Purpose:

To enumerate on the basic dynamics and economics of crypto-networks and its pros and cons against legacy economic systems.

Vocabulary: used throughout the article.

0) Crypto-network: Any decentralized network

1) Token: Any crypto-currency ‘coin’ that can be exchanged for a service in a network.

2) Value: The price (primarily speculative ;)) of any crypto-token.

3) TCRs: Token Curation Registry(explained further)

4) Governance- Ability to change rules/decisions of network (will be more clear deeper into the article).

5) Service: Any kind of ‘Work’ performed in exchange for a token, eg: file storage, transactions, crypto- kittens etc.

6) Stake: Like equity

7) Liquidity: Volume of currency and/or tokens.

Rules of Game:

1) The value of a crypto-token is determined by an expectation of what participants can do with it(as a medium of exchange), like everything else(like Gold).

2) Value is relative. The only meaning of the price of a crypto-token is to compare its value with that of the asset in which it is being priced.

Basic Ideas: In decentralized app any activity surge of frontend app will mean that more people want to buy the tokens, which increases activity, and token price, and this loop continues.

The tokens serve as both currency and capital.

-> Currency: For consuming the asset/service of the crypto-network; exchange; high velocity for short-term gains/losses.

-> Capital: For stake(governance right); storage; low velocity for long-term investment.

Dynamics of Crypto-Systems:

Key Actors- Users, Miners, Investors

1) Miner: provide the service

2) User: consume the service

3) Investor: provides liquidity

Relationship between actors:

1) Miners and Users trade : Work(Service) and Tokens

2) User and Investors trade: Capital and Tokens

3) Miners and Investors trade: Capital and Tokens

Exposition: Simply put:

1)The User gets tokens from Investors capital, to consume work of the miners. eg: Bitcoins are generated by miners as a service of confirming transactions and the users consume that service. Investors help converting user currency to BTC for doing the transactions.

2) The miners get capital from the investors when they need to finance the cost of providing the service and doing work. eg: Miners get BTC which need to be exchanged for currency to pay for computation(work), facilitated by investors. Therefore investors are the interfaces for the miners and users for facilitating exchange.

Decentralized app lies between users and miners, to regulate and guarantee the tokens and services. Therefore more correct idea: If users grow, increase in token demand, which is satisfied by investor pool, which in turn, also increases demand for miner services. Also token value increases.

Impact of Governance:

Governance based on stake can significantly influence the value of token as well. It is essentially replacing a central board of directors with a community - run stake-based voting mechanism.

eg: If miners increase and provide more services of the network; this adds activity due to influx of users to the network, hence further increasing the value of token. Here if a governance-based token is available; the investors would be incentivized to maintain and protect their stake(governance rights in network) and thus hoard tokens. Furthermore this would remove tokens from high-velocity trading arena, underwrite the growth of the network, and hence chart the route for long-term value. Moreover, the miners would be incentivized to act as investors for participation in the governance of their network marketplace.

Incentivizing:

Economics 101: Whatever is incentivized is more likely to occur over the opposition.(Law of demand-supply stated differently)

The reason designing crypto-systems is difficult, is because the several involved parties need to be incentivized for, and more importantly, against the expected and fraudulent behaviour respectively. Therefore it’s essentially social engineering, but in a constructive manner. People are really smart, and unless strongly incentivised(Note: primarily economic incentivizing is most effective for obvious reasons) against something, will find loopholes, rendering the token/crypto-network useless and of no value.

This phenomenon is what powers all crypto-networks, and is critical for the understanding of incentivising . If any crypto-network is compromised, for eg: token theft, fraudulent behaviour of service providers, abuse of governance powers etc; the networks token loses all value/credibility and renders the effort to hack into system useless. That’s the incentive to primarily stop people from compromising the network, and gives these networks their ‘un-hackable’ status. This is where decentralized networks win over centralized ones, which force trust on the central entity/ use semi-central moderators curating the network.

eg: TCR’s:

TCRs are lists/registries on crypto-networks; they combine traditional listing with governance features and intrinsically built-in economic incentives of token-based networks.

-> Incentive Game:

Primary incentives for crypto-network actors:

Investors: Token value(profits)

Users: Access to quality list information

Miners: Recognition to list item (+profits)

To add another entry to the listing, a deposit of tokens must be made to the listing. All token holders are eligible to vote on the legitimacy of the claim, and challenge it. If the listing is accepted; the owner of the information may keep the deposit tokens; but if not, the deposit is forfeit and the money is distributed between the challenger(who also has to make a deposit to challenge the claim, and may lose if his challenge is rejected) and token holders who refuted the claim. Main incentive here for the token holders is to vote, since they stand to win tokens based on the voting results. Furthermore they are incentivized against falsifying by the above mentioned principle of losing token value . Moreover an additional layer of incentive here for token investors, this voting right is proportional to stake. Note here that token holders can be all of formerly explained miners, users and investors.

Challenges for crypto-adoption:

In spite of the usefulness of these technologies, it cannot be argued that they are still being opposed by governments around the world. Following are some of the key issues:

1) Novelty: Since these crypto-networks are such a new and ‘disruptive’ technology, the users are highly susceptible to fraudulent coins, market-gaming and scams. Solution is regulation.

2) Volatility: The values of currently ruling coins like BTC and Eth, are highly volatile due to speculation, causing changes in purchasing power of token-holders, reducing the trust of service providers and users alike. Solution is deleting the ideology of the masses(short-term investors) that tokens of crypto-networks are a get rich quick scheme, and instill the idea of them being a new way to accomplish the same task.

3) Limits of Rationality: Humans cannot be completely programmed to behave as expected, despite the knot of incentives. eg: in TCRs vote memeing and coin-flip voting are important concerns, not because they are too big to manage, but because they are silly and random.

Conclusion:

Crypto-economics is increasingly looking like a viable solution to the growing scamming, spamming, dishonesty, and corruption as a result of the digital dark age that we are living in. The world is coming on the internet and so classical business models need to be revamped for network crimes by the anonymous. One way this can be accomplished is by the incentives of the crypto-networks. Without compromising the internet’s biggest strength and weakness, its openness, the anti-social acts can be contained. Another major advantage is the distribution and democratization of wealth, rather than centralizing it into the hands of a few. While crypto-currencies may be the only really mainstream implementation of these crypto-networks, their real use lies in all kinds of other applications, to create economic sub-systems in the diverse areas of assets, currencies, and data.

Disclaimer:

I have intentionally refrained from using buzzwords like blockchain and crypto-currency, in order to broaden the scope of the article to all token-based crypto-networks in general.

This article has been titled v1 since several other articles will follow as my personal knowledge grows and the field advances.

References:

1) The Price and Value of Governance by Joel Monegro- Youtube 2) Token-Curated Registries - Mike Goldin - Medium