HashKey: In-depth Analysis of the Token Model Design of the Star Public Chain Dfinity

The author of this article is Cui Chen from HashKey Capital Research, and it has been reviewed by Zou Chuanwei, Chief Economist of Wanxiang Blockchain.

The concept of Dfinity began in 2015, and it completed its seed round fundraising in early 2017. Subsequently, in 2018, it received investments from institutions and community members such as a16z and Polychain Capital, with a total fundraising amount of $195 million. Although the fundraising was very successful, the project's progress has far from met expectations. Dfinity originally planned to launch its mainnet in 2019, but the date was repeatedly postponed, eventually confirming that the genesis version would go live in the first quarter of 2021 and distribute ICP tokens (formerly known as DFN). ICP futures have already been launched, and at the current price, Dfinity is valued at $13 billion, which could place it directly among the top ten in the cryptocurrency market capitalization rankings after launch. As one of the most anticipated public chains of 2021, this article will analyze the design and impact of its token model, primarily involving node rewards, locking for governance rights, and consumption for resources.

1. Introduction to Dfinity

Dfinity's goal is to create an Internet Computer, making the internet a public computing platform. Unlike its initial fundraising, Dfinity's current marketing no longer emphasizes blockchain but focuses on reconstructing the way software is deployed. The Internet Computer hosts software in tamper-proof, non-downtime "containers" (which can be understood as another form of smart contracts), improving interoperability between systems and allowing developers to operate without relying on servers and cloud computing companies. However, Dfinity still underpins the "containers" with blockchain, which can theoretically scale infinitely in terms of extensibility and computational capacity. Additionally, Dfinity's token mechanism references blockchain design, including economic models and governance mechanisms.

Dfinity's launch is divided into several phases: Copper, Bronze, Tungsten, Sodium, and Mercury. Except for the final Mercury, which is the public network, the others are testnets. The alpha internal testing version of Mercury has already been launched, and the genesis version is expected to go live in the first quarter of 2021, distributing ICP tokens.

Figure 1: Dfinity Roadmap

ICP (formerly known as DFN) is Dfinity's native token, with 469,213,710 tokens issued directly upon launch, distributed to investors and the community according to the proportions shown in the figure below.

Figure 2: ICP Distribution Plan

2. Economic Model of ICP

Supply and Demand of ICP

In the economic model overview released by Dfinity, ICP has two main uses: one is to lock for opening "neurons," and the other is to convert into cycles, which are the fuel for running containers. In simple terms, the use cases for ICP are divided into governance and exchange for computational resources.

Figure 3: Economic Model of ICP (Image Source: Dfinity Medium)

Supply

In the Dfinity system, ICP inflation is used to pay rewards, with part allocated to reward neurons (governance nodes) for participating in governance, and another part to reward data centers. However, the distribution quantity of ICP has not been disclosed and may be determined by neurons in the future.

The Network Nervous System (NNS) is Dfinity's governance system, composed of neurons. Every holder of ICP can lock their tokens to form a neuron, thereby participating in Dfinity's on-chain governance and receiving system rewards for their participation. This is similar to staking behavior in PoS, where users must be accountable for their choices. If the proposals and voting content harm network development, the value of ICP locked in the neurons will also decrease. The proportion of ICP locked in neurons and the unlocking delay time represent their voting weight. The system determines the maximum voting rewards each month, which will ultimately be distributed proportionally based on user participation. Users can also set their neurons to automatically vote in line with other neurons.

In addition to rewarding neurons participating in governance, ICP is also used to reward data centers, which refer to nodes providing standardized computation. To ensure the network has sufficient computational capacity, Dfinity has specific equipment requirements for nodes, particularly high-performance CPUs and RAM. Data centers with professional equipment typically run multiple nodes, so the number of network nodes will far exceed the number of data centers. Dfinity expects that in ten years, the number of nodes in the network will reach millions, with the number of data centers reaching thousands.

Data centers can use brokers to convert ICP into direct cash income. If the value of ICP remains stable, this will provide predictable and stable income, and stablecoins may be introduced in the future to reward data centers. It is evident that the threshold for Dfinity's data centers is much higher than that of Ethereum's validators. The high computational requirements of the Dfinity network mean that ordinary users find it difficult to participate in operation, but there are no barriers to creating neurons to become governance nodes. When the network requires more capacity, more data centers need to join, and they must apply to the NNS for a DCID (Data Center Identity). Ordinary users can indirectly participate in building nodes through voting.

Demand

Dfinity's containers are transparent, tamper-proof, and permanently exist, containing code and state uploaded by users. Containers run in dedicated management programs, and the "fuel" required for operation is cycles. Container owners need to purchase ICP to convert it into cycles, which are then consumed in the containers, creating a deflationary model. The conversion of ICP into cycles is one-way, but the exchange rate is not fixed and can be changed by the NNS.

In the NNS, the demand for ICP is reflected in locking. Users need to lock a certain amount of ICP to create neurons, and the amount locked will affect the voting weight of the neurons. Additionally, the "dissolution delay" of neurons will also impact voting weight. Users wishing to exit the neuron governance system must dissolve their created neurons, but this process takes time. The period during which the neuron is closed is called the dissolution delay, which users can set from 6 months to 8 years, and they can terminate the dissolution at any time. This is designed to deeply bind users to the Dfinity network.

Multi-layer Token Design and Impact

In addition to IPC, Dfinity has designed two other tokens: cycles and stablecoins, with stablecoins not expected to be implemented in the short term. The introduction of multiple tokens is based on the idea that currency should maintain stability. ICP and cycles are one-way exchanges with a non-fixed ratio, allowing cycles to maintain a stable value range. If the exchange rate between cycles and ICP were to be adjusted in real-time, cycles could also be considered a stablecoin.

