A New Paradigm In Crypto Investment and Architecture
Hello Bubble Riders!
I’m writing this newsletter in part as an update on IditaCoin and in part as a crypto investment case study on how to solve real problems with crypto DAO (decentralized autonomous organization) formation.
The main news on IditaCoin is that the project is transitioning to become (simply) the DGZ project. It will have its own DGZ DAO, website, and app. Maybe later, the team will add some NFTs for fun metaverse integration, but right now the focus is on simplicity.
Increasingly, developers and founders in the crypto investment world have come to recognize that projects face three hard problems, namely
1. that token incentivization often fails to support sustainable interactions,
2. that token launches often face regulatory difficulties, and
3. that DAOs have limitations as corporate structures.
I can say, with confidence, that the DGZ project–in consort with our own 1.2 Labs–is the first in the world to have solved all three problems (at least for a broad range of possible projects).
Even if you only ever aim to invest, understanding these points will prove critical in evaluating whether future moonshot projects are well-conceived. It will also help you understand how the crypto-space is operating and where it might go. There is a new paradigm at work here and I recognize even now that it is going to be mass copied after this roll-out.
Let’s start with the tokenomics problems.
1. Tokenomics Problems 1
Ok, here’s the basic problem we all recognize. GST token (the utility token) from the StepN project. It’s suffered better than a 93% decline even after it’s recent bounce up (some 81% in the past 72 hrs).
That decline is completely predictable and anyone who has worked in this space will recognize the first pump (from $4.9 to over $8.25) and subsequent dump process.
I don’t think the StepN developers wanted their coin to be a functional “rug pull” or “pump and dump” scheme. I think they just acted on industry standard “solutions,” which are flawed.
The error in their tokenization is that users of the StepN app are compensated in GST tokens for running (or walking)–that’s their way to interact with the app. New users are (rightly) uncertain about the long term prospects of the project, so they sell the coins for USDC (or some similar stablecoin) and that produces downward pressure on the coin. Other people notice the downward pressure, so they sell too, even if they hadn’t originally intended to so so, and a self-reinforcing death spiral follows.
How do you avoid that?
Our solution is simple: make the tokens (DGZ) reward multiplier tokens. This could be done in a variety of ways, but here’s how we’re thinking about it.
- Interact with the application (or website) to get compensated in DGZ. You could also buy your initial DGZ and stake them.
- After you hit a minimum threshold of DGZ (representing a minimal amount of contribution to the DAO and dog well-being) you can elect to start getting paid in USDC.
- You can build up even more DGZ, though, to get a higher reward bonus. You’ll also have stronger voting rights from that and–if DGZ takes off later–you’ll have made a nice crypto investment too.
- Presently, we’re looking to cap the max multiplier bonus to 7x–meaning that when you’re at that level, one time a week interaction will be equivalent to a 1x user’s 7-day a week interaction.
This approach incentivizes people to hold onto their DGZ coins–lots of them–to earn money through USDC. The draw back, and I honestly think this is why more projects don’t take this approach, is that you need to have a working business model to continue to pay people. Your project has to make financial sense from the beginning.
The DGZ project makes money by collecting data and selling that. That’s a proven web2 paradigm. What makes it web3 is that the DAO cuts you into the profits from that resale. Also, you can opt out at any time (though you’ll stop earning money too).
A related advantage of this approach follows from the point that you can earn DGZ without ever purchasing them. This means that there is no financial entry barrier, unlike StepN’s $100+ minimum payment for their NFTs. DGZ isn’t “pay to play.”
And that brings up the second reason most tokenomics projects fail.
2. Tokenomics Problems 2
A related pitfall you’ll see in the crypto investment world is that projects often issue many token types, including a mixture of NFTs, in the hopes of “gamifying” interaction.
While I get that the idea is to promote continued activity from participants, the result is that they create cross-incentives, so that governance, participation, and profit are not aligned. Let’s go back to StepN, which is my go-to comparison because they were both immensely successful and suffered a catastrophic token value decline. In addition to the GST token, StepN has the GMT token. That’s their governance token. They also have four types of shoe NFTs and you can upgrade those with gems, and you can buy specialty shoe boxes, and there are other opportunities to earn still. See below.
After you upgrade your shoe to a level 30, you can choose to be compensated in GMT rather than GST. And it’s only with GMT that you can vote on any governance. So, you are incentivized to spend your earned GST into your shoe, to level that up to 30, and then convert your earnings as quickly as possible into GMT and never worry about GST again.
No wonder GST declined in value so quickly! It’s not even valuable within the StepN economy. And once you’re holding GMT, you have no real reason to care about GST–especially since you can buy shoe upgrades with SOL or USDC.
It’s the same problem corporations with multiple share classes face. The C-Suite, which compensated in one kind of share, has different incentives from the regular shareholders on the stock market. And we all know who wins that battle.
How did we fix it?
Easy. Just use one token. It’s given to you as a reward for interaction. It’s used as a multiplier for receiving real USDC. It can earn you extra money (the equivalent of gems and upgrades in StepN) by holding more of it. And it gives you governance and voting rights.
One token = one set of incentives.
Of course, there is a related concern about securities regulation, since the team presently envisages the ability of DGZ holders to trade the token on exchanges. How is that addressed?
