50 Hours of Homework: Token Incentives for Networks | IkarisDaily #21
Saturday, 2 April 2022
I had a dream… No, really I did. Last night. It wasn’t a nightmare but I didn’t really like what happened in it. My mood has been really off the entire day. The thing that made me happiest was finally working on the 50 Hours of Homework. It took a turn for the better when I attended Whale Office Hours just before posting this.
I started the day by posting about $WHALE’s tokenomics on my Twitter as a thread. The content was largely identical to that of the article, but while I was writing the thread, I realized a deeper level to the tokenomics. I adjusted the articles accordingly.
I ran a couple of errands but by the end, I settled in for a nice evening researching and learning. I planned to attend Office Hours so I was operating on a schedule. Nonetheless, I managed to engage in the meaningful research I wanted.
1) Token Incentives to Spur Early Growth in Networks
Today’s research started from the tweet above. Chris proposes the idea that temporary token incentives allow networks to get through the bootstrapping phase in their early days.
With networks. the utility to each user increases as the number of users increases. However, if there are fewer users, there is lesser utility for each user. If there is lesser utility, there is no reason for users to adopt the platform/network. For example, when Whatsapp started its operations, there was no reason for users to use it as their friends or family most likely weren’t on Whatsapp. If they had no one to message over Whatsapp, they had no reason to be on it. Chris calls this the Bootstrap Problem (also known as the Cold Start Problem) — Networks only become useful when they reach a critical mass of users. However, at the start, the network has a small user base and thus, there is low utility.
Token incentives add the aspect of financial utility in the form of token incentives, such as airdrops. This gives users the reason to become early adopters while the application utility of the network is low. In time, as more users adopt the solution (via a combination of token rewards and network effects), the financial utility is decreased until what remains is a scaled network. In the end, the network provides utility like any other online network. A well-designed token network system carefully distributes tokens across all 5 groups of network participants (users, core developers, 3rd party developers, investors and service providers), such that each group is incentivised sufficiently to maximize growth.
When considered, almost every crypto project is a network because each one requires community. Community is an important aspect of every project and can determine the project’s success or failure. Looking at $APE, the airdrop of the token to existing BAYC and MAYC holders would have attracted many other market participants to become a part of the network in expectation of future rewards. This will help Yuga Labs gain the scale they need, in terms of users, for The Otherside. A virtual world is a network because you will enter the world and participate if there are people you know and want to interact with that are already participants. Among other things, Yuga Labs seem to be establishing the scale they need for The Otherside using $APE.
While Chris covers a bulk of the Bull Case, there are certain aspects that I picked up on from other Twitter users. Most notably, this model is fairer than traditional network effects, as it gives ownership to the users who helped to make the project meaningful. The early users were the ones that helped to take the network off the ground by contributing to the early activity. By distributing tokens to them early on, they are rewarded for their faith in the network.
On the bear side, there is plenty of valid opposition. The biggest point is from Sameer Singh who notes that while token incentives are a good way to bootstrap passive participation networks, they can be harmful to the long term trajectory of active participation networks. Active participation networks are networks that require the continued, active engagement of users. For any network, there is the ‘right type of participants’ — participants who require the network as it solves a pain point for them. Eventually, their early activity on the network increases the utility of the network. Offering financial incentives via tokens can attract the wrong type of users — users drawn to financial incentives, not the utility of the network. When such users make up the majority of adopters, adoption does not have a direct impact on network utility because users are there to earn and speculate on tokens, not to engage with the network. The financial incentives lead to user behaviour that isn’t aligned with network utility. The result:
Another perspective is that a small number of participants can use the system of such incentives for their own benefit. This can be done by recycling the same funds within the network to receive the yield. This was proven to be a legitimate concern by LooksRare. They intended to use token incentives to achieve scale for their Opensea competitor. However, certain participants just traded the same NFTs back and forth between the same wallets to earn the token rewards that LooksRare offered for transacting on the network.
To sum up, while token incentives can definitely be a good way to bootstrap early network growth, their direct and indirect impact has to be carefully considered. The incentives have to be engineered in a way such that the desired result is achieved. The network’s participants and engagement requirements have to be considered. The token initiative could succeed or fail depending on how it is structured. All in all, there is much more than meets the eye with token incentives.
It was a great day on the web3 front. This was a really meaningful topic and I gained some great perspective by diving deep and understanding both the bear and bull sides. Just goes to show… There are cons to even the great ideas from some really smart people. Thus, we should always do solid research and never take anything at face value.
As mentioned, I’ve decided to be more active and contribute more to the Whale Community. I’ve been loving my time so far and I hope to continue this way. Now, I have to attend Metaverse Marbles and it starts in a couple of hours so I really have to get some sleep in. See you tomorrow!