In the future, Dfinity plans to introduce stablecoins into the system to reward data centers. However, the source of these stablecoins is a concern, as the ICP used on the payment side is destroyed. If stablecoins come from the foundation's reserves, the entire system would no longer be sustainable. If the payment part is also converted to stablecoins, it could create a model where container owners pay data centers directly, reducing ICP's value capture capability.

Before the stablecoin scheme is launched, the value input into the system comes from container owners purchasing and destroying ICP, thereby increasing the usage and visibility of ICP. The value of ICP will expand with the usage of the computational network, so the stablecoin scheme will not be used in the early stages of Dfinity. The stablecoin scheme can reduce the impact of ICP price fluctuations on the system, and later, the value of ICP can only reflect the governance rights of the network. To maintain the value of ICP, the stablecoin scheme can only be implemented in the later stages of Dfinity's development.

Network Nervous System (NNS) and Its Impact

Design of NNS

Dfinity adopts an on-chain governance model called the Network Nervous System (NNS). Neurons within the NNS are connected in a non-fixed manner, meaning neurons can choose to follow other neurons, forming a fluid democracy. The decision-making content of the NNS mainly includes modifying system parameters and rules, upgrading clients, freezing and unfreezing accounts, etc. If a neuron cannot determine the content of a decision, it can choose to abstain or follow trusted neurons to vote. This following relationship is invisible, allowing for the concealment of voting weight. For example, if a community participant wants to publicly disclose their neuron address, they can publish a neuron A with a very small voting weight and then use a neuron B with a much larger voting weight to follow A. Since the following relationship is invisible, users can avoid blindly following large holders when choosing whom to follow. The following method of neurons differs from delegated voting in other public chains in that the followed neurons do not receive additional rewards.

Any neuron can propose in the NNS, but for certain types of proposals, professionals need to conduct investigations and evaluations. For example, if someone wishes to restore a smart contract that was accidentally locked, the proposer must prove their authority by demonstrating their association with the address and accurately describing the issue while uploading a repair plan. This information requires significant manpower to verify and assess repair risks, so the NNS requires proposers to pay two fees: one for the professionals' remuneration and another as a deposit, which will be refunded after the proposal is approved.

Impact of NNS

The governance model of NNS is more democratic and flexible compared to other public chains, as all neurons can initiate proposals and receive rewards for participating in voting. Dfinity's governance is more adaptable; for instance, the NNS has the authority to modify smart contracts, which can help avoid issues caused by project vulnerabilities. To prevent exploitation by malicious actors, the NNS extends the dissolution time for neurons, requiring ICP locked in the creation of neurons to be held for 6 months to 8 years before it can be retrieved. If someone harms the Dfinity network within the NNS, the value of the ICP they hold will suffer significant losses. The ultimate goal of the NNS is to enhance the market value of the Dfinity ecosystem.

Dfinity's NNS governance is an innovation among mainstream public chains, as most public chains still adhere to the "code is law" principle, where issues with smart contracts can only be resolved through hard forks. The governance methods of mainstream public chains are as follows.

Table 1: Governance Methods of Mainstream Public Chains

Open public chains are often considered to have more decentralized decision-making control, meaning they are more democratic, but in practice, this is not entirely the case. Taking Bitcoin as an example, while Bitcoin achieves decentralized transactions and verification, it has not realized decentralization in governance control. Firstly, the way the Bitcoin community discusses proposals is quite loose, and Bitcoin mining pools have become forces threatening decentralization. EOS's representative democracy has faced issues such as bribery, collusion among nodes, and entrenchment, with EOS holders showing low governance enthusiasm due to the opportunity cost of locking their tokens. The improvement in Polkadot's governance method lies in allowing governance voting to occur simultaneously with delegated node voting, with technical upgrades proposed and voted on by professional members of the council. Proposals from the council and the public are counted differently in voting statistics, with council proposals being more easily passed. Dfinity's governance method is more democratic compared to the aforementioned projects, as anyone can create neurons to participate in governance, and voting weight is determined solely by the amount of locked ICP and the unlocking period.

3. Reflections and Conclusions

Dfinity's native token ICP realizes the entire process from creation to destruction within its model. ICP inflation is used to reward neurons participating in governance and data centers, while container owners purchase ICP to convert into cycles to support container operation. As the number of users on the Dfinity network continues to grow, more people will purchase ICP to run containers, thereby increasing the network's value. To help payers and data centers avoid losses due to token fluctuations, stablecoins may be introduced in the future.

The operation of data center clients means that ordinary people find it challenging to participate, which may lead to centralization and manipulation issues. Dfinity's official explanation is that data centers will be distributed across different locations worldwide, helping to avoid manipulation. Additionally, Dfinity's NNS governance can also prevent issues from arising in the network.

The decisions made by the NNS in Dfinity range from parameter settings to locking and changing smart contracts, with a more flexible governance approach and greater power compared to other public chain governance mechanisms. Therefore, users need to set a longer locking period when creating neurons, which is the time from the user's decision to withdraw from the neuron until they can retrieve their ICP, lasting at least 6 months and up to 8 years. The NNS binds users' interests deeply with the system's interests in this way. If Dfinity uses stablecoins to replace ICP for rewarding data centers and paying cycles fees in the future, ICP will only represent governance rights in the network, which could affect its value if Dfinity's network scale is small at that time.