A Sustainable Token Economy Cannot Be Inflationary

Oded Noam
Oded Noam

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2 years ago

blog

Blockchain is a young business, too young for us to have seen any project fully develop. If we look around, we see how inflationary models benefit projects in their infancy. But this observation will not remain once these projects grow out of their infancy.

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For bootstrapping a good blockchain platform, having a good protocol and implementation is not enough. A key element in the success of a decentralized system is having different and independent groups use it, operate it and govern it. Designing an economic incentives mechanism to incentivize such participation by all these different groups is a big part of the work related to launching a blockchain platform.

How to take off, how to cruise

It's important to distinguish between incentives that can get a platform “off the ground” and what’s needed for it to sustain in the long run.

When starting from zero, none of the participants can expect to benefit from any normal course of business: The value generated is just not sufficient to sustain any economic activity, and surely there’s not enough to go around. The only asset a blockchain platform has at this point — and in fact, the same may apply to any product that is launching for the first time — is its growth potential and the benefits of joining early on what could become a success.

There are many ways the promise of future success can be used to promote participation: Sell shares of future success to investors and pay participants (or at least subsidize their service) to lure them in; distribute shares in the future success to the early participants; have an “early mover advantage” in place so participants can hope to enjoy the fruits of their seniority; and more. And though there are different ways to achieve this, the principle is one: Participants allocate value (either plainly by providing funding or in the form of putting in the effort, time or their reputations) and expect to gain benefits, financial or otherwise, if the platform takes off.

Of course, this cannot apply in the long run, when the growth potential has been exhausted. Just like other products, blockchain platforms that reached their “cruise altitude” must have a sustainable model. In a sustainable model, the total value gained from the platform surpasses its total operating costs and the parties gaining that value are sharing enough of their gains with the parties bearing the cost to make the operation beneficial.

Outside of blockchain, this can be seen with tech start-ups who raise venture funding and subsidize their services to gain market share, starting to monetize only after growing enough to ensure their market dominance. In the public blockchain space, no platform has yet reached that point. Even Bitcoin, the first blockchain platform, is still in its early growth stages, and is heavily subsidized: for example, in the past 3 months miners gained about 3,850 BTC from mining fees and 164,450 BTC from block rewards. In other words, block rewards paid for 97.5% of the mining cost. Block rewards are simply subsidies transferred from the pockets of early purchasers (whose BTC is worth slightly less due to inflation) to the pockets of miners. The purchasers, of course, are happy to subsidize Bitcoin use, because they expect it to enable wider adoption of the protocol and increased demand for the BTC they hold.

Long-term Strategy

It may sound as if creating an economic model that works during takeoff is the harder part of the problem: it involves estimating the future value of assets, including intangible assets such as experience, brand, seniority and so on. But in fact, takeoff models have been tried in the hundreds, and by observing which blockchain projects created a high-quality community of operators we can assess what works in the existing economic models. The long-term sustainability of an economic model is, on the other hand, mostly uncharted territory.

There are, though, two types of stakeholders we can profile:  the token holders and the platform users (app developers).

Who are the token holders and what do they want?

Token holders in platforms that are taking off are a very diverse group that is quite hard to define. But the future is much simpler: When the platform has matured and its growth is completed, utility tokens’ use is just as their name suggests — to pay for a utility (for that matter, the utility can be for paying fees, staking, voting, etc). Naturally, those holding the token, are doing so only because they intend to use it in the future, or used it in the past. They don’t expect to get rewarded for holding it, and they surely don’t expect to be diluted for subsidizing someone else’s use of the network.

What platform users want

The needs of the app developers are actually easy to predict. When all the hype dissolves, we can expect to see that consumers using blockchain-based apps aren’t willing to pay more than — or experience a product inferior to — its centralized competitor. The watermark for the platform is cloud: centralized apps using cloud platforms have the best tools to create a great product in predictably low costs. Decentralized apps that compete with them must be able to offer similar quality at roughly the same costs.

Note that it’s not enough to have low fees in the present. If the network economics don’t make sense, the fees may be low now but skyrocket when there’s actual demand for the platform. This is the case with many of today’s public blockchain platforms. The economics of cloud services is aimed towards the exact opposite: in almost all services, users expect to pay less as they grow, and for all costs to decline over time — in proportion to ever-declining hardware costs.

Our full analysis of what blockchain platforms need to do in order to win in the bigger competition with centralized ones is now on our website.

My conclusion

I firmly believe that inflationary models and perpetual rewards models are unsustainable. In designing the economy of the Orbs platform, we focused mostly on making sure the users can expect to have low and predictable fees in the long term, so they don’t have to worry about changing their chosen platform as they begin to grow fast. Economic models need to be determined early on and are extremely hard to change at later stages, so getting the fundamentals right in the first time is critical. I'd be happy to answer questions or see comments on our models in our discussion board.

Inflation on the Orbs platform

Accordingly, the ORBS token which drives the Orbs platform is non-inflationary. All tokens have been pre-mined and the supply is fixed (at 10 billion tokens).

Funds needed for bootstrapping the platform in its early years, such as token rewards in the Proof-of-Stake model, do not come from inflation - unlike many PoS projects. Instead, the source of funds for token rewards is a pre-allocated and limited reserve pool (55% of the total supply, vested over 55 months from TDE).

For the detailed breakdown of the ORBS token distribution, please take a look here.

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