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Besides being the medium of fundraising for the company in a less regulated matter, a token’s purpose is the underlying driver for determining its true value. Tokens require functionality to maintain and accrue value. There need to be incentives for investors to hold onto their tokens besides the promise that when the invested project is successful in the future, they will be rewarded, otherwise a great portion of the token price being left to pure speculation.
The rise of Defi has pushed forward the importance of token design, and its different nature to many previous crypto projects has also made it easier for Defi tokens to justify their value. Most Defi tokens are designed with the focus that holders benefit proportionally to network usage and growth of the protocol. It’s no surprise that some of the functionality of Defi tokens is modeled after equity, where investors value their stake based on the revenue provided by the underlying asset and have the right to influence the direction of the organisation. I aim to cover some important features of Defi tokens and explain how they contribute to retaining a token’s value.
Staking is when investors deposit their tokens into a protocol, locking it for a period of time and reducing the circulating supply of the token. Staking is a real functionality feature for the token since staking in a network protocol’s PoS consensus helps guarantee the underlying security of the network (like MATIC tokens on the Polygon Network). Staking can also occur in a protocol without a PoS reason like many exchange protocols (QuickSwap, SushiSwap, PancakeSwap) where depositing funds simply means the investor believes in the long term interests of the protocol since with all things equal, staking raising the price of the token. In both cases, the staking is in effect making the network more valuable and thus rewarded with more of the staked token i.e. via inflation.
Inflation provides liquidity into the market in a healthier way than releasing all the available tokens at once. The gradual injection of liquidity lowers volatility on top of rewarding holders of the token. When a token utilises inflation as the primary incentive to attract current investors and provide a new supply of tokens for new users in its early growth stages, this is known as bootstrapping via liquidity mining. The economic dynamic between staking and inflation is also very important. Although both work together to justify fundamental value for a token, their balance is important. High staking yields draw out large amounts of tokens from the supply causing prices for the token to rise significantly. Lower liquidity also means interactions between buyers and sellers have a greater impact on the token price. With high yields, when stakers un-stake and sell their yields, the sudden influx of supply tank the token price (exchange tokens are also a great example). Depending on the potential of the protocol, the price recovery can also be a slow process with the high inflation. This further adds volatility to the token price.
Staking provides investors with inflationary rewards, but investors can also be rewarded with noninflationary rewards in the form of the fees generated by the underlying protocol. Fees are typically integral in transacting on the protocol, where they are distributed proportionally to the Ethereum address that holds the underlying fee token. The fees can be in stablecoins, ETH, or the underlying fee token. Fees function like dividends with equities and provide investors value accrual for holding a token. In some cases, the fees can also be burned directly, creating a deflationary token supply and increasing its value, equivalent to stock buybacks with equities. The network value can be valued through basic finance frameworks like a Discounted Cash Flow Analysis, where the fees can be forecasted out based on future network growth. This further translates to the ability to perform a comparative analysis of tokens relative to similar tokens to determine if a token is mispriced or not.
Governance in a protocol works in mind that token holders collectively own the set of contracts holding the protocol together and decide how they change over time through a voting process. Governance incentives within a Defi protocol hold more significance than their equity counterparts. In cryptocurrency ethos, no minority party should be deciding on the outcome of the token. Governance tokens aren’t just a driver of the fundamental value of a token but also actively impact the future valuation of the token. For example, deciding on how protocol fees should be handled whether they should be burned or distributed directly impacts a token price. For lending protocols like Compound, the decisions made on the over collateralisation levels for borrowed assets impact the protocols risk profile and thus attractiveness to investors. In the future, the impact of governance tokens won’t just be limited to every major protocol change but potentially down to every smart contract upgrade i.e. like a vote on approving a pull request for the smart contract code.
Over time, with the continual experiments in the Defi space, improvements to token design will continue to be made, with changes being ever more granular and better in capturing the value of the underlying protocol network.
