Demurrage advantages & opportunities

There are a number of advantages and opportunities for Web3 ecosystems that adopt demurrage via a network coin tax. Demurrage can help to improve the properties and reliability of the network coin as a fungible asset. Demurrage is also advantageous for the network, its treasury and society more broadly.

Fungible assets

The following are some advantages that can be applicable to fungible assets that adopt demurrage, fungible assets would also include any system of money.

Increased network coin velocity

Implementing demurrage would help with increasing the velocity of the network coin due to the incentives it creates for users to not leave their coins idle in their wallet. The longer that someone holds the network coin in their wallet the more of the coin they will lose due to the network coin tax. Users are incentivised to do something productive with the network coin rather than just hold it, such as using it in financial protocols or by purchasing goods or services or investing it into business ventures.

Smaller network coin supply changes

The network coin could benefit from having a supply change mechanism that is suited to its use cases, such as fixed, expansionary, contractionary or elastic. These supply changes could be automatically adjusting, which is desirable to avoid the need for community governance at a global scale. Demurrage can help with improving any systems around supply changes as it can help with increasing the velocity of the network coin. Higher velocity should mean that even small supply changes are more effective at influencing economic activity in the network. Any new supply of the network coin would then be under the same impulse and incentives for it to be used productively due to the effects of demurrage. Demurrage should help with reducing the number and scale of any required supply changes.

Incentivises productive network coin usage

If users don’t leave their coins idle in their wallet, due to the incentives created by demurrage, they will need to find a place to use those coins productively. Demurrage could help with persistently increasing the amount of economic activity that occurs in the network if the right productive use cases can be incentivised. Every holder of the network coin would have an incentive to put it to better use rather than just hold it. The network can be very deliberate about what use cases get incentivised to improve the effectiveness and operation of the network.

Increased availability of the network coin

People that don’t have any network coins could greatly benefit from demurrage. Demurrage can help to prevent people from storing the network coin excessively, which can prevent the price from rapidly appreciating due to a lack of availability. If people can always easily access the coin they will be able to use it to pay for network usage. Demurrage also incentives people to lend their network coins when they are not using them productively as they are less storable. This gives people access to network coins in the form of a loan when they have a productive use case for the coin.

Reduced risk of concentrations in coin ownership

If someone receives a risk free reward from simply holding or staking the network coin there is a likelihood that concentrations in coin ownership will increase over time. A storable network coin will mean a positive and risk free return is achievable due either staking rewards or from lending it out in a single asset borrowing and lending protocols. The amount of interest they earn could vary however it would still generate a positive rate of return.

Let’s consider a 1% return that is generated from staking, lending or a combination of the two. A person holding $1 million worth of the network coin might receive $10,000 in interest each year. If they are able to live off less than this amount they reach financial escape velocity where they can continuously increase their network coin position each year without contributing anything else to the economy. Demurrage prevents this likely inevitability as instead of gaining 1% each year they would be losing 1%. Now instead of reaching escape velocity it would instead get harder and harder to retain large amounts of the network coin over the long term due to the loss from demurrage. A positive interest rate for holding or using the network coin in a risk free manner is an example of unearned income - someone is receiving income without contributing anything meaningful to the economy. Demurrage helps to remove or reduce these issues around unearned income and reduce the possibility of growing concentrations in coin ownership over the long term.

Network

Increased coin decentralisation

Even a small network coin tax can be effective for preventing concentrations in coin ownership over the long term. The larger the amount of coins being held the larger the taxation amount, making it harder to hold and retain increasing amounts of the coin. Consider a 1% rate of demurrage applied to people holding either 100 or 1,000,000 coins. For someone holding 100 coins the taxation rate would be 1 coin per year. For 1,000,000 coins it would be 10,000 coins per year. So to retain 1,000,000 coins one would need to earn 10,000 coins elsewhere to just maintain their initial holdings. Coins would therefore disperse more easily and become more decentralised over time due to the difficulty and cost burden of retaining larger amounts of coins. Decentralisation of coin ownