Cryptoeconomics, Value of Governance, Understanding User Behavior, Identifying Network Effects

In this post, I discuss a couple of processes and ideas that I try to connect together for a working thesis that started for me as intuitive but has become more evidence-based. I will discuss:

• How I approach a network’s cryptoeconomics.

• The long-term value of having a governance utility token.

• The importance of understanding the user’s behavior.

• Identifying a cryptonetworks ability to enable a network effect. 

As always, these topics and processes are meant as a foundation for further conversation. I invite anyone to provide their evidence-based responses and research. 

Also, none of this should be interpreted as investment advice. Please DO YOUR OWN RESEARCH!

Before we dive in, I would like to provide a framework inspired by Chris Burniske and Joel Monegro from Placeholder VC that I believe helps paint a clear picture of what cryptonetworks actually are. When it comes to evaluation, most of the disconnect is created by how we tend to look at cryptonetworks the same way we look at companies or equities in a company. In reality, cryptonetworks are less like companies and more like small emerging economies (the network) that provide a single exportable good (the service/utility) with a native currency (the token). Here is an excellent analogy to give you a complete picture of this argument:

• The consensus protocol is the constitution.

• The community is the constituency (miners are the supply side, users are the demand side).

• The core developers are the executive branch: they write the code and execute the strategy - but any changes to the protocol require approval from the constituency (community).

• The token is the native currency.

• The investors underwrite the currency.

Analogies are the best tools to use for intellectual clarity. However, choosing the wrong analogies can lead to mass confusion as they get repeated in scale. I believe this has been the case with tokens/equities and cryptonetworks/companies comparisons. The analogy above provides a more sensible foundation for the crypto industry.

Alright, now that we have a good framework for evaluating cryptonetworks, let’s dive in. 

Cryptoeconomics💰

Cryptoeconomics refer to the guidelines and policies that govern the nature and behavior of the token inside the cryptonetwork and are particularly important to the long-term performance of the asset. The cryptoeconomics are as important to a cryptonetwork as a business plan is to a company or a monetary policy to a country. When I analyze the cryptoeconomics of a token, I want to understand how it’s created, distributed, and earned. The long-term success of a cryptonetwork depends heavily on the quality of its ability to distribute value across all token users. A lot of that success has to do with the issuance model and the utilities of the token. In the end, the market tends to reward the cryptonetworks that provide value to the most amount of people possible - identifying this is something crypto natives have proven to be exceptional at - go dig around r/CryptoCurrency (which has over 3M community members) and see for yourself.

There are some variables I focus on when evaluating a network’s cryptoeconomics. These include transaction volumes, velocity, total supply, issuance model, and additional metrics that depend on the asset’s monetary policy and the token's utility. There are also a substantial number of talented people with impressive technical and profound economic backgrounds who are putting a great deal of time and resources into building cryptoeconomic models for better forecasting. For example, Chris Burniske’s INET Model, Adam Haye’s cost of production model, Alex Evan’s VOLT model, John Pfeffer’s mature equilibrium model, Johnny Antos’ black-scholes option model, and the list goes on. 

A lot of these models don’t have so much to do with forecasting the price but instead the potential performance of the network. One of the most intriguing things about owning a cryptoasset is that its price is almost directly correlated with its performance. The performance is (mostly) benchmarked by the use, volume, and velocity of the network’s token, unlike a company’s stock which could have a terrific earning call but results in -8% day because everyone started “selling the news” (financial markets aren’t irrational; people are). 

The challenge is that crypto is still an emerging industry with limited historical data, affecting our confidence in projecting long-term performance. But that’s okay. We’ve faced similar forecasting challenges during the computer hardware era in the 50s-60s, the software era in the 70s-80s, the network era in the 90s-00s, and now we’re in the early stages of penetrating the crypto era. The unfamiliar brings new opportunities. It also rewards those who are diligent (DYOR!). 

Governance👨‍⚖️

Once I understand the cryptoeconomics of the token inside the network, I then take a look at its utilities - I want to understand what the users can actually do with the token. The utilities of the token play a big part in how the cryptonetwork can potentially accrue long-term and short-term value to the users. The users, in this case, are defined as the investors, miners/developers, and the actual participants inside the network (it is possible to be all three). One utility I am particularly focusing on is governance. Without getting too technical, when a token has a governance utility, it allows the holders to participate and vote on the future of the cryptonetworks protocol, executed via the smart contract written into the blockchain.

An excellent example of this is to imagine if everyone who had an iPhone or held Apple stock had the ability to be presented with upcoming iOS updates and products. Then after getting a chance to review, everyone could utilize their iPhone or Apple stock to vote ‘yes’ or ‘no’ on the proposals, shaping the future of Apple products by user consensus. 