3. Regulatory Overhang
As the crypto investment market matures, more and more of it will become regulated. Quite a bit of it is going to be regulated by the SEC–or at least the CFTC (Commodities Futures Trading Commission).
(featured is Gary Gensler, Chair of the SEC and enemy of all things crypto except Bitcoin)
The big concern which hangs over the space is that the SEC can act retroactively–as they’ve done with Ripple (XRP more exactly). That means that you can potentially issue a token, and 10 years later the SEC decides that your token is a security and they’ll fine you.
How do you avoid issuing a security?
The main thing is that you have to ensure is that participants “admix their labor” (to paraphrase John Locke in The Second Treatise on Civil Government) with their acquisition of tokens. A security is defined as anything that passes the Howey test. Without getting into the specifics, the reason that an item will fail the Howey test (= is not a security) is if, in order to derive value, you need to do your own work in order to receive it.
By using the tokens-as-reward-multipliers paradigm, however, you are receiving money based on using the tokens–”admixing your labor.” You’re earning it. And the SEC doesn’t care at what rate you earn money as long as you have to work for it.
For presale participants who might want to flip the coins, we’re going to require that you lock them up for a period and at least provide liquidity. You’ll be able to earn rewards from interacting during that period, so it’s not all bad. In this way, all tokens will have been used before exchanged, thus transforming them into something other than securities.
While it’s a bit annoying, on this approach you can have confidence that Gary and crew are not going to come after the DGZ project and shut it down, thereby nullifying the value of your tokens or eliminating your stream of earnings with the app.
We’re doing it right because we’re planning for the future. And the topic of future prospects brings us to the last matter of concern…
4. DAO Structures
The original decentralized autonomous organization (DAO), called simply The DAO, came to an ill-fated end when hacked. The episode split Ethereum in two, which is why we have ETH Classic (with the hacked DAO on that block chain) and Ethereum.
Recent DAO projects have been better about hacks, but they have still met with a serious difficulty: they’re not well suited to project development.
DAO’s are decentralized autonomous organizations. As a result of that decentralization, they have unique features allowing them to achieve marginal cost advantages that traditional firms cannot. But that decentralization makes it difficult to organize regular tasks like shift schedules, tax accounting, and project assignment.
There’s also the worry that a group of malicious actors could get enough of the voting power to propose and pass something stupid. For example, some recent “hacks” have come from members who acquired enough voting power to propose a transfer of treasury funds to their personal wallet. Then, because voting participation is typically low (just as it is in society during our regular political elections), they have enough votes to pass their own proposals, and in that way drain the DAO treasury.
What are we to do about these problems?
The DGZ fix is as follows. Remember that there is a minimum amount of coins that you need to acquire to start earning USDC? We call that the basic membership level.
After you achieve that basic membership level you can propose improvements and vote on them as a regular member. If a proposal passes among the members, then it makes it onto the docket for the House of Representatives (name to be changed). These are members who have 10x the basic membership amount of coins.
If it passes there, then the proposal goes to the Senate (name also likely to change). Senate holders own 100x the basic membership level of DGZ tokens. They are typically going to be the DGZ sponsors–those are the members buying the data generated by users. They have to vote to approve the proposal too. But, because we don’t want corporate sponsors ruling this thing, there is one final stage.
At the top level are 7 executive members (likely, details are still finalizing). They each own at least 2% of the protocol tokens (200m DGZ tokens). They also have to stake those coins for 3 years. Executive members cannot make any proposals for improvement (PIPs as they’re known), but they can veto proposals with a majority vote. Stupid liquidity draining proposals, then, will be stopped because these members would lose all their money.
The executive members also review the performance of the “governance” agents–this solves the decentralization problem. These governance agents are members who execute on all the day-to-day affairs of the DAO, including tax reporting, bank payments, and the like. At present, the DAO has in mind to task and pay the Iditarod organization with these duties.
There is more to say about the DAO structure–I haven’t even explained the two treasury model I pioneered to cap governance costs and return a maximal amount of value to the community. And there is an incredible legal structure that we’re using to organize all this, but we can keep that for later.
5. Concluding Thoughts
This post is already longer than I anticipated, but I hope you are in a position to understand the headline. I honestly didn’t oversell it, since the DGZ DAO has a brand new tokenomics paradigm that aligns the incentives of participants, avoids death spirals, and avoids securities regulation.
That trifecta of wins is likely to make the approach a crypto-paradigm copied everywhere …
…unless a project doesn’t actually make any money, in which case probably not. This paradigm only works with a functioning business.
The DGZ team will be updating the community more regularly with advances, but I thought this newsletter could explain a lot of material clearly. It could also serve as a case study for evaluating the adequacy of future moonshot projects. If they aren’t using something much like this, then why? Will they be able to avoid the pitfalls of bad tokenomic design outlined here?
As a professor, I know that everyone learns better with multiple media of presentation. So, this will probably be made into a video format. And we’ll obviously be incorporating the framework in our own future analyses for paid subscribers.
This week I wrote a number of pieces that are related to this post, so you might want to have a look if you’ve missed them.
That’s it for this week. Remember to join us on Discord if you haven’t already.
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