Crypto projects fail at the hand of their tokenomics - unless done properly.
Tokenomics, or economic model of tokens, only became popular in the 2020s. Prior to that projects built without any consideration of linking project growth to their native asset, leading to their peril.
Whether you decentralise for governance purposes, community leading or revenue sharing (*cough* *cough* SEC), a coin/token is always involved. The latter’s price is meant to reflect the project’s success in some form or manner unless you create 0 link between the project and the token; meaning the only link is the project’s name and the asset’s ticker with no underlying mechanics.
For instance, whenever Ripple would allegedly onboard a bank back in the day, XRP’s price would react purely from believooors speculation. In fact, there was no link whatsoever between RippleNet succeeding (poor idea but wtv) and XRP’s price. XRP’s sole purpose was a medium of exchange for a bank in country A to sell their local currency for XRP, send that XRP to a bank in country B who will then sell that XRP to their local currency. In this case even if Ripple’s product replaced SWIFT worldwide, there is no supply lock on XRP whatsoever (except for Ripple’s “escrow”) and the velocity of the asset is incredibly high which leads to no value accrual even if the project were to succeed in its mission. XRP’s only purpose has been to dump on speculative retail.
Speculation led by the left side of the IQ curve only lasts so long. To create sustainability, tokens must hold intrinsic value.
Then you have the other side where linkage between the project and the token is too intertwined such as LUNA, that can lead to a death spiral. LUNA’s purpose was to back UST and the creation/redemption mechanism of that stablecoin was that you’d burn $1 worth of LUNA to issue 1 UST and vice versa. When redemptions begun en masse after the de-peg, LUNA’s supply hyper-inflated over a very short period of time leading towards its price death. The second problem here is that this model was too reflexive and LUNA’s valuation in theory should always be superior to that of the total UST supply. But, LUNA is subject to market speculation and cycles which in recent weeks led to UST’s market cap exceeding that of its backing asset.
In Arabic, there is an old saying that states “profusion and absence are siblings”. This is applicable to tokenomics. When designing your token, you must find the perfect balance to avoid complete disconnect and death spirals.
Enough history talk for now, let’s dig into how you can build a robust coin/token. There are three areas we will look at: Allocations, Vesting & Value Accrual.
The general rule is: the further you’ve built your project the more of an allocation you can reserve for the team/investors.
One example is dYdX, they’ve built the full protocol, delivered a working product with traction before decentralising and this allowed them to reasonably justify a large team/investors allocation of 43% (+7% for future employees). Had they decentralized in 2019 and allowed the community to take on the project’s maturation then that allocation should have gone down to a fraction of the above.
When to decentralise is a topic for another day. In the meantime, here is a guideline for the team/investors allocations based on when decentralisation takes place:
Pre-product: 5–10%
MVP, minimal to no usage: 10–20%
Post-product (V2+), low to mid usage: 20–30%
Working product, high usage, functional community: 30–40%
50% is an excessive amount to own as that represents half the voting power, I do not believe any project should go above the 40% mark.
If your investors are pushing you towards maximising the allocation despite there being no product or little traction, know that you’re in bed with the wrong people. They are simply with you for an early seed entry and to dump on retail; they do not care about your project’s success or longevity.
Also called “unlocks”, vesting is an important aspect of tokenomics as it aligns incentives for continuous building even after coins/tokens are issued.
Imagine a project decides to decentralise and the team’s tokens are completely unlocked from Day 1. Well if the founders sell, why would anyone else hold? We call this “pulling a Charlie Lee”.
For reference, Charlie Lee is the creator of Litecoin and he sold the top of LTC’s rally in 2017 under the reasoning that Litecoin was too influenced by him and for it to grow he must step away. Selling a portion is fine as everyone needs to lock profits but having 0 exposure to one’s own project?
The founders can of course “promise” that they’d never sell but crypto is trustless by definition so this solution is incongruous.
Of course, everyone wants to make a profit, especially if you’ve spent blood, sweat and tears building day in and day out but it must be done within reason. This is where vesting schedules fall into place.
There are a two categories of token holdings so let’s break them down as each will have their separate vesting guides:
Initial Offering & Secondary Market: Immediate Vesting
Private/Public Pre-Sale: 6/24 months linear
Team & Investors: “1-year cliff + 2/4 years linear” or “3/5 years linear”
The longer the vesting schedule, the more conviction is exhibited by founders which gives a positive impression. Shorter vesting schedules tend to raise eyebrows about a project’s longevity and whether it is simply a capitalisation on near-term hype.
Recently, we’ve seen the rise of conditional vesting where tokens only unlock if certain metrics are attained. We’ve seen this with MCDEX where tokens only unlock if certain volume levels are attained, this incentivises wash trading and hence isn’t optimal. This type of vesting may work based on roadmap achievements that cannot be faked.
Supply & Demand rule this area and is arguably the most important one. There are four main methods towards building an asset with value accrual:
Revenue sharing with token holders: complex at times and also should never be 100% sharing (the value should be in the 30–70% range with the remainder going to the project’s treasury for future upgrades). This builds immediate value accrual and intrinsic value as more product usage leads to higher volumes and revenues, increasing the token’s value.
Fixed Supply (or deflationary based on usage): Inflation can obliterate a project when not handed over for actual work; the simplest example is P2E games and their perpetual token dumps. 2–10% annual inflation that gradually falls down over the years can work for projects given that new tokens are handed over to genuine active project participants, not farmers. Therefore, the best method to avoid such a scenario is a fixed supply.
Network Security derived from high unit price: This is particularly valid for base layers that use a Proof-of-Stake consensus algorithm as a low unit price can lead to a 51% attack and hence a high unit price means better network security. Not applicable to protocols.
Supply Locking Mechanism: Lock the float, increase demand and a token becomes the reflection of a project’s success. This mechanism only works if you are sharing revenue, have inflation or an allocation for active participants. In either case, steer away from inflation given to stakers in exchange for “not selling now” (read Cobie’s insightful piece here about staking). There must work being done for which stakers get rewarded for. In base layers this is for validating, for protocols that can be governance 👀
Next up… guide on Incentivised & Efficient Governance.
If you’re building and need advice on your project’s tokenomics, feel free to reach out on Twitter or Email on: info@alpha-dao.io
🐂