0. Opening Remarks
- This article mainly focuses on the applicability as well as the necessity of Token economy for Web3 applications from a reflective perspective.
- The specifics of the token economy design are not covered in this article, meaning an economic background is not required for reading.
- Web3 iterates very fast, and many concepts are still in the exploration stage. Keep questioning and thinking independently.
- This article only represents personal opinions and has nothing to do with Chainbase.
1. What is Token Economy?
1.1 The Origin of Token Economy and The Initial Use Scenarios of Cryptocurrencies
Speaking of origin, it often corresponds to a piece of history. To understand the initial use scenarios of cryptocurrencies, let's go back in time and have a look at some historical fragments.
The Birth and Early Use Scenarios of Bitcoin
Let's start with the birth of Bitcoin. Bitcoin is the world's first cryptocurrency; its whitepaper is less than 10 pages, and the first sentence reads: Commerce on the Internet has come to rely almost exclusively on financial institutions serving as trusted third parties to process electronic payments.
This sentence clearly states that the intention of creating Bitcoin is to solve various problems caused by centralization in financial activities.
In Camila Russo's book The Infinite Machine: How an Army of Crypto-hackers Is Building the Next Internet with Ethereum, she mentioned that Argentines used a digital currency called Bitcoin since the government banned buying US dollars with Pesos.
The background of the incident is the widespread devaluation of the Argentine Peso in 2013. At that time, in order to prevent the situation from further deteriorating, the Argentine government adopted a one-size-fits-all measure that prohibited the exchange of Pesos for US dollars. As a result, Bitcoin was used by Argentines to fight against this unreasonable policy to avoid the loss of their personal properties.
The Original Intention of Ethereum
Let's take a look at Ethereum. In the historic version of Ethereum's whitepaper (Vitalik, 2014), the first sentence regarding the definition of Ethereum reads: The intent of Ethereum is to merge together and improve upon the concepts of scripting, altcoins and on-chain meta-protocols, and allow developers to create arbitrary consensus-based applications that have the scalability, standardization, feature-completeness, ease of development and interoperability offered by these different paradigms all at the same time.
This description clearly expresses that Ethereum inherits the idea of decentralization from Bitcoin, and expands the single utility of Bitcoin. Its original intention is to enable developers to build an ecosystem on Ethereum and make it a "world computer".
These historical fragments truly represent the vision and use scenarios at the birth of cryptocurrency.
While Bitcoin was designed as a weapon against centralized financial institutions and was used to minimize trade frictions between sovereign currencies (thus considered a decentralized financial revolution), Ethereum is not specifically geared toward the financial field (though it has the most prosperous DeFi ecosystem). The original intention of Ethereum is to enable everyone to build everything with it. From this perspective, the current hyper-financialization of the crypto world actually limits the development of other applicable fields.
1.2 Token Economy: From Capturing Value to Accumulating Wealth
As the ecosystem grows, the use scenarios of cryptocurrency have been greatly expanded. Thus, Token Economy comes into being, which refers to a set of economic models designed/constructed around cryptocurrencies. The token economy includes:
- The design of the token itself
- The degree of association/binding between cryptocurrency and its corresponding values
- Market feedback after the token launch
The Birth and Early Adoption of Ethereum are Inseparable from the Token Economy
In the early days of crypto, the token economy helped many startups obtain initial capital, including Ethereum.
In mid-2014, the founding team at Ethereum was still worried about its direction. They had heated debates about if Ethereum should be a for-profit company or a not-for-profit organization. At that time, about ten of them came to Switzerland from all over the world and shared a house to live and work together. They had been working day and night without being paid for a long time.
Eventually, Vitalik decided that Ethereum would be a not-for-profit open-source project, and the eight founders would always be founders and get everything they deserve, including ETH (the Ethereum token). It was the existence of tokens that made the implementation of Vitalik's decision possible and enabled the neutralization as well as decentralization of Ethereum.
A Paradigm Shift and a Key to Wealth Accumulation
Today, 8 years later, there are nearly 10,000 cryptocurrencies listed on mainstream platforms (not including non-listed ones), and the total market cap once exceeded 3 trillion USD. These cryptocurrencies constantly deliver value to the ecosystem, attracting a large number of talents and users. They have created hundreds of public blockchains with different characteristics, a great number of protocols, and tens of thousands of dApps.