Comply with me on Twitter @ordcryptoguy
In addition to being the medium of fundraising for the corporate in a much less regulated matter, a token’s goal is the underlying driver for figuring out its true worth. Tokens require performance to keep up and accrue worth. There must be incentives for traders to carry onto their tokens apart from the promise that when the invested undertaking is profitable sooner or later, they are going to be rewarded, in any other case an important portion of the token worth being left to pure hypothesis.
The rise of Defi has pushed ahead the significance of token design, and its completely different nature to many earlier crypto initiatives has additionally made it simpler for Defi tokens to justify their worth. Most Defi tokens are designed with the main target that holders profit proportionally to community utilization and progress of the protocol. It’s no shock that among the performance of Defi tokens is modeled after fairness, the place traders worth their stake based mostly on the income offered by the underlying asset and have the correct to affect the course of the organisation. I intention to cowl some vital options of Defi tokens and clarify how they contribute to retaining a token’s worth.
Staking is when traders deposit their tokens right into a protocol, locking it for a time period and lowering the circulating provide of the token. Staking is an actual performance function for the token since staking in a community protocol’s PoS consensus helps assure the underlying safety of the community (like MATIC tokens on the Polygon Community). Staking also can happen in a protocol with out a PoS purpose like many trade protocols (QuickSwap, SushiSwap, PancakeSwap) the place depositing funds merely means the investor believes in the long run pursuits of the protocol since with all issues equal, staking elevating the value of the token. In each circumstances, the staking is in impact making the community extra priceless and thus rewarded with extra of the staked token i.e. through inflation.
Inflation gives liquidity into the market in a more healthy approach than releasing all of the obtainable tokens directly. The gradual injection of liquidity lowers volatility on prime of rewarding holders of the token. When a token utilises inflation as the first incentive to draw present traders and supply a brand new provide of tokens for brand new customers in its early progress phases, this is named bootstrapping through liquidity mining. The financial dynamic between staking and inflation can be crucial. Though each work collectively to justify elementary worth for a token, their steadiness is vital. Excessive staking yields draw out massive quantities of tokens from the availability inflicting costs for the token to rise considerably. Decrease liquidity additionally means interactions between consumers and sellers have a higher impression on the token worth. With excessive yields, when stakers un-stake and promote their yields, the sudden inflow of provide tank the token worth (trade tokens are additionally an important instance). Relying on the potential of the protocol, the value restoration can be a sluggish course of with the excessive inflation. This additional provides volatility to the token worth.
Staking gives traders with inflationary rewards, however traders can be rewarded with noninflationary rewards within the type of the charges generated by the underlying protocol. Charges are sometimes integral in transacting on the protocol, the place they’re distributed proportionally to the Ethereum deal with that holds the underlying price token. The charges will be in stablecoins, ETH, or the underlying price token. Charges perform like dividends with equities and supply traders worth accrual for holding a token. In some circumstances, the charges can be burned straight, making a deflationary token provide and growing its worth, equal to inventory buybacks with equities. The community worth will be valued by way of primary finance frameworks like a Discounted Money Circulate Evaluation, the place the charges will be forecasted out based mostly on future community progress. This additional interprets to the flexibility to carry out a comparative evaluation of tokens relative to comparable tokens to find out if a token is mispriced or not.
Governance in a protocol works in thoughts that token holders collectively personal the set of contracts holding the protocol collectively and determine how they alter over time by way of a voting course of. Governance incentives inside a Defi protocol maintain extra significance than their fairness counterparts. In cryptocurrency ethos, no minority get together needs to be deciding on the result of the token. Governance tokens aren’t only a driver of the basic worth of a token but in addition actively impression the long run valuation of the token. For instance, deciding on how protocol charges needs to be dealt with whether or not they need to be burned or distributed straight impacts a token worth. For lending protocols like Compound, the choices made on the over collateralisation ranges for borrowed belongings impression the protocols threat profile and thus attractiveness to traders. Sooner or later, the impression of governance tokens gained’t simply be restricted to each main protocol change however probably down to each sensible contract improve i.e. like a vote on approving a pull request for the sensible contract code.
The longer term
Over time, with the continuous experiments within the Defi area, enhancements to token design will proceed to be made, with modifications being ever extra granular and higher in capturing the worth of the underlying protocol community.