That is the kind of community coordination tokens with governance provide. I believe people will pay a premium price to be involved in that kind of governance.

We’ve seen examples of the value of community & coordination with the r/WallStreetBets movement. One of the obstacles the subreddit’s 10M+ members experienced was the challenge of coordinating everyone to stick with $GME once the story hit mainstream media. There were many members inside the subreddit pitching other meme stocks such as $AMC, $BB, $NOK, $CLV, the list goes on. Although many of those other meme stocks did receive some jump, it took away from maximizing the potential profits from the original movement towards $GME. It was rumored that many of those members pushing other meme stocks were doing so on behalf of the institutions that had short positions on GME. It appears there is still similar manipulation in the subreddit today.

Now imagine if r/WallStreetBets was a DAO with a token that provided a governance utility where everyone could vote on which meme stock to focus on for investment. Again, this is an example of the value of 1) community and 2) coordination. When you have both, you have a robust governance system built for scale.

Users Behavior 🧐

Like legacy financial markets, in crypto, you have to really try and assimilate the psychology of the users if you want a real investment advantage (understand this is easier said than done). Luckily, there is plenty of game theoretics, behavioral economics, and user index research reports to guide us to better understand the characteristics and behaviors of current and future crypto users. This includes users outside your domestic location, age, and gender. For example, I have been focusing a lot on the gen-z generation and what qualities and utilities they will value to be worth their future financial investments (Tiffany Zhong is an excellent resource for any research on the gen-z generation). Focusing on the younger generation can help you anticipate how the market will adapt for long-term investments.

A good example of this is what’s happened with the gaming industry. In the past, our parent’s generation (I’m a millennial) downplayed video games when fueled by speculative & opportunistic stories by legacy media outlets about how bad they are for children. However, instead of focusing on speculation, the intelligent investors and business operators at the time realized this was going to be a powerful movement that millennials (and younger) all over the world would eventually professionalize, monetize, and scale into a giant industry. Fast forward to the present and egaming is now projected to be $265B industry by 2025 and has opened doors to significant revenue streams for startups, content creators, and professional gamers all over the world. We’re even seeing a transition of officials from legacy sports leagues transition into the gaming industry.

Understanding which cryptoassets are gaining the biggest following is also essential. There are many resources that provide social sentiment metrics of different cryptoassets by scrapping data from various social media platforms and aggregating them into useful metrics. If used at a 3,000 ft view, social media can be a powerful tool for evaluating the communities around a cryptoasset. It can also assist in gaining context around why certain assets are building a community better than others. Not utilizing social media as a user-research tool nowadays is like trying to play pond hockey in July.

Network Effects 🧑‍💻🔄👨‍💻

In the end, one of the essential attributes for evaluating a cryptoasset is if the network and its token can create strong network effects. The addition of robust cryptoeconomics and user-value-driven governance is usually a network that distributes the right amount of incentives to grow its user base and enable a lindy type network effect.

⬇️ More Users = Higher Demand for the Token

⬇️ Higher Demand for the Token = More Investors

⬇️ More Investors = More Miners/Developers

⬇️ More Miners/Developers = Stronger Network Security

🔄 Stronger Network Security = Consumer Confidence & Trust 

Everything above creates a flywheel of community growth and participation with accurately distributed incentives. 

Cryptoeconomics + Governance + Users = Network Effects

Final Thoughts 🎬

As we progress deeper into the crypto age, I believe that cryptonetworks with a governance token will accrue the most value long term. We are already seeing the success of this implementation through many defi products such as SushiSwap, Aave, MakerDAO, UniSwap, and many more. If the rise of investments and user participation continues with these governance tokens, we will start to see other future cryptonetworks develop their protocols with similar attributes. 

We could see many similar models to what Star Atlas is doing with their governance token (POLIS). POLIS holders can vote on the game economics (i.e., inflation rates), asset release schedules, and game direction. 30% of the initial token supply is allocated to the core developers, and the rest of the supply has a vesting period until users can partake in the governance, with the goal of the token vesting when the network is ready. This allows the core developers to have significant control in the early stages until everything is developed well enough to be operated by community consensus. By the time it’s ready, there will be enough tokens distributed and purchased by users and investors for the community to gain control. 

The incentives are all aligned. Although they are eventually giving up control, the core developers will continue to be rewarded for the quality of the game development and user experience. The value of their token supply will increase as the game draws more users, which will raise the demand for the token, which will raise the demand from investors.

Suppose such governance and cryptoeconomic strategies prove to draw in a significant amount of users. In that case, I think we could eventually see non-crypto native companies experiment with this in the future.