Ethereum founder V God: To go beyond the token economy

****Author: **Elaine , Dirk, **brookbit.eth , Compiler:****Sissi

Ethereum founder Vitalik posted such a tweet on July 8, 2022: **The first law of token economics is: don’t start using the word "token economics" Get advice on token economics from people. **This sentence is quite confusing at first glance, but after a thorough study, you will actually understand that what V God wants to express is: **People who are too obsessed with token economics cannot see the overall situation clearly and cannot ensure the balanced development of the protocol . **

**Indeed, the token economy is certainly a part that cannot be ignored when building an agreement economic and financial system, but as V God said, it is not the whole of the agreement. **Imagine a scenario. If you are the founder of a stablecoin project, what things do you need to consider on Day 1? **First and foremost, consider what is missing in the market. **Homogeneous projects abound on the stablecoin track, and those that are truly scarce are those that can solve market pain points. Fully research and find out where the real demand for stablecoins in the current encryption market is. This is an important prerequisite for whether the project can have positive externalities and whether it can create real benefits. Secondly, we need to consider the business model. Is it necessary to mortgage the stable currency with fiat currency? Or a cryptocurrency-collateralized stablecoin? Or an algorithmic stablecoin? So how to determine the pledge rate? Which liquidation mechanism to choose? How to set the liquidation parameters? **Next comes the design of incentives,**Should I send out project tokens, and how should the economic mechanism be designed? Which form of financial incentive to choose? Is it to hold and earn? Or staking rewards? What is the appropriate range for transaction fees and incentive parameters? Finally, governance, Do I want to form a DAO? What are the permissions of the community? Do you need a governance token? What is the community proposal process like? How to improve community activity? How to prevent sybil attacks? How to understand the belief distribution of members and so on.

Therefore, it is best not to limit your vision to the token economy. **This is like the Internet is an innovation of science and technology, but it is the proposal of the "Internet +" model that has had a profound impact on the human social and economic paradigm. Similarly, **Today’s encryption market is no longer a single competition of token economic mechanism, it has evolved into a comprehensive power game in three aspects of “business & incentives & governance” around positive externalities. **Only by cooperating with business, incentives, and governance, and **finding out a logical and self-consistent "token +" new economic paradigm, can the **project agreement continue to leverage new attention, and **become a real "shaping the future". **

Based on this, we have picked up the business and governance neglected by most people, brought it back to the same level as the token economy, and innovatively proposed a more complete "token dynamics", **It regards the Token-based economic and financial system as a dynamic system. The dynamic game process of this complex adaptive system uses positive externalities as the objective function, supplemented by three dynamic mechanisms of business, incentives, and governance to complete the system. Adaptive optimization and upgrading, and finally realize the positive externality of the agreement. It includes scientific principles, method paradigms and cutting-edge theories at three levels of business, incentives and governance, in order to provide more scientific and complete help and guidance for the development of future encryption projects and DAO organizations. **

The encryption market has been trapped in the "token economy" for a long time

**From a theoretical perspective, the research perspective of "Token Economics" is relatively single. **It is generally believed that it is a term used to describe all factors that affect the value of Token, including supply and demand mechanisms, incentive mechanisms, consensus mechanisms, role definition, technology determination, target group definition, etc. In this ecosystem, Because of transparency, consensus, algorithm mechanism, etc., the token economy is quite powerful. However, the Token-based economic and financial system is a complex open game system with chaotic and nonlinear characteristics. The inherent emergent characteristics of this type of system must be explained with interdisciplinary knowledge such as mathematics, modeling, and computers. Tokens It is difficult for economics to attribute the complex results emerging from the system only from the perspective of economics.

