How to determine the quality of the economic model of an X to Earn project?

Written by: veDAO Research Institute

Is the economic model important for a Web3 project? Among ten people, eight might answer yes. However, to some extent, the economic model is not that important; either the economic model paradigms of most projects exhibit a high degree of convergence, or the proportions of token distribution often do not appear as professional as they seem to outsiders. In fact, most token distribution figures, while referencing mature solutions in the market, are more the result of the founding team's brainstorming decisions.

Now, let's return to the question: Is the economic model important for a Web3 project? It is important, but it must be combined with various factors such as the project's vision and product quality, rather than simply piling up complex formulas in the economic model to play numerical games.

In fact, a good project target does not necessarily use the latest economic model; even this model may not be very complex, but it must be the most scientific economic model, which should be integrated with the product characteristics.

What is an Economic Model?

First, we need to understand what an economic model is.

Economic Model: In English, it is called Tokenomic, a combination of the words Token and Economics. As the name suggests, it refers to the economic operation methods of different projects issuing cryptocurrencies within the blockchain ecosystem. Its main role is to dominate the supply, use, distribution, incentives, utility, governance, monetary policy, etc., of the project tokens.

With the rise of the DeFi concept and the increase in on-chain participation channels such as interactions, airdrops, staking, and IDOs, users have more opportunities to participate in project growth and early stages, thus increasing the emphasis on project economic models. At its core, this is because it is the mechanism behind all current on-chain behaviors. As a project party, you must incentivize all participants through tokens to jointly maintain the spontaneous operation of a complex economic incentive system; as a participant in the decentralized revolution, you must study and observe the pros and cons of different tokenomics to choose investment targets, as tokens are the mainstream financing method for Web3 projects, thus tokenomics is an important factor affecting investment returns.

Importance of Economic Models

There is a saying: From 0 to 1 relies on the product, from 1 to 100 relies on the economic model. A quality product first needs good quality to push the first step, and then requires an economic model to get the flywheel turning.

Therefore, the economic model has the following importance for a product:

1. Replacing Traditional User Acquisition

For internet products, the economic model provides a brand new business model. If the survival strategy of traditional products is to bear the pressure of losses in the early stages of the project to lower user prices and invest huge amounts of money to acquire users, achieving market share and then aggregating user relationships to recover costs.

Then, with the introduction of tokens, the task of seizing the market can be handed over to tokens. On one hand, through market cap management, creating a value window for tokens attracts more people to hold them, completing the occupation of user mindset. In this process, the emergence of the token value window often spontaneously attracts more user and market attention, indirectly completing the traditional user acquisition task.

During the DeFi Summer, the battle between Uniswap and Sushiswap is a classic case: As the pioneer of DEX, Uniswap initially did not want to issue tokens, but Sushi attracted a large number of users from Uni through token airdrops, at its peak, Sushi users accounted for 70% of Uni, creating a sense of crisis for Uni.

Sushiswap's cold start and rise were built on the "vampire attack" process against Uniswap. When Sushiswap launched, it quickly attracted liquidity by distributing SUSHI to early LPs. With each block update, a certain amount of SUSHI was released and distributed to LPs; initially, Sushi required the liquidity provided to be LP Tokens from specific pools in Uniswap, which caused Uniswap's locked amount to rapidly increase after Sushi's launch.

Two weeks after launch, Sushiswap initiated liquidity migration, transferring all LP Token liquidity participating in SUSHI mining from specific pools in Uniswap back to Sushiswap, thus completing a rapid liquidity raid.

2. Reducing Financing Difficulty and Shortening Cost Recovery Cycles

As mentioned above, traditional internet products often need to complete market share before achieving profitability, which is one reason why JD and Bilibili have been continuously losing money. However, aside from policy risk reasons, a Web3 product that issues tokens often issues its own tokens shortly before the project functions go live, bringing forward the revenue through the economic model, allowing the project to reinvest the recovered funds into development, making the flywheel turn faster.

It must be admitted that in the current Web3 context, the main means for projects to make money is still through selling tokens. But when a project has the conditions to issue tokens but chooses not to, it means the pressure for profitability is entirely shifted to product quality, which brings it back to competing with traditional internet products.

This phenomenon is not uncommon in the Web3 industry, especially among teams whose work revolves around game chain modifications. Due to the uniqueness of games, these teams often absorb many Web2 practitioners, and due to a natural fear of going overseas, regulatory issues, or limitations of traditional game operation thinking, despite developing blockchain games, they often hesitate to issue tokens, which places immense operational pressure on the team and reduces the success rate of entrepreneurship.

Moreover, for purely Web3 projects, not issuing tokens also means being passive in the Web3 market. Take Opensea as an example; it once held over 98% of the market share. Relying on a 2.5% transaction fee, its highest monthly revenue exceeded $350 million.

However, due to Opensea's slow iteration speed and its desire to pursue equity financing without issuing tokens, it was subsequently overtaken by projects like LooksRare, X2Y2, and Blur, which used token airdrops and incentives to seize Opensea's giant users.

According to Dappradar data, as of June this year, Blur, which innovated its economic model, reached a total locked amount of $167.7 million, occupying 65% of the NFT market share, while the once-dominant Opensea fell to 27%.

Classification of Economic Models

Currently, within the industry, the classification of economic models for X to Earn projects can be divided into four types of tokens: governance tokens, utility tokens, special tokens, and NFTs.

Here we reference the definitions of the four types of tokens from Buidler DAO's article "Tokenomic: The Economic Order of the Crypto World."

It is worth noting that Buidler DAO directly categorizes ticket tokens as a special third type of token, but in fact, this category can be expanded. Some current industry chain games and social products generally implant a type of off-chain token similar to points under the conventional dual-token model, which can only be converted into on-chain currency under specific conditions. This type of point-like token should also be considered a special third type of currency.

