When people talk about cryptoeconomics, they mostly talking about value accrual. How can we make sure a network’s token gains value as the network grows? But how do we know that optimizing for value accrual leads to the healthiest network? There is ample evidence to the contrary. Many projects with contrived mechanics that reward holders possess communities of pure speculators unable or uninterested in taking valuable actions like building on top, evangelizing the network, and so on.
The history of property rights shows us that inefficient designs that reward speculators lead to stunted (and sometimes negative) growth and concentration of power. Token networks, digital asset registries, and even pure cryptocurrencies should consider these lessons when designing their systems. Rather than optimize for speculative value accrual, they should optimize for network growth.
A tiny history of private property
In modern America, anybody with the capital can purchase land and own it for as long as they can afford to pay the ~1% annual property tax. While constant debate surrounds the parameters of the current system, centuries of evolution inform the design. Fewer than 500 years ago, monarchs controlled all the land in feudal Europe. Private land ownership is a fairly recent phenomenon and property taxes even more recent1.
We learned that private land ownership led to net productivity increases–as Adam Smith wrote “the most efficient use of property.” But it came at the cost of inequality and poor conditions for those without the means to obtain land. Henry George would say, “the relation of poverty to progress is the great question of our time2.” Those following the crypto space may see some parallels. Rampant speculation and concentration of wealth are hot topics.
Our current system for private land is our best effort at resolving the three biggest problems of prior regimes: (1) poor allocation of property, (2) poor stewardship of property by owners, and (3) the formation of monopolies.
In Radical Markets, these problems are characterized by the following:
- Allocative efficiency: getting the property to those that value it most
- Investment efficiency: getting owners to increase and not decrease the value of the property
- Monopoly problem (heretofore referred to as “Diversity efficiency”): getting property to a diverse set of owners (resistance to monopolies)
The ideal system for property ownership, the authors argue, maximizes these three efficiencies. With this objective in mind, we can better understand the pejorative nature of the term “speculator.”
In isolation, a speculator is simply a “person who invests […] in the hope of making a profit.” Nothing wrong with that. But taking into account an objective of maximizing efficiencies in a network, the speculator becomes a person who decreases the investment efficiency of the system and thereby decreases the allocative and likely diversity efficiency alongside it.
In modern America, the land speculator is punished with a property tax, which is intended to get the land into the hands of someone who values it more because they plan to make it a productive asset (e.g. a restaurant). Vitalik recently wrote on “Harberger taxes” which are “intuitively quite unrealistic and impractical” but are designed to achieve perfect efficiencies.
Designing for efficiency vs speculation
Crypto projects–token networks, digital asset registries, maybe even pure cryptocurrencies–could benefit from understanding this prior art. Just as we seek to maximize the network value of property, we seek to maximize the network value of token networks and digital assets. We face the same problem with speculators that make suboptimal contributions to the network.
- Poor allocative efficiency means that users that would otherwise contribute value to the network are unable to.
- Poor investment efficiency means that users are not properly incentivized to add value to the network
- Poor diversity efficiency means that concentration of ownership (and sometimes control, in the case of networks with governance mechanics) impedes efficient use of the network.
I’ll give you two examples–one from a token network and the other from a digital asset registry–to illustrate the point.
First, let’s look at 0x, a protocol for decentralized exchange. They provide components that enable developers to construct systems (for simplification, I will refer to them as “relayers”) that allow users to trade with one another without a trusted third party. Their token, ZRX, exists to–in the future–allow the network to make decisions about future upgrades of their components. It’s in their best interest to get ZRX tokens into the hands of the optimal set of developers that will build valuable relayers using 0x.
The controversial ZRX denominated transaction fee is meant to organically achieve this3. If ZRX was held primarily by speculators, the protocol would not evolve congruent to the needs of those actually building on it. Over time, this would destroy the value of the network and developers that would otherwise build on ZRX would look elsewhere.
Second, consider Decentraland’s LAND digital asset registry. LAND is a non-fungible token and a tidy example in the context of this essay because it shares properties with physical land (obviously). Just like physical land, it’s in Decentraland’s best interest to get LAND into the hands of those that would make the best use of it. If LAND is held primarily by speculators with no intention to build, swaths of the world would be empty. Over time, the value of LAND would decrease because speculators decrease the value of the world itself, and developers that would otherwise build compelling experiences in the world would look elsewhere.
0x and Decentraland are both hard at work designing sustainable ways to maximize efficiency in their networks. This is an area I spend quite a bit of time thinking about so if any readers have ideas, suggestions, or prior art that you think I should see, please send it my way.
Interestingly, designing for value accrual seems orthogonal (but not necessarily unrelated) to designing for efficiency.
What would happen if private land policies were designed around value accrual? Assuming we believe that decreased velocity leads to increased prices, we could remove taxes, charge fees for transactions, periodically give landowners some money to reward them for holding. Maybe we could even buy back some of the land periodically to take it off the market, increasing scarcity. This would lead to suboptimal allocation and investment in the land, and would likely lead to a few rich people owning most of the land and getting richer over time. Overall, that society would suffer.
I expect we’ll see more experimentation with things like high distribution networks designed to incentivize adoption by the most valuable users (e.g. Handshake), taxes (haven’t seen this yet, but inflation is an invisible tax), quadratic-voting style pricing of assets (e.g. tokens are more expensive the more tokens you own), and much more. It’s not obvious to me (or I think anybody else) what the right design is. What is becoming increasingly obvious, though, is that optimizing for speculators will be a losing strategy in the long run.
Keep asking “does this token accrue value,” but also ask whether the token will end up in the sufficiently diverse hands of those that will add the most value to the network.
Thanks to Tom Schmidt for his input on this post
Posner, Eric. Radical Markets. 2018. ↩
O’Donnell, Edward. Henry George and the Crisis of Inequality: Progress and Poverty in the Gilded Age. 2017 ↩
It’s worth noting that the ZRX fee is designed to incentivize all stakeholders in the system to hold the token and vote. Otherwise, the relayers may have too much power to control the direction of the ecosystem. ↩
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I publish high quality analysis on the strategy and business of crypto, covering topics like competition, governance, protocol design, growth and more.