**From a practical perspective, the application of "token economics" is also in its early stages and immature. **

**On the one hand, everyone focused on token economic mechanisms such as supply and demand and incentives, ignoring the importance of business and governance. **Of course, this is also understandable. The immature supervision of the early encryption world, the aggressive staking of capital, and the exaggerated bubble of the Ponzi project have allowed every participant in the encryption market to see the wealth accumulation effect brought about by the token economic mechanism. No one has carefully designed the business and polished the governance, because studying the token economy seems to be easier to create bubbles, which has become the default shortcut for the public to get rich. It is human nature to seek advantages and avoid disadvantages. In front of the huge cake, everyone is scrambling to use the token economy to increase leverage. Fomo emotions, gambler psychology, and herd effect are flooding the sky above this dark forest. The consequences of ignoring business and governance are also obvious. A large number of "hit" encryption projects only focus on economics, and in the end they failed to survive a round of market cycles. In contrast, projects like Compound and Uniswap, which have carefully designed their business and polished their governance, have survived to this day even without the leverage of economic incentives. The results speak for themselves, and business and governance cannot be ignored.

** On the other hand, the Token project is one of the most complex economic and financial systems, and the industry is still relying on Excel and experience to judge which is better. **In the traditional economic and financial system, these are areas where risks can be controlled only by modeling by mathematicians and computer scientists. In contrast, the Token-based economic and financial system is more complex and chaotic, coupled with its adaptive and non-linear features, making the game and evolution speed of the system unmatched by traditional financial systems, and such a rapidly evolving The ecosystem is still making judgments and qualitative analysis based on experience and Excel, which is really staggering. If the theoretical guidance in the encryption field still stays in the "token economics" of the last round of bull market, it will undoubtedly cause a huge obstacle to the development of the encryption industry today.

**This is not to belittle "token economics". We must admit that the development of token economy has indeed brought about the ICO craze, DEFI Summer, and the "X2Earn" carnival. The development of the encryption industry today is inseparable The power of token economics. **However, the industry is developing, and the theory cannot stand still. Going back to **Vitalik's point at the beginning of the article: the first law of token economics is: don't take advice about token economics from **** people who use the word "token economics" . **Essentially, not the people who use the term "token economics", but those who: ** failed to find the positive externalities (creation of value) of Token projects, and designed poor token economics for the project . **

Therefore, apart from the positive externalities, business logic and governance structure of the project, it is obviously not enough to only talk about the incentive mechanism, which will also bury many hidden dangers for the project. Focusing too much on token economics, the consequences we can see with our naked eyes are rounds of ever-increasing economic risks, from Fcoin to Luna to FTX. We cannot estimate the final impact of the butterfly effect of each crisis. All we can do is to curb the birth of risks from the source as soon as possible. Otherwise, in the face of the ups and downs of the market, everyone will be discouraged, and the next dawn of the dark forest may be difficult to come.

Contain the birth of risk from the source——Theoretical innovation

**The Token-based economic and financial system is a complex and rapidly evolving open game system. **In the three-body movement, the three subjects interact and interfere with each other. The nonlinearity, dynamics, and complexity that emerge make it impossible for us to give an analytical general solution that accurately describes its dynamic trajectory. And the general three-body problem is often chaotic, that is, if the initial conditions of two three-body systems are only slightly different, in the subsequent evolution process, the dynamic states of the two systems will produce Huge difference. The Token-based economic and financial system involves many different types of subjects such as contracts, agreements, and users. The degree of chaos and evolution speed of the multi-body game are much higher than that of the three-body system, so the multi-body system often has a stronger Dynamic, Adaptive and Emergent. This is definitely not a problem that can be solved by "economics" alone. It requires ****single **** learning and the symbiosis of interdisciplinary research to conduct integrated research on the system in order to Achieve breadth and depth consistent with complex nonlinear systems. **

Therefore, we propose the concept of "token dynamics".

**Token dynamics, which regards Token-based projects as a complex dynamic system, is a science dedicated to studying the value growth law of Token projects from an overall perspective, and discussing the relationship among business, incentives, and governance. Interaction logic and the discipline of studying the various models that a token ecosystem may involve. **It will describe all factors that affect the value of the Token project, including but not limited to the business construction logic of the Token project, token incentive mechanism, community governance methods, etc.

