Back in 2017 everyone needed a blockchain. It was the tool to solve all problems and the hype around it was truly amazing. Now most people understand that a blockchain is not the solution to all problems and that the approach back then was more of a hammer looking for nails. When talking about tokens nowadays I often get that similar feeling. Every project wants to launch a token.
The drivers behind it are diverse and I would like to look into when a token makes sense and when it doesn’t. A good real world resemblance of tokens are shares of a corporation. According to the australian shareholder association the share market has two functions:
Primary – to allow companies to raise money by issuing shares through an Initial Public offering or float
Secondary – to allow investors to buy and sell shares at prices that are determined by supply and demand factors
The risks, according to the australian shareholders association, are price movements including losing your money as well as lack of control.
This is a pretty spot-on definition that also applies to tokens in web3. The main novelty of web3 is the fact that here, almost anybody can launch a token and use it for the above purposes. Almost anybody can buy these tokens giving equal access to retail investors and less friction for the system overall. Less friction because it costs very little to transfer ownership to anyone.
I don’t want to get into the regulatory aspects of this, but issuing shares is regulated and tokens are often somewhat unregulated. This is due to the classification of tokens into either securities tokens or utility tokens. Most protocols will make an effort to ensure their token is a utility token to avoid the regulation of securities. This is done by defining a utility into the token i.e. turning them into a voucher to grant access to a service or functionality.
Coindesk has a good analogy here:
Utility tokens are like chips in a casino. They can be used as currency within the casino for playing games and tipping dealers, and converted back to fiat/cash when it’s time to cash out. Holders of a casino’s chips do not own a stake in the casino, nor are they entitled to any of the casino’s winnings or profits.
Security tokens, on the other hand, are like owning stock in the casino, shares in the company itself. When the house wins, you win. Security token holders own something that might pay off through profits or distributions. Utility tokens are used in an ecosystem. Security tokens give you ownership in that ecosystem.
Ownership however can not easily be excluded from utility tokens as they might give governance rights, and by that allow users to decide on how the treasury or potential profits might be distributed. Fabric Ventures classifies utility tokens as value capturing.
To summarise, tokens allow you to raise money, let investors buy and sell them and to some degree represent ownership or value.
Is there more to a token though?
Given our recent thoughts on how the principal-agent theory (listen to it here or here) applies to DAOs, we have seen that holding tokens can turn people from agents to principals, incentivising them to participate driven by their own self interest. This is a big differentiator for token ownership vs more traditional structures currently in use. Just think about how you treat your own car versus a rental car. That’s how contribution quality towards the goal of a project or a DAO changes with token ownership.
Julien Thevenard from Fabric Ventures has written a great piece on tokenized ownership and I highly recommend checking it out here – the piece is full of goodies. I tried to summarise parts of his findings and other properties / benefits of tokens in the diagram below, showing that there really is more to a token than ownership and raising capital.
I covered off the market valuation, raising money and ownership but let’s go through the details of what a token could do for the Tokenomics DAO.
Raise money: The obvious one, known from shares, is to mint tokens and distribute them to investors to raise money.
Raise time: A concept not as common in the traditional world, but many DAOs use it to pay contributors for the time they spend working for the DAO. The Tokenomics DAO could utilise this same concept to encourage members to create value.
Represent ownership: Ownership does not only move members from agents towards principals but would also give the Tokenomics DAO a marketing department. Members who have chosen to have skin in the game will tell others about why they do so and attract more talent and attention to the community and its mission.
Market valuation: For almost no cost, a token can be traded on exchanges like Uniswap where supply and demand will set a price for the token. This can turn into one of the disadvantages of using a token as live price action will make holders constantly evaluate their position. Price drops could lead holders to doubting their holding and their contributions in the project.
Coordination: In the manifesto, we’ve laid out our vision for where we want to take this tokenomics initiative. The token will help us coordinate members towards this vision.
