding only 50% of the community generating a powerful incentive to those who remain in the community. The same type of mechanism works for miners, if most miners leave because the process is no longer financially viable, the remaining miners’ reward is increasing hopefully to a point of equilibrium. This is possible because the community is composed of users and miners, and if the users are still present in the system, the reward potential remains relatively stable but with fewer miners competing. So, with a network effect built to prevent attrition with a delayed reward mechanism, projects can significantly reduce massive drop in user base, and therefore hopefully annihilate the negative network effect that often results from excessive growth.
Putting it All Together
When putting all the mechanisms discussed in the past 6 blogs of this series, we have a theoretical framework that, if designed properly, might be able to sustain a new category of assets affectionately called stablegrowth tokens. Those stablegrowth tokens are what the crypto-industry desperately needs to attract businesses without high volatility risks, while still having financial incentives compared to traditional centralized banking.
A stablegrowth token should have a dynamic supply management of tokens that prevent excessive growth, while providing financial incentive greater than inflation-plagued stablecoins. They should have an over-collateralized treasury achieved through diversified un-correlated revenue streams (trading activities, loan programs, asset-backed staking with passive income). The stablegrowth token should be launched fairly without pre-minted token allocation.
Ideally, we are looking for a stablegrowth token that will benefit from low volatility, while growing a bit above inflation rate (10% to 20% per year), and suffer low risks of failure. However, if the treasury management generates significant returns, it’s not impossible to provide much higher returns to this type of stablegrowth token.
Building our Community
If you are a web3 builder and feel this tokenomic design is key for a better future of DeFi, please join our community, let’s collaborate on a common design and eventually launch a DAO to support the required infrastructure. Join the telegram group while we prepare to launch this project.
Conclusion
I explained the most critical aspect behind successful tokenomics design which are based on double sided network effects designed for growth and prevention of attrition. Final comprehensive integration of all the previously discussed mechanisms into a well thought out tokenomic design goes far beyond simply managing supply, demand and token allocation with vesting. I hope this series of blog posts will push the imagination and thought process of the industry and lead to a more sustainable crypto-industry where companies can participate as well for the benefit of all participants in the quest for circular economy away from traditional centralized banking. Please subscribe on my various social media channels to keep up to date with additional content.
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Keywords: #web3 #crypto #cryptocurrency #ethereum #blockchain #tokenomics
