[Web3] Sustainability Checks for Tokenomics and Protocols

April 19, 2024

Disclaimer: This post is for informational purposes only, and the author is not liable for the consequences arising from any investment or legal decision based on the information contained in this post. Nothing contained in this post suggests or recommends investing in any particular asset. Making any decisions based only on the information or content of this post is NOT advised.

Bear markets are a great opportunity to examine the sustainability of major protocols because they are free of the noise associated with speculation.

The sustainability of a protocol and the sustainability of tokenomics should be separated. Considering token incentives as spending, the total revenue generated by the protocol as revenue, and the portion of revenue that contributes directly or indirectly to the accumulation of token value as token value accrual, revenue must exceed spending for the protocol to be sustainable. Furthermore, for tokenomics to be sustainable, the token value accrual must exceed spending.

MakerDao, 1inch Network, and Perpetual Protocol serve as examples where both protocols and tokenomics demonstrate sustainability. Conversely, Lido, Aave, Uniswap, and GMX are examples of sustainable protocols, but tokenomics is not. Lastly, Balancer and Stargate are examples where neither protocols nor tokenomics are sustainable.

1. Introduction

The year 2022 posed challenges for crypto investors, characterized by falling asset prices compared to the rising trends of 2020 and 2021. However, bear markets provide a unique opportunity to contemplate the essence of blockchain and tokenomics. In bull markets, protocols may appear innovative, and tokenomics seems like a magical support system for the economy, but bear markets unveil the reality behind the illusion. The noise of bull markets can distract us from critically assessing protocols and tokenomics. Amid uncertainties about the current bear market, it is essential to take a closer look at the sustainability of major protocols.

For a protocol to be economically sustainable, the generated revenue and value must exceed spending. In this context, spending primarily comprises token incentives offered by protocols to encourage user contributions, such as DeFi liquidity providers and bounty program participants. These tokens, minted through smart contracts based on predetermined tokenomics, dilute the value of the tokens, directly affecting the utility and governance of the protocol. Consequently, the tokens provided as incentives are considered the protocol's spending.