Governance: Token based voting is not a must (read about it here), but it can be an easy way to make use of tokens and let the community decide on DAO related topics.
Community status: Status is important to people and owning a certain amount of tokens and holding them can create a sense of belonging that in combination with ownership can even enhance the incentive to bring an initiative forward (coinvise compare it to airline miles and lounge access).
There is not a lot that speaks against the idea of utilising a token and honestly it is what makes up web3. If we, the Tokenomics DAO, were to miss out on all of this, it would severely limit our ability to operate in the web3 space. It’s not about needing one, it’s more that we should have one to benefit from the token’s properties.
To summarise, with all of the above, it looks like a good idea to use a token. Most of these properties however don’t contribute to making a token actually valuable or enabling it to capture the value the coordinated and incentivised community creates.
How does a token accrue value?
To answer this question, we should first look at what value we want to create. In the manifesto, we talk about content to make tokenomics relevant for everyone. If we, as a community, achieve to demystify tokenomics and widen the knowledge in this field, we would assume that we would have created substantial value. After all, the success of a lot of web3 applications is partly due to their tokenomics. With the benefits listed above, we believe it is a fundamental building block of web3.
So where does a token’s value come from?
Value of the DAO / project: The Tokenomics DAO itself has value. It’s valuable for people to join a discord with hundreds of like minded individuals and it’s valuable to consume the articles, videos and podcasts we have produced.
Expected value of the DAO / project: If we agree it’s valuable already, the Tokenomics DAO will be even more valuable with more content and more members. Giving all these like minded people a place to exchange ideas has the potential to create even more value – potentially quite unexpected value.
Ownership: The fact that owning the token could give owners a say in what we do and how we do things is valuable too, making a token worth holding or buying.
Stake for access to value: Tokens can have utility. A way to use a token of the Tokenomics DAO could be to encourage staking for access to the community or the content we produce. Many gated community DAOs do this and it makes their token more valuable.
Fee on value: Quantifying the value is hard because the content and discord is free for anyone, in the future the community might decide to raise a fee on certain pieces or monetize in other ways. Parts of these fees could (1) end up in the Tokenomics DAO treasury, (2) might be paid out to token holders or (3) buybacks and token burns could increase demand and scarcity of a potential token.
Reduced fee for holders: The newly raised fee could be waived or reduced for holders of the token.
Even though the project does not extract value yet and even if it does not plan to do so, the anticipation or just the possibility is often enough to ascribe value to a token.
The motivation that comes from investing one’s time or one’s money in exchange for ownership is enough to incentivise value creation, even if the path to value extraction remains unclear for many years.
The Tokenomics DAO community is growing towards 500 members and the last 200 have joined in the last month. A distilled group of people that are interested in tokenomics, brought together, is something that did not exist before. Think of the network effects of bringing together people interested in a topic like tokenomics. There must be some value in that. It’s hard to measure and we don’t know how this will all play out, but with the right coordination tool and community ownership we might be able to utilise this network to create even more value.
So, do we need a token then?
As far as I can tell from my analysis, the benefits of having a social token outweigh its risks. The mechanism of ownership, raising time and the powerful coordination tool outweighs the volatility and risk of the token price dropping.
I tried to think of communities without tokens. Reddit and the general open source software world come to mind.
Reddit has vibrant communities, members are active and engaged. The community creates value with the information and discussions happening, but fails to capture the value of the hive mind knowledge for the community. The majority of value created goes to the Reddit corporation and not to the individual community members and I think that is something slowing down communities from evolving to the next level. DAOs with tokens and ownership do this a lot better.
To summarise, there are great communities outside of web3 and there are ways of capturing value created by them, but tokens seem to offer this novelty of coordination through ownership in a much better way allowing value capture along the way, not just after incorporation.
We will keep adding to this series, continuing to explore how we want to define our own tokenomics. If there are topics you’d like to see covered, please reach out here.