From a cyclical perspective, the token economy has indeed helped countless projects solve the problem of bootstrapping, and to a certain extent, the problem of attracting users. The token economy is a powerful tool for value capture, but also because of people's profit-seeking nature, it has gradually gained a new identity: the secret key to rapid wealth accumulation.
Profits and risks are always proportional, and if you get rich too quickly, you may go bankrupt someday. Since the birth of Bitcoin, the crypto market has experienced ups and downs. Excessively low thresholds and extremely high returns have attracted a large number of rug-pull projects and speculators to enter the market. Now a fair amount of people only focus on short-term returns without considering long-term values. Therefore, the token economy has also laid a hidden bomb for the entire Web3 ecosystem.
1.3 What are the Future Possibilities of Token Economy
Currently, tokens are categorized as:
Governance Tokens - Tokens for project governance and collective voting. They are commonly seen in DAOs.
Utility Tokens - A key element of project operation. Utility includes dividends, staking rights, interests, etc. This type of token often brings about speculative behaviors.
Store-of-Value Tokens - such as Bitcoin, which has gradually emerged as an alternative investment asset/commodity. Store-of-value tokens are usually top-valued cryptocurrencies.
In this basic categorization framework, there're also innovative uses of tokens implemented by various projects.
Quadratic Voting/Funding
Gitcoin, DoraHacks, etc. are using a quadratic mechanism to distribute funding to their Hackathon projects.
Compared with the traditional one-person one-vote as well as one-person multiple-vote model, quadratic voting can prevent the "winner takes it all" scenario that may occur in the one-person multiple-vote system, as well as avoid excessive suppression of personal will in the one-person one-vote model, through increasing the cost of voters continuously voting for one project.
Though quadratic voting/funding has competitive advantages over traditional solutions, it is still not perfect. For example, if the ID is controlled by centralized parties, quadratic voting may be deflected towards the one-person one-vote model. Moreover, despite the high cost, if the rich are rich enough, they can still influence the direction of voting. There is still room for improvement.
Regenerative Cryptoeconomics
Kevin Owocki at Gitcoin argues that humankind faces coordination failures on a global scale - including climate change, insecure digital infrastructure, misinformation, and a lack of economic prosperity - that our traditional institutions fail to deal with.
Kevin states that coordination failure occurs when a group of people who could have cooperated to achieve the desired outcome failed to do so because they did not coordinate well in terms of decision-making (climate change is a typical example).
Global coordination failure brings systemic risks to the prosperity of human civilization. Kevin calls the god of coordination failure Moloch. The weapon to defeat Moloch is a new mechanism deployed on decentralized blockchain networks - regenerative crypto-economics.
Regenerative cryptoeconomics is more of a mechanism/principle. It envisages a regenerative Internet of value that promotes the full development of diverse global citizens. The system includes decentralized infrastructure, tens of thousands of creators, and a more equitable distribution of capital that helps people get rid of the zero-sum game as well as "the rich get richer" norm.
If you are interested in these ideas, read his book GreenPilled and you will get a lot of inspirations.
The Definancialization of Tokens
The non-financial usage of tokens is also one of the hotly discussed topics recently. SBT proposed by Vitalik is the most prominent case. SBT refers to soulbound token, which is non-transferable and de-financialized. It is more like the reflection of a person's social identity in the blockchain networks, which greatly differs from tokens with speculative attributes.
SBT is rather a concept than a token that has been implemented in specific scenarios. At present, though people are trying to find practical pathways for SBT, there are not many influential projects. At least for now, the concept is still controversial.
No matter what form non-financial tokens such as SBTs will eventually land on, the concept of soul binding aligns with the core spirit of Web3. I believe that such ideological innovation and product experimentation will continue to thrive.
2. The Particularity of the Application Layer in Web3
2.1 The Web3 Ecosystem
(Web 3.0 Stack, Source: IOSG VC)
According to the picture above, the Web3 ecosystem is divided into five layers:
- Layer4 = Decentralized Applications
- Layer2 & 3 = Middleware Stacks
- Layer1 = Protocol Layer
- Layer0 = Infrastructure and Network Layer
Among them, layers 0-1 are on-chain, and layers 2-4 are off-chain.
It gives the reader an overview of Web3 in a clear and comprehensive way: Layer0 & 1 lay the foundation for the ecosystem; most users only access Layer 4; and Layer 2 & 3 help better connect Layer 1 & 2.
Next, we focus on the protocol layer at Layer 1 and the application layer at Layer 4, you can read Part 2 of this article next week.
(to be continued)
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