Messari: An Overview of 4 Types of Web3 Infrastructure Token Incentives

Author: Mason Nystrom

Source: Messari

Compiled by: DeFi Dao

Key Insights

• Token incentives are a powerful mechanism for addressing cold start problems and initializing two-sided marketplaces.
• However, various Web3 infrastructure protocols are burning tens of millions to hundreds of millions of tokens in incentives each quarter.
• Web3 infrastructure protocols need to analyze their token incentives and determine the specific value they derive from these incentives. Additionally, as protocols scale, they need to dynamically adjust their incentive structures.

In all markets, buyers need sellers, and sellers need buyers. However, two-sided marketplaces often struggle to generate sufficient supply and demand to initiate this exchange. While there are many potential solutions to this "cold start" problem, tokens have clearly become the most effective mechanism for incentivizing both sides of the supply and demand equation. Crypto networks have adopted unique strategies for their token incentives, resulting in varying efficacy for each token.

Analysis of Web3 Infrastructure Token Incentives

While token incentives in DeFi have been extensively discussed, research on the distribution of token incentives in Web3 infrastructure networks and middleware protocols may be less prevalent.

DeFi protocols almost always provide incentives for liquidity (supply side) to attract users seeking better pricing. This relatively straightforward trade-off makes it more direct when evaluating the incentives of DeFi networks. In fact, the incentives of DeFi protocols maximize the dollar value of token incentives to obtain the most dollars in liquidity or users. However, in Web3 infrastructure, the dynamics of protocols are more complex due to non-standard metrics and various stakeholders.

Examining four unique protocols—The Graph (indexing), Pocket (node infrastructure), Helium (IoT network), and Livepeer (computing network)—it is clear that they have a wide range of token incentives.

The Graph

The Graph, as an API protocol, provides valuable services to organizations or individuals needing to query protocol data. The network has several core participants, the most important of which are subgraph indexers—parties that maintain the query network. Throughout 2021, along with the appreciation of The Graph's token, the indexing protocol distributed an average of $60 million in token rewards over the past five quarters.

These incentives apply to many use cases, such as rewarding participants in the network—Delegators, Indexers, and Curators—to help stimulate growth.

Given that The Graph's revenue from demand is very low, GRT rewards/incentives are primarily used to subsidize users' query fees. This is normal outside the cryptocurrency industry, where many venture-backed companies use venture capital to help subsidize user costs until reaching a certain customer or revenue threshold.

One threshold that may need monitoring is the ratio of inflation to token incentives. Token incentives should not exceed the network's inflation for an extended period, as this would be unsustainable in the long run. Notably, The Graph provided the lowest amount of token incentives last quarter, which may indicate that the fundamentals of its network are improving.

Livepeer

Livepeer is essentially a computing marketplace where applications can pay for various video transcoding services.

Livepeer offers inflation rewards to node operators who stake LPT to perform work (provide transcoding services). The Livepeer network operates under a dynamic inflation model, where LPT rewards fluctuate based on the percentage of LPT staked.

From a mechanism design perspective, Livepeer's staking architecture is complex yet elegant. Livepeer's staking issuance is dynamic, allowing it to incentivize participants to reach a given threshold. If participation in a round is below 50%, LPT inflation will increase by 0.00005%, incentivizing token holders to commit their stakes to the Livepeer network. Conversely, if participation exceeds 50%, the inflation rate will decrease by 0.00005%. Thus, as the value of the Livepeer network grows, operators earn more fees, and LPT issuance/incentives will eventually drop to zero. If inflation rewards become nominally valuable based on token appreciation, then the minimum inflation decline for Livepeer may need to increase to prevent over-rewarding node operators.

Livepeer node operator revenue (in ETH) grew by 22% (down 13% in USD due to overall market downturn), and revenue from LPT staking rewards grew by 18% (down 12% in USD). Additionally, Livepeer processed 33 million minutes of transcoded video, a 12% increase from the previous quarter.

Pocket Network

One of the most discussed infrastructures in recent months is node infrastructure. ++Pocket Network++ aims to create an alternative to centralized node infrastructure that can resist censorship, remain operational at all times, and be cheaper than existing service providers. Similar to The Graph, Pocket is a two-sided marketplace between node providers and developers wanting to query data from specific blockchains.

Unlike its centralized competitors, Pocket Network does not use a paid service model. Instead, it adopts a "staking for usage" model, requiring users to stake POKT to access services. Due to Pocket's initial design—linear rewards of POKT tokens to node relayers—the network experienced malignant inflation. In the last quarter, Pocket distributed $375 million in POKT rewards. This action effectively brought new node operators into the Pocket ecosystem but also led to significant sell pressure, with POKT prices dropping over 50% in the past 30 days.

While POKT is subject to permanent inflation, it will ultimately be constrained by a burn mechanism managed by the DAO. Recently, Pocket stakeholders proposed and approved a significant reduction in the inflation rate to establish a more sustainable inflation system. Over the past few months, the average daily inflation rewards have been systematically reduced to help stabilize token incentives.

Helium

Helium may be one of the most aggressive propagators of token incentives, having paid out $770 million over the past four quarters. That said, Helium is incentivizing a global hardware network for IoT devices. To date, Helium has nearly 800,000 hotspots, with 85,000 units coming online in the past 30 days.

Historically, telecom companies have paid billions of dollars in ++spectrum auctions++ for the rights to transmit signals in specific wavelength bands. In this regard, allocating $1 billion in token rewards could actually represent good unit economics. Nevertheless, given the appreciation of HNT over the past year, it seems appropriate to reduce token rewards, especially considering the passive nature of hotspot operators.

Final Thoughts on Web3 Infrastructure Token Incentives

It is worth noting that these protocols do not belong to the same category of infrastructure or provide the same services. Therefore, it is challenging to compare their token incentives. Helium's $200 million in token giveaways each quarter is nominally significant but can incentivize global hardware infrastructure. In contrast, The Graph's $40-80 million in token incentives supports developers and heavily subsidizes network usage (for users and developers). Is one better than the other? Perhaps, but that is relative.

Broadly speaking, inflation/token incentives should be dynamic or at least change with increased network adoption or token appreciation. Over-incentivizing demand or supply in the network may attract hired capital and operators who are not long-term stakeholders. Additionally, without holders willing to endure significant dilution, many potential business partners may become ongoing forced sellers to maintain operational margins.

While using tokens to address cold start problems may be effective, it also has two drawbacks. Using tokens to guide cold start issues is a very effective strategy, but it has its downsides. First, when a network issues tokens for the wrong behaviors (e.g., before product-market fit), it may incentivize low-value activities. Second, tokens effectively extract returns from later participants, benefiting early adopters. However, token incentives need to evolve over time so that protocols have sufficient incentives for sustained adoption, thereby avoiding massive dilution for stakeholders.

As more crypto networks emerge, they will undoubtedly learn to standardize around optimal models for certain services. Until then, each strategy should be analyzed based on the spending of crypto protocols on incentives and the tangible value these protocols derive.