Based on the combination of these four types of tokens, the mainstream schemes can be divided into single-token, dual-token, and tri-token models.

Single-token model: Refers to a single token issued based on the ecological content itself. This type of token often only carries a single governance function (like UNI) or simultaneously has governance and utility functions.

However, this model often adopts a fixed supply, which means if it only carries on-chain governance functions, the value of the token is difficult to reflect, and the willingness of holders to hold the token will decrease as the project's iteration speed slows down.

If it simultaneously has governance and utility functions, it means users will obtain more tokens through various means, ultimately leading to an explosive inflation rate, which also affects the market's valuation of the token during its IDO.

Therefore, many project parties have optimized on this basis, either by splitting governance and utility functions, which is known as the dual-token model, or by reflecting utility functions in the form of points.

Dual-token model: The so-called dual-token generally refers to the combination of governance tokens + utility tokens, with the addition of NFT elements. The earliest proposal was by NEAR, whose issued stablecoin USN can be integrated into the protocol layer as a native asset for paying gas and storage fees. This can be seen as the earliest form of utility tokens. Subsequently, the dual-token model was popularized by the well-known Axie.

The emergence of the dual-token model greatly delayed the death spiral cycle of the original single-token model. By linking utility tokens with governance tokens, it transferred and consumed the selling pressure of governance tokens, reducing the risk of project failure. However, on the other hand, managing a dual-token system well, considering the potential correlations between tokens, is not merely a matter of doubling the difficulty. Additionally, when there are more than one type of token in the system, how to reasonably allocate value also becomes a necessary consideration. Furthermore, since utility tokens are often infinitely issued, they can easily fall into inflationary situations. If excessive inflation or other related reasons lead to price declines, more tokens need to be issued to maintain sufficient incentive levels for users, further reinforcing inflation.

Tri-token model: This scheme is not a popular choice in the Web3 market, as the tri-token model was generally seen as a patch for the dual-token model, but it has also seen some innovations. The tri-token model is best known for the VCT model that emerged last year: based on traditional governance tokens + utility tokens, it adds an asset value capture token.

VCT Tokens have a strong correlation with utility tokens: in terms of quantity, regardless of inflation or deflation, the ratio between the two always remains 1:1; in terms of price, since each utility token can be "exercised" at any time (exchanging a utility token for a VCT token from the project party, which can then be exchanged for a stablecoin equivalent to the current VCT token price). Therefore, the price of utility tokens is always greater than or equal to the price of VCT tokens.

Additionally, VCT Tokens are "invisible" to ordinary players, do not increase the burden on players, and do not circulate in the secondary market; they are only used during the "exercise" process. Moreover, the "exercise" process is unidirectional and irreversible; each utility token and VCT can only be exercised once, and the utility token and VCT token after "exercise" will be destroyed.

For example:

• The number of utility tokens in a game = VCT = 10,000

• The total value of VCP from advertising revenue and fiat revenue = 10,000 USDT

• At this point, 1 VCT = 1 USDT

• When the game's utility tokens are massively sold, starting from 3 USDT and continuously declining

• Through the "exercise" mechanism, players feel they can at least lock in a 1 USDT return rate, thus preventing panic, and the deflationary expectations from "exercise" effectively suppress the downward trend of utility tokens.

This model sparked a heated discussion when proposed. Prior to this, many game teams had already allocated a certain percentage of tokens from governance tokens specifically to serve the role of VCT. In other words, under the premise of introducing new tokens for related functions in the future, is it necessary? Furthermore, the "tri-token" model represented by VCT is also based on the ability to capture sufficient value at the game's inception, which is an enhancement but does not solve the problem of where the initial liquidity comes from.

Key Elements of Economic Models

After discussing the classification of economic models in the X to Earn model, we also need to focus on several dimensions:

First, the three key elements of economic models:

Supply: Refers to the source of the target token, usually divided into two methods:

Public fundraising activities: ICO, IEO, IDO, Launchpad, Fair Launch (Benddao model, same cost for everyone), ILO (X2Y2 model, initial liquidity issuance, most small projects do this now).

Incentive activities: Airdrop, TVL investment incentives, staking incentives, volume incentives (projects primarily based on exchanges), liquidity (DEX as the main battlefield), P2E (X to Earn model).

Three terms to pay attention to:

TGE: How much circulation is there at the time of token issuance
Cliff: How long is the freeze before unlocking
Vesting: Over what period is the token unlocked

Demand: Refers to the use cases of the target token, generally including: value storage, spending, mining, governance, protocol income, collateral,

Memes, speculative demand (sector rotation).

Value Capture: Ultimately, the path for capturing token value needs to be resolved: service fee payments (MV=PY), buybacks & burns (now rarely used after staking), staking protocol income, buyback rewards.

Conclusion

In summary, a good economic model should possess the following characteristics: low inflation rate, high incentives, low selling pressure, rich use cases, sufficient liquidity, and governance primarily coming from B-end groups.

Additionally, when we invest in public chain projects that require decentralized governance, we need to analyze whether their economic models provide incentives for maintainers and capture the value of tokens, ensuring that the project can provide users with continuous and stable services while allowing network maintainers to capture value, thus reducing selling pressure from maintainers;

When we invest in DeFi projects involving large amounts of capital transactions, the focus of analysis should be on how the economic model coordinates the interests of LPs and governance token holders, including whether income can incentivize LPs to continue providing liquidity and whether governance token holders can distribute reasonable income.

But that said, a good product is the key to user retention. As mentioned above, the economic model can only complete the transformation from 1 to 100, but the most difficult 0 to 1 relies on the quality of the product itself and operational methods.