The correct way to design Web3 tokens

Author: Sunny, TechFlow

Robert Koschig is a token economics researcher at crypto venture capital 1k(x). At the Decentralized Application Summit held by Gnosis in Berlin this year, Koschig summarizedhis token design for decentralized hardware networks. For example, he believes that Filecoin's token issuance plan based on KPI index is more scientific than the time-based token issuance plan. At the same time, Koschig also pointed out that the unpredictability of token rewards in the current Depin network challenges the predictability and stability of the Bitcoin model.

What does token design mean in general outside of decentralized hardware networks? As the industry gradually moves from the barbaric "Wild West" to today's Ethereum ETF, reasonable and scientific token design has become an indispensable part of most decentralized protocol products. In other words, the current token designers will be the product managers of the next generation of the Internet.

So is there a routine for token design? Is there a constant token design model in the industry for projects to follow? Koschig pointed out the main thinking directions of supply-side token issuance (supply), governance (governance), demand-side subsidies (incentives), and venture capital (investment). The conversation also compared the two classic token models in the industry: Bitcoin and Ethereum, from the perspective of immutability and ever-changing, and how projects can extract appropriate design models from them according to local conditions.

Token design should focus on continuous improvement rather than being limited to the concept of "Tokenomics" because it carries the baggage of past practices.

A protocol doesn’t necessarily need to have a token, but it is a very powerful tool if used effectively.

Unlike traditional coupons or rewards, tokens are yours forever.

The commonality of token design lies in coordination, value capture and value transfer.

Centralized payment channels contradict the purpose of decentralized infrastructure.

Owning your own token can bring additional benefits, such as controlling issuance - how much you mint and who you distribute it to.

If you want broader community participation, governance tokens allow for that transition.

In terms of governance, tokens decide on proposals and votes, but different entities are responsible for executing decisions. This separation helps manage the economy, staking mechanisms, and governance more efficiently.

Tokenomics hasn’t changed much: the project designed it, launched it, and it continues to run at a fixed inflation rate.

When you look at Ethereum's approach, you'll find that there is a situation where they can think, adjust, and introduce infinite possibilities in economics through code.

Tokenomic Design is a new product design in Web3

TechFlow: Can you share why you chose to focus on token economics research? Robert: Tokenomics is still in the research phase. Usually, developers are very good at technology, but when it comes to economic design, this field is full of opportunities. This field fits my background very well. You need to have knowledge of mathematics, game theory, and economics, and also understand data science, such as simulation and data analysis. Combining these two parts, you have a new and promising field, which fits right in with my main strengths.

TechFlow: Can you explain what Tokenomics is?

Robert:

Certainly, if someone asked me, “What are Tokenomics?”

I would describe it as a preliminary attempt to explain how the protocol works in terms of the economic aspects of its design.

You’ll always have questions about the technology, like, “What is this product?”

but once people understand the technical side, they’ll realize how powerful these economic coordination mechanisms are. They’ll focus on the powerful potential of tokens and what they can unlock, like when you suddenly do an airdrop.

We’ve seen what happens when projects don’t issue tokens initially and then introduce them later. Tokenomics was the term first used to describe this process.

However, the term “Tokenomics” often comes with the burden of pie charts and vesting schedules.

Real economic design is about the coordination dynamics of your product. It’s not just something you do before your token launch or include in your whitepaper; it’s an ongoing effort, just like technical development. You start with a minimum viable product and incrementally build and improve the technology — as developers test it on testnets and mainnet. The same iterative process should apply to economic design.

Token design should focus on continuous improvement, rather than being limited to the concept of "Tokenomics" because it carries the baggage of past practices.

We should think more about economic design and how it evolves over time.

Does Every Web3 Project Need Its Own Tokenomics?

TechFlow: Does every Web3 project need its own Tokenomics?

Robert:

I don't think it's necessary. If you don't need to rely on incentive mechanisms, that's naturally the best! Even so, for projects that don’t rely on incentives, there may still be benefits to trying some experiments. Traditional economic approaches use methods like cashback or Starbucks coupons, but tokens offer some new possibilities because they are immutable. For example, if I give you my tokens for completing a specific task, I can’t take them back. Unlike traditional coupons or rewards, once you have a token, it’s yours forever. This immutability makes tokens a powerful tool in protocols. They can provide important incentives without the risk of revocation, unlike some miles or coupons that may come with conditions.

A protocol does not have to have a token, but if used properly, tokens are indeed a very powerful tool.

TechFlow: Why do some protocols require token design while others do not?

