| | | The next 100 million crypto investors. |
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| Health, Wealth, and Happiness |
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| “Optimism is the most important human trait because it allows us to evolve our ideas, to improve our situation, and to hope for a better tomorrow.” – Seth Godin |
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In today's issue: Cryptoeconomics is a six-syllable word that can be reduced to just three systems.
These systems (like the three systems of government) are fundamental for understanding how crypto projects work.
It's another mental model that smart crypto investors (like you) can use to judge crypto investments before you buy. Read on. |
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| Must Read Today's most important story for crypto investors. |
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Good roundup of crypto investor tools to help you pull vital, real-time stats on potential investments. The five tools listed in this article are:
CoinGecko DeFi Llama Dune Analytics Nansen Token Terminal
Investor takeaway: We use these tools at Bitcoin Market Journal all the time. We encourage you to bookmark all five. They also come in handy when analyzing the cryptoeconomics of a blockchain (explained below). |
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| | | Cryptoeconomics for Investors by Anatol Antonovici |
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Summary: Cryptoeconomics is an emerging field that helps us design or analyze the economies of crypto projects. For crypto investors, understanding the cryptoeconomics of a blockchain reveals the fundamentals that can determine whether that project is healthy or stagnant. Here's how to use this investing superpower. Cryptoeconomics is a discipline that uses cryptography and economic incentives to create new forms of decentralized networks and applications. We can regard this new field as a mashup of math, computer science, and economic theory.
The goal of cryptoeconomics is to find the ideal approach to coordinate the behavior of decentralized network participants. In plain English, cryptoeconomics tries to understand how to best design, fund, and facilitate the growth of blockchains.
(Note: Cryptoeconomics is slightly different from tokenomics, though the two overlap. Tokenomics refers to the economics of a token, while cryptoeconomics refers to the economics of the blockchain as a whole.) |
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The Cryptoeconomic Circle. Courtesy Placeholder.vc
The Three Elements of Cryptoeconomics
Joel Monegro pioneered the so-called Cryptoeconomic Circle to describe the relationship between the three leading players of a decentralized network:
Miners are responsible for contributing to the consensus protocol and coordinating their resources (e.g., computing power) to maintain the network and add blocks. If the decentralized network relies on a PoS algorithm, block creators are called validators, and they stake native tokens to become eligible to participate in block creation processes.
Users consume the service, whether it’s a form of digital money or a utility token.
Investors capitalize on the network and contribute liquidity.
The Cryptoeconomic Circle has three forms of interactive relationships: the miner-user, the investor-miner, and the investor-user. This model implies a dual role for investors like us:
We provide liquidity, so miners can capitalize on tokens that are rewarded for their mining efforts. We ensure the network is well-capitalized, so token rewards exceed mining costs and keep mining profitable.
In this model, crypto investors are divided into two main groups:
Traders (those who aim for short-term gains) Hodlers (those who buy and hold tokens hoping for long-term gains)
Traders are responsible for creating liquidity so miners can sell mined coins and cover operational costs. This is a direct form of value transfer in which miners sell earned tokens via the open market to cover costs and possibly reinvest profits.
The second group of investors includes hodlers, who capitalize the network to foster its growth by supporting the crypto price. This miner-hodler relationship implies an indirect flow of value that can be deduced from miners’ balance sheets instead of their income statements.
Investors play important roles in maintaining the health of a crypto network. Different capitalization levels have direct impacts on how the supply side evolves.
We may consider that a cryptocurrency network is fully capitalized when the token price is at a level where mining is breakeven. If the token price drops below this level, the network becomes under-capitalized, and mining becomes unprofitable.
When prices increase above that line, the network is well-capitalized. This contributes to an expansion in supply and boosts the profitability of miners. In this way, by achieving certain price levels, hodlers have indirect impacts on the supply.
This relationship is especially important at the start of a crypto network, as investor capital helps bootstrap the supply side (i.e., kickstarts user demand). It may happen the network is over-capitalized, which is a problem when user demand falls short of investors’ expectations. In this case, capital withdrawal can lead to sudden price drops that take miners out of business.
Aside from this interaction between investors and miners, there's also an investor-user relationship. Investors usually expect the price of a token to appreciate as demand increases over time (i.e., as more users join the network).
The Cryptoeconomic Circle calls for strong collaboration between all three groups, as all participants depend on each other to achieve goals. The strong interdependence, with investors playing a key role, is what makes a healthy blockchain ecosystem. |
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Cryptoeconomics in Decentralized Finance
Decentralized finance (DeFi) is probably the most important trend within the crypto industry. ING and Bank of America have separately concluded that DeFi is more disruptive than bitcoin itself.
The goal of DeFi is to move financial services onto blockchain infrastructure so as to cut middlemen and streamline peer-to-peer (P2P) interactions. Think about trading, lending, insurance, payments, and investing. These and other financial services can be decentralized.
In DeFi, cryptoeconomics determines the rules for how the application works. For example, most DeFi protocols are built on existing blockchains like Ethereum. This underlying Layer 1 blockchain provides a unit of value (in this case, ETH) that can be used to make the cryptoeconomic system work in the same way dollars make the US economy work.
This is an enormous innovation. It's why we expect only one or two L1 networks will win over the long term. Developers will build on the networks with the most commonly accepted units of value (i.e., ETH on Ethereum).
Cryptoeconomics Use Cases
One of the best examples of cryptoeconomics applications in DeFi is the Automated Market Maker (AMM) model employed by DEXes. It enables liquidity providers (investors) to generate income by facilitating trades and collecting fees. The AMM model helps DEXes like Uniswap and dYdX operate without centralized order books, which are key elements for spot exchanges.
Another example is prediction markets like Augur and Gnosis. The former has a system of incentives that use its native token REP. The protocol rewards users for reporting accurate information to the app, which is eventually used to settle bets. Elsewhere, Gnosis employs a similar cryptoeconomics mechanism. However, it also enables users to determine true outcomes with the help of so-called oracles, thus providing blockchains with verified off-chain data. Investors can benefit by providing or verifying data on these prediction markets. They can then generate income based on their contributions to a network.
Another use case of cryptoeconomics in DeFi relates to governance, which enables DeFi protocols to be managed by communities rather than corporate teams. For example, the lending protocol Compound is managed by a decentralized community of COMP holders and their delegates. They have the right to propose and vote on upgrades. Contributing to governance (like being an active shareholder of a public company) is both an investment opportunity and a tool to directly influence the direction of a crypto project. |
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Cryptoeconomics define the ecosystem of a crypto project.
Investor Takeaway
Both institutional and retail investors can benefit by understanding the three basic elements of cryptoeconomics: miners, users, and investors. This helps them make better crypto investing decisions.
Cryptoeconomics can give you insights into the fundamentals of a project. Understanding a project’s incentive mechanisms also helps investors find great income opportunities (lending, staking, or yield farming) that may be overlooked.
At Bitcoin Market Journal, we believe cryptoeconomics will become a recognized field with its own principles and applications. It will attract many traditional investors looking for alternative strategies and exposure to assets that show low correlations to traditional markets.
Understand cryptoeconomics, and you understand the ecosystem. Understand the ecosystem, and you can uncover new opportunities. |
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Bitcoin Market Journal is a daily newsletter that makes you a better crypto investor. It's created by John Hargrave, Nick Marinoff, Steve Walters, Anatol Antonovici, Ben Burn, Preetam Kaushik, and Daniel Joel.
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