**Token dynamics will also integrate research methods in multiple disciplines, opening up a new research perspective on Token-based economic and financial systems. **It will be composed of Industrial and Systems Engineering, Artificial Intelligence, **Optimization and Control Theory, **Computer Science and Cryptography, **Economics and Game Theory, **Psychology and Decision Science, Behavioral Economics (Cognitive Psychology Science), political science and political economics, **institutional economics and governance, **philosophy, law and ethics and other disciplines to build a more robust, more complete and more systematic theoretical and practical basis.

The "power" of continuous value growth - self-driven snowball model

**Token Dynamics believes that positive externalities are the core source of motivation for the value growth of Token projects, otherwise, no matter how big the snowball is, it will be just an empty shell, which will collapse in one blow. **

Looking at the previous flash crash projects, we will find that all those that do not have positive externalities will eventually collapse. (However, it does not mean that the collapse is due to the lack of positive externalities. Business, incentives, governance, any link is not properly deployed, and it will eventually collapse. It is just a matter of speed). **So what is a positive externality? **Simply speaking, we regard the project as an independent subsystem. If it provides value to the external system, solves real problems and pain points in the market, meets the actual needs of the market and thus obtains feedback from the external system Gain, we think it has positive externalities. However, there are tens of millions of market demands, but it is difficult to find the real pain points. **This requires the project party to keep their eyes open, carefully explore the value points of the business itself, consider whether the market really needs it, whether the current technology matches and Whether the timing of entering the market is appropriate, etc., and even the ultimate ideal realization path must be planned in advance. Many project parties entered the encryption market with a good original intention, but did not seriously examine where the real demand of the market is. They thought that the project had the so-called "positive externality", so they started to make a big fuss about incentives. The "magnification effect" of the currency economy has become even worse. **Therefore, exploring positive externalities is the most worthwhile and valuable thing in the current Token project entrepreneurship, and the "project snowball" that is separated from positive externalities will be just "an empty shell". **How to find market pain points and lock positive externalities? This is a profound and grand topic. Its related theories, methods and practices are beyond the scope of this article. We will discuss it with you in the follow-up original series.

**In addition to the core power source, a mutually compatible business model, incentive mechanism and governance system will also greatly reduce the resistance of the "value gear" in the process of progress, and the "project snowball" can quickly and steadily grow bigger and bigger . **

The business and governance of encrypted tokens are as important as the design of the underlying token economy (incentives). Maybe you can start the project by carefully designing a Token incentive mechanism, but without a long-term profitable business model and maintaining a stable governance system to optimize the system, your project will soon fall into a "death spiral". ** The Token project is neither a sprint nor a marathon. It is more like a directional exercise: through trial and error, the expected goal is gradually achieved. The core of its success is whether it can create continuous value and revenue growth. **That is to say, "creating value" is the goal or core of the Token project. Business, incentives and governance are the basic elements for the project to create value, or they are the three pillars of trust that make up the Token project, and they are indispensable. **

For the Token project: **A well-planned business plan can prevent the project from becoming a "castle in the sky". **The best business layer design can create a new type of attention black hole, and its positive externalities can ensure that the project will truly take root and grow in the encrypted world; **The properly designed incentive mechanism can help the project to maximize its future. *The best incentive layer design can provide a stable supply and demand mechanism for Token, which will help the community to actively hold and use Token, maximize build consensus, and magnify the influence of the project; * Well-crafted governance methods can continuously optimize anti-fragility. The best governance layer design can make the project continue to evolve independently, the continuously optimized business layer and incentive layer can make the project have stronger "resilience", so that it can adapt to the unpredictable market environment, Travel through longer market cycles.

**Therefore, Token Dynamics believes that projects with positive externalities can grow rapidly like a "snowball" under the protection of business, incentives and governance. **The three elements are indispensable, which is a necessary and sufficient condition for the project value to "roll and grow" smoothly. Before deciding to participate, it is very important for investors and project parties to understand the power source of project tokens, analyze and evaluate the three basic elements of the project.