Robert：

It all depends on what you want to achieve as a protocol.

Are you a consumer-facing application or a DeFi application?

Typically, common use cases for tokens involve coordination, value capture, and value transfer. In these areas, tokens can be very effective tools. But the key is always tokenomics and token design - how you implement it is up to you.

You may have a goal of launching a specific token through your protocol. But if it is not done correctly, the results may be completely different from the expectations. This decision should be solid, ensuring that adding a token to your protocol can truly enhance your product. Once this decision is made, it needs to be given enough attention because while tokens can bring benefits through economics and dynamics, they can also cause harm if not handled correctly.

TechFlow: Can you elaborate on the advantages and rationale for using digital tokens in decentralized infrastructure versus traditional fiat currencies?

Robert:

Of course. There are multiple reasons for needing digital tokens, even to experiment with different hardware. The typical argument for tokens is to incentivize the supply chain. Someone needs to buy these tokens and provide storage services. Technically, you can have users pay with USDC or other fiat currencies and operate outside of the crypto world, even if you run on decentralized crypto infrastructure, you can use centralized payment methods. However, this is generally illogical because centralized payment methods contradict the original purpose of decentralized infrastructure. This is why it is better to stick with decentralized payment methods, such as using stablecoins. This doesn’t necessarily mean you have to use your own token; there are other excellent payment tokens on the market. However, having your own token can bring additional benefits, such as controlling issuance — how many tokens you mint and who you distribute them to. The beauty of token design is that it offers a lot of freedom. You can make any decisions you want, and even change them over time. This is a powerful tool for growing your community and engagement. A simple mechanism is a governance token. Initially, it may be your team driving things, but as you grow, you’ll want the broader community to get involved. Governance tokens allow for this transition. Of course, you can also build more advanced features on top of it.

Modular Tokenomics Design

TechFlow: Can projects take a modular approach when designing their tokenomics? Robert: Yeah, ideally, you could have modularity. That's the ideal goal. You could say, "Okay, supply-side incentives are one module, governance is one module, demand-side incentives are one module, and the investment speculation part is one module." Ultimately, you just have one token, and then you need to figure out how all of these relate to each other. That's why governance becomes very interesting in DeFi. For example, in the early stages, you might need to cover real costs through governance decisions. Investors want to know that if they invest in your protocol, they will get a better return from a rational perspective.

This means that you need to allocate them a significant share of your network. However, when this is combined with governance, rewards become dependent. For example, if you allocate a certain amount to the supply side and leave the rest to be determined by governance, operators who do not sell their tokens will accumulate more voting power over time. This can lead to internal problems because they may decide their own rewards, and game theory predicts that this can lead to power struggles.

You also need to consider the governance aspect, as managing different interest groups is crucial. Relying solely on token-based governance may not be enough. This is why many well-known protocols like MakerDAO have set up independent governance committees. Tokens are used to determine proposals and votes, but different entities are responsible for executing decisions. This separation helps manage the economy, staking mechanisms, and governance more efficiently.

Comparing Bitcoin and Ethereum’s Tokenomics: What Has Changed and What Has Not

TechFlow: Have you observed the evolution of tokenomics? How have different projects adapted their tokenomics models and what changes have been made?

Robert:

Token rewards always make sense, right?

Early projects like Bitcoin demonstrated how powerful they are as a network effect and economic incentive. Bitcoin's fixed issuance schedule inspired many platforms to adopt similar strategies. They often emphasize the importance of fixed issuance schedules.

However, some realized that this approach might be too restrictive. So they added a second layer of logic that was more dynamic, albeit still fixed. From this perspective, Tokenomics hasn’t changed much: the project designed it, launched it, and it continues to run at a fixed inflation rate.

But there have been tweaks. For example, The Graph has improved its design over time. Initially, it had a curated function for data indexing via bonding curves. Over time, they found inefficiencies and tweaked the model.

This suggests that while the initial design may be fixed, learning and adjustment are necessary. Complex token economies like DeFi require iterative learning and modification.

It is important to allow for experimentation and learning rather than rigidly adhering to the initial design. While this approach may seem more flexible than the traditional crypto narrative, it avoids being stuck in an inefficient model. This industry is evolving rapidly and new technologies are constantly emerging. Leveraging simulations, data science, and continuous adjustment can help get token design right.

TechFlow: What are the fundamental components of Tokenomics design that have remained the same over time?

Robert:

What I think has not changed is that the underlying economic principles have been consistent since the development of the field of economics. Your tokens and their issuance incentive contributions are similar to the way that early Bitcoin incentivized miners. This is more efficient than starting from scratch yourself. The early issuance of Bitcoin was much higher than it is now.

The basic concept remains that if you have a well-functioning supply system, your protocol works as expected and provides a good user experience, revenue will come naturally. Then these revenues can support the system. This principle is fundamental and always relevant.

You can cover some of the reward amounts by issuing additional incentives or adjusting the revenue stream to ensure that the overall reward is sustainable even if the reward does not decrease.

TechFlow: Cryptocurrencies other than Bitcoin seem more complicated in some ways. Do you think Tokenomics or Web3 protocols will ever become as composable as smart contracts, given the complexity involved? Is there a way to simplify the theory? Robert: It is, it is difficult, but that is the beauty of Bitcoin. It takes a simple mechanism. On the other hand, when you look at Ethereum's approach, there is a case where they can think through code, tweak it, and introduce endless possibilities in terms of the economy.

If mistakes are made, then offline discussions come into play. People understand the new dynamics, different committees emerge, leading to proposals to separate or collaborate. It is a challenging process, but it allows for adaptation and optimization.

The complexity is a huge challenge, and even the smartest minds in the industry are working through them without seeing every dynamic. Predicting behavior is extremely difficult.

Long story short, yes, it is complex and it may never get simpler. The simplest and most effective models already exist and can be replicated. Today, new projects tend to be more complex and adjustable, rather than static and rigid. This is usually the way technology evolves.

Think about bicycles: they have been around for a long time and were once the fastest means of transportation. The basic concept remains the same, but they are no longer the best choice for all modern needs. People keep adding new features, creating new problems and solving them. This evolution makes Tokenomics more complex but also more reliable.

The goal is to reach a stage where people can understand what is going on. If understanding is lost, trust is also lost. Balancing the need for immutability with adaptability is key, ensuring that a majority of owners can vote to make necessary changes while maintaining stability.

Common Pitfalls to Watch Out For in Tokenomics Design

TechFlow: What common pitfalls in tokenomics design have you observed that can hurt a project? Do tokenomics designs help or hinder a project’s growth? Robert: It’s easy to fall into the trap of treating tokens like candy. When you tap into a pool of tokens, it’s like you’re getting a reward. People get addicted to it, not realizing that the more they do it, the more the project becomes focused on the token. That’s why we now have problems like misleading metrics, high total value locked (TVL), and low market cap. We lose sight of the fundamental purpose of the token. Tokens are more than rewards; they are powerful tools for alignment, growth, and acceleration of your project. However, tokens should not overshadow the core product. At the end of the day, you still need to build a solid product. The token will eventually become part of your product, but it should not be the sole focus. At first, you may feel like you have a certain budget and criteria, but ultimately you’ll find that you’ve spent all your incentives on short-term appeal and hype without real revenue, usage, or commercialization. This often leads to a rapid collapse when market conditions change.

That's why I spend a lot of time running simple simulations analyzing the basic mechanics of supply and selling pressure, ignoring any narrative content. I ask questions like: "Do you think these participants will hold or sell the tokens?" When the tokens are unlocked, how will this affect the market? Understanding these dynamics is critical to avoiding the pitfalls of short-term incentives and building a sustainable project.

Case Study: Tokenomics Design at Safe

TechFlow: I want to talk about the Tokenomics Design at Safe. Do you have any insights into the design and evolution of Safe? (Note: Safe is a company invested by 1KX) Robert: Safe launched their token two years ago, initially as a pure governance token that was not transferable. I really appreciated its community features. At that time, I had not joined 1KX yet, so I didn't pay close attention. Because the governance was running smoothly, I didn't have much to do.

They had a good governance structure in place, and another team member helped with that. They had a clear communication plan detailing the steps needed to make the token transferable. One of the key steps involved the utility of the token, and they got government approval. Now, the token is tradable.

This shows a good governance token design. Initially, it was non-transferable, and it served its purpose well. They distributed the tokens to the target group, and it has remained that way. However, the community eventually decided to make it transferable. It will be interesting to see how this unfolds. Safe is very driven and has a clear vision for value capture and potential collaborations. They recently talked about plans to monetize their success and build an economic model around this. Safe is an excellent product and we invested in it for a reason. They also now have a points program, which I think is a trend and there will be more similar programs in the future. For example, I have heard of similar initiatives in the DeFi space. These programs are moving away from pure mining activities and focusing more on real product participation. Users are providing feedback because they truly like the product, not just to earn rewards.