- Designing tokenomics that help foster growth in the surrounding ecosystem is likely to be a key tokenomics lesson to be learned from Terra’s collapse.
- “Staking is gaining traction in the tokenomics discussion and is likely to continue that way for the near future.”
- “The fact that Terra failed is not necessarily proof that the design is wrong.”
- “Ecosystems like Terra would do well to spend as much time simplifying and educating the public on what they’re attempting to achieve.”
It seems that tokenomics is in crisis. Where before a superficially deflationary monetary system was enough to draw in investors, the Terra collapse and the ongoing downturn have likely had an irreversible impact on the perceptions of traders, who now may think twice before throwing their money in with a coin that claims ‘strong tokenomics.’
So what are platforms and developers to do now? Abandon tokenomics altogether and focus more on actual utility, or refine their use of tokenomics so as to avoid catastrophic death spirals?
It seems that the approach, perhaps unsurprisingly, is going to reside somewhere in the middle. So while creating demand by offering real utility is going to become more of a focus for serious projects, there will also be a shift to more conservative tokenomics principles, which don’t bake in the possibility of a dramatic rug pull.
From speculative to sustainable tokenomics
Following the sudden — but perhaps not shocking — collapse of Terra, a consensus has formed that a more cautious use and design of tokenomics will emerge in the future.
“Money in whatever form it takes has strong network effects. During the expansion phase, they are highly beneficial but, as Terra/Luna owners found out, they are equally powerful in reverse,” said Ryan Shea, a crypto-economist at London-based digital asset broker Trakx.
He is referring to the “death spiral” in which the terraUSD (UST) stablecoin and the luna (LUNA) (now luna classic (LUNC)) token found themselves in last month. Because while a rising price for terraUSD resulted in luna being burned (and hence being ‘deflationary’), a dramatically falling terraUSD price resulted in massive amounts of luna being minted, making the latter all-but worthless in the process.
For Shea, the key lesson to pull out of the Terra fiasco is that tokenomics should not be centered solely on encouraging speculation.
“Designing tokenomics that help foster growth in the surrounding ecosystem based on rising token usage as opposed to encouraging speculative demand is likely to be a key tokenomics lesson to be learned from Terra’s collapse, at least for those projects interested in not being labeled a Ponzi scheme,” he told Cryptonews.com.
In other words, any design mechanisms or structures that can help foster a thriving ecosystem and actual use will become more prevalent in the coming months. For Shea this development is likely to unfold by necessity since users and investors should become more cautious from now on.
One example of possible future directions is provided by Ethereum (ETH). Last year, it deployed EIP-1559, under which the base fee is burned.
“This can only be denominated in ETH, so it creates a direct tie between the token’s value and its usage over the Ethereum blockchain. The greater the number of transactions, the greater the base fees burned, the more valuable the coin,” Shea explained.
Another additional tokenomics feature Shea suspects could become more common is vesting/lockup periods for token issuers, which he would like to see lengthened.
“This should incentivize issuers to focus more on the longer-run sustainability of the project(s) underpinning the token, than [on] the likelihood that it experiences an unsustained speculative bubble because they will be unable to sell during the vesting period,” he said.
Of course, some might argue that the only really reliable tokenomics feature is a limited supply (as seen with Bitcoin (BTC)), with everything else possible introducing emergent systemic effects that can’t be foreseen. However, some commentators do see an increasing role for staking as a tokenomics measure that can help improve value in a more organic way, and without risking the sustainability of a platform or coin.
“Staking is gaining traction in the tokenomics discussion and is likely to continue that way for the near future. The ability to earn additional value out of held tokens holds strong appeal,” said Chris Caruana, Vice President of anti-money laundering (AML) solutions at Feedzai, a risk operations platform.
Indeed, with Ethereum moving to a proof-of-stake (PoS) consensus mechanism and nearly every new layer-one blockchain using PoS in some form, it seems like staking will become the dominant tokenomics system, if it hasn’t already.
A focus on utility
There’s also the strong likelihood that many platforms and cryptoassets will turn away from tokenomics to some extent in the future, and simply work on making themselves more useful. Put differently, projects may shift their focus from the supply-side to the demand-side.
“Any design mechanisms/structures that can help foster a thriving ecosystem which incentivizes users not to consider them solely as a speculative asset is likely to be an area of focus,” said Ryan Shea.
He emphasizes that token issuers should concentrate much more on schemes designed to support the sustained evolution of the token’s broader ecosystem, rather than on simply ‘pumping’ their coins.
“Tokenomics can accommodate such a shift to the extent that it focuses on [the] longer-term, i.e., encouraging more stable and persistent demand (sticky demand in other words),” he added.
However, not everyone is entirely convinced that Terra’s demise signals the end of tokenomics as a mechanism for boosting prices. A counter-argument runs that, because TerraUSD was a stablecoin, its lessons aren’t necessarily those for tokenomics as a whole.
“The fact that Terra failed is not necessarily proof that the design is wrong but can be due to other factors like the way the yield on Anchor protocol is determined. The high yield was no longer consistent with the decrease in the crypto market,” said Nathalie Janson, an associate professor of economics at the NEOMA Business School.
(The Anchor lending protocol housed the majority of UST’s circulating supply, and it was used as a key incentive mechanism for users to hold UST with its high yields of 20%.)
Likewise, Chris Caruana argues that it’s not especially wise to lump Terra’s collapse into the wider discussion on tokenomics.
“For those who wish to scratch deeper at the ‘tokenomics’ of the Terra ecosystem they’ll find that, while TerraUSD is a stablecoin in name, there exist arbitrage opportunities in that network. If investors/traders 1) weren’t aware of arbitrage opportunities in tokenomics they are now and 2) learned anything from the collapse it’s that they should understand the finer details about the tokens they’re utilizing/investing in,” he said.
Lastly, it’s also worth pointing out that what’s needed isn’t so much (or only) a change in tokenomics itself, but also a change in how tokenomics is communicated and understood.
As Caruana concluded, “The general public is still educating themselves on the basics of cryptocurrency and they now have to contend with terms like ‘NFTs’, ‘DeFi’, and ‘tokenomics’. Ecosystems like Terra would do well to spend as much time simplifying and educating the public on what they’re attempting to achieve, and the value they provide, as they do expanding tokenomics.”