**Token dynamics - empty talk or full of dry goods? **

As we mentioned earlier, the Token-based economic and financial system is a dynamic open game chaotic system that requires interdisciplinary fields to jointly solve its emerging economic security issues. Therefore, we propose the "token dynamics" from the perspective of multi-field integration Learning", which makes the three levels of business, incentives, and governance have professional and mature disciplines to provide specific guidance:

• Sound Business Logic - Optimization and Cybernetics in Guidance

Business logic (or business scenario) is the basis for the existence of a Token project incentive mechanism and governance method. ** Only when the business logic is established, the profit model has a prospect, and the system mechanism is stable and reliable, can there be continuous users, which is also the basis for the project to avoid Ponzi. **We need to ensure that the business logic can support the development of the project throughout the life cycle of the project. ‍

**In the process of business operation, it involves the parameters and mechanism of the smart contract of the project. **For example, MakerDAO is a project that runs on the Ethereum blockchain and integrates over-collateralized stablecoins, lending, storage, user-co-governance and development. In the selection of the liquidation auction mechanism, MakerDAO mainly considers the English auction and the Dutch auction. English-style auction is also called increasing price auction. The starting price of the lot is the lowest expected price. From low price to high price, multiple bids can be made, and the highest price before the countdown ends. The price is the highest expected price, from high to low, and the first bidder to respond wins and pays the price that was called at that time. For MakerDAO, the rules of the English auction are simple, and there may be super high auction prices. The Dutch auction can be traded in real time, and will not lock up a large amount of funds of users for a long time. The two auction methods have their own advantages and disadvantages, and different mechanisms choose corresponding Different project ecologies have a real impact on MakerDAO's ultimate value realization path. In terms of liquidation parameters, there are key liquidation variable parameters such as step, cut, buf, cusp, tail, etc. How to adjust and adapt is also crucial to the value capture of MakerDAO.

**Therefore, there is an urgent need to introduce optimization and cybernetics. **Optimization and cybernetics is an interdisciplinary study that focuses on the iteration and optimization of systems, involving cutting-edge concepts such as learning, cognition, adaptation, social control, emergence, aggregation, communication, efficiency, effectiveness, and connectivity. **For projects like MakerDAO, it can provide a set of scientific design verification methods for the improvement of business logic and the analysis and adjustment of internal mechanism parameters. Compared with the "head-slapping" decision-making, the iterative business plan under the guidance of optimization and cybernetics is theoretically less risky, more logical, and more likely to be recognized by the community. **

• Effective Incentive Mechanism - Game Theory Guidance

In addition to looking at the white paper, founding team, roadmap and community development, the incentive mechanism is also an important part of evaluating the future prospects of the Token project. **Token projects design token incentives around their business and governance frameworks to encourage or discourage various user behaviors. Different users have different target expectations, so the same incentive parameters may produce hugely different incentive results among different user groups, so a balance must be found at the position where the cumulative incentive utility is the highest, this is a bit like the central Banks regulate the macroeconomy by printing money and implementing monetary policy to encourage or discourage spending, borrowing, saving, and money flows.

At present, the incentives of Token projects still mainly rely on tokens, and game theory entered the field of token economy very early. For example, Olympus DAO (OHM) is trying to create a global stablecoin asset backed by encryption instead of US dollars. It uses pledge as the main way to increase the value of its Token OHM to achieve the value storage status. This strategy is called (3, 3), Its inspiration also comes from game theory.

In the Olympus system, you can Stake, Bond, Sell or combine these strategies. The numbers on the graph are just a visual representation of how beneficial each strategy is to the Olympus protocol. Stake is +3, Bond is +1, and Sell is -1. (3, 3) means that Olympus regards pure staking as the most beneficial strategy for the project, so users use this strategy to earn the most. Combinations of Stake and Bond (3, 1) or Sell and Bond (-1, 1) generally yield smaller returns.

