Nami's Nexus: Stop Going in Circles
In this opinion piece, we explore how the misconception of tokens as a form of currency has led to a repetitive cycle of circular design in token economies.
We often observe a pattern in token economy design that results from thinking of tokens as money, which is often referred to as “circular design”. Unfortunately, despite the numerous projects that have collapsed over time, this pattern still persists, especially amongst those transitioning to crypto from sectors like finance.
A common example of a token economy is as follows:
Tokens are limited in supply, which creates perceived value
Token holders can stake or buy NFTs with tokens
Token stakers or NFT holders get airdropped new tokens at a defined interval
Holders of airdropped tokens can sell their tokens to others if they want to cash out early
The tokens provide governance rights, typically concerning the token treasury
It works at first
Initially, this seems like a simple but effective system. Users want to purchase tokens to invest in the system for long-term earnings and a chance to govern or participate in a project. Due to the limited supply and the gradual release of the token, coupled with the fact that tokens are being locked or burned by owners staking or buying NFTs, the number of available tokens is decreasing. As a result, the token is becoming more scarce and thus more valuable. This system may work well with initial token releases selling out rapidly and users reinvesting their earnings, however, latecomers may have to pay high prices for remaining tokens. Eventually, after the hype around the reward distributions driven by endorsements from YouTube personalities and other influencers has died down, the system's momentum starts to decline. As prices drop, some of the early adopters become increasingly hesitant, leading to a surge in selling activity and a sharp decline in token value. The price then remains stagnant for a while, with a slow downward trend as loyal supporters hold on and encourage others to "buy the dip.”
Why does this happen?
It is easy to get caught up in the idea of things having “value” due to certain attributes such as scarcity, investment potential, governance rights, or excitement. However, in the end, the value of a token or anything else is determined by its exchangeability. In the case of games, it might be a source of fun and enjoyment, and in the finance context, it could be a source of profit, but it only retains that value when it is exchanged. The value of financial-type tokens is determined by the price at which they are sold for fiat or an equivalent that can be converted into real-world value. This is critical because it implies that the owner of a token does not dictate its value; rather, the person who wants the token does. Unless the tokens can independently satisfy one of Maslow's hierarchy of needs, owners have to rely on someone else to give them something they do need for it. This is why demand matters more than supply.
Need to have it
When considering the previous example, one might wonder why an individual would be interested in purchasing tokens from other owners. Your first thought might be “so they can stake it to receive more tokens and governance in exchange”. You may want to stake some of the additional tokens that are rewarded to you but eventually, you will want to take some profit and might find it harder to sell than expected. What is the reason for this? For one, the token supply has been steadily increasing over time, and many of the individuals who were highly interested in obtaining them have already done so. Furthermore, prospective buyers may be skeptical that there will be future buyers who are more enthusiastic about the tokens than they were. Essentially, the motive for purchasing tokens is to eventually sell them to someone who is interested in acquiring tokens that they, in turn, wish to sell to someone else. This cycle has earned the label of a pyramid or Ponzi scheme, where one is merely kicking the can down the road, looking for the next victim.
What about governance?
Typically, the next line of defense of this system is that the tokens do hold some value, namely, voting rights. But what do these voting rights include? They provide the right to participate in decisions such as the distribution of tokens or the deployment of treasury assets. As a result, the value of the token lies in determining the fate of tokens that only have value in determining the fate of other tokens - it should be evident by now why this is referred to as a circular design. It appears to make sense when only looking at a portion of the circle or at a limited timeline but it does not add up when viewed as whole. Governance is only valuable to the extent that you have control over something that holds value outside of these tokens and that transcends mere monetary value. In the context of a game it could refer to voting on decisions around gameplay features and multiplayer-wide changes. However, when contemplating this concept for games, one must also consider whether it is appropriate to outright sell decisions to players for money. The usage of terms such as governance, staking, and tokens obscures the fundamental notion that one is selling votes for money. It is unwise to hand over game design and balance decisions to whoever has the most money. Of course, we like to justify this by claiming that it aligns incentives with the most invested players, but let us call a spade a spade.
What about utility, then?
The last defense of circular token economics is to simply fall back on the vague notion of adding “utility”. However, if you look into the term in economics you will find that it is an extremely broad and ambiguous term, as it means different things to different people. Rather than subscribe to these vague ideas, consider a simpler approach: Imagine all tokens are purchased from the source and cannot be resold, only used. This is a similar concept to premium currencies such as "gems" that are used in games. If a token's main feature is the ability to be sold to someone else, then it does not have any real utility. Ultimately, the purpose of a token should be to exchange it for something with implicit value, without the need for multiple intermediate steps. Staking does not add any utility, and it may be better to exchange the token directly for the item of value rather than stake it. Reducing the circulating supply of a token does not increase its value; it only makes it more expensive to buy something of no real worth. Even non-fungible tokens like PFP/Art NFTs can have no apparent need for "utility." To understand how the art market creates pretend value, try playing the Uwe Boll card game Modern Art.
Coming full circle
Why discuss this topic now when we have already moved past Ponzi schemes and similar practices in Play-to-Earn games? The reality is that we are not beyond these schemes, and many systems are being designed with complex structures that give the illusion of legitimacy, although they are still fundamentally flawed. It is time to face the truth that creating value for a token out of thin air is not possible, and we must consider whether the token provides something of real value to the buyer. There is a reason smart VCs are not taking many token deals anymore.
When designing tokenomics, we have to focus on creating genuine demand. We have to exercise caution when dealing with systems where the value of something is dependent on selling it to others, as they are often unsustainable Ponzi-style schemes. It is also crucial to distinguish between pyramid schemes and multi-level marketing, as certain projects that claim to empower player economies are often just disguised MLMs. To truly advance web3, we need to develop projects that understand and cater to the users' needs and are built around genuine value delivery, providing innovative systems that go beyond circular designs.
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