**(3, 3) The introduction of game theory played a huge role. **Currently, 91.5% of the OHM supply is collateralized - a figure possibly one of the highest of any cryptocurrency. Game theory is an economic concept that assumes that traders are rational actors who will eventually make optimal choices under certain incentives, such as staking to obtain high returns, mining Bitcoin, etc. The case of OHM allows us to see: **Game theory provides a more scientific and complete methodology for the design of incentive mechanisms, making the system goals and Nash equilibrium tend to be consistent. Token dynamics will also further explore more application scenarios of game theory and tap its greater potential in combination with tokens. **

• Complete Governance Program—Institutional Economics Guidance

In most Token projects, Token holders can already vote to change the rules of the Token project. DAO can change the number of token incentives given to pledgers through independent voting, or modify risk parameters in business logic, etc. **For example, 1HiveDAO, which is committed to the development of public products, decided to decide whether to distribute HNY tokens to motivate contributors who can bring value to the community through a vote of belief. Conviction voting is a novel decision-making process. Voters pledge Token to support the proposal they want to be approved, and continuously express their preferences. As time goes by, the collective belief continues to accumulate until it reaches the threshold set according to the proposal requirements. When the accumulation of belief exceeds a threshold, the proposal passes and the funds are released. It can be seen that the setting of the governance parameter-threshold has a huge impact on whether the proposal can be passed, and even determines the next development trend of the project and the community. Facing a community network with complex relationships, the community needs to better perceive and respond to the belief voting network in order to make more scientific decisions.

In this case, ** institutional economics can give full play to its strengths. **It is the branch of economics that studies the role of institutions, formal or informal, governed by a set of rules, norms, procedures, conventions, arrangements, traditions, or customs to guide socioeconomic interactions in order to incorporate individual decision-making into Organize decisions so that systems can coordinate toward a common purpose. **This is highly consistent with the governance paradigm of the Token project. It can be said that the introduction of institutional economics is the only way to optimize the governance model. **

** Various disciplines are like "Eight Immortals crossing the sea, each showing their magical powers", laying a more universal and diverse theoretical foundation for token dynamics. **

**However, the theoretical upgrade is only the first step. To usher in a healthier, freer, and more active encryption world, two problems still need to be resolved. **

First, data open source in the encrypted world is not really "open source". ** "Code is law" is the basic law of the encryption world. The project party will open the actual running code on GitHub, but except for hackers and some professional developers, no one will spend a lot of time and energy to study the running code. This has created a huge "information asymmetry", which is also the main reason why users are unwilling to easily deliver trust. If you can convert the code logic into a visual model with the help of tools, and display the macro data and laws emerging from the code operation in the form of diagrams, change "Code is law" into "Model is law", Then, All projects will become a model that the public can read, use, and verify. This is the arrival of the "open source world" in the true sense.

**Second, **Usually, the project party will design a relatively complete token-based economic and financial system based on relevant scientific guidance, but a large amount of market evidence shows that **users’ The real behavior is often far from the expected behavior of the project party. This is because, on the one hand, there is currently a lack of a universal verification framework for evaluating the design of token systems in the market; The financial system creates a high degree of uncertainty. **Uncertainty cannot be completely eliminated, only by using tools to optimize iterations again and again to narrow the huge gap between the expected behavior of the project side and the real behavior of users.

at last

"Token Dynamics" is committed to providing profound theoretical guidance for the value growth of encryption projects. Only when the public's cognitive foundation is improved, can a more solid step be taken in practice. **To solve the problems of Token projects such as "opacity" and "high uncertainty" and truly realize the technical and economic goals of the project, we also need to introduce more reliable practical methods in the stages of conception, design, development and deployment and application tools. **We will continue to introduce in detail " Model is law " and token engineering and other related concepts in the follow-up tweets, in order to contribute to the good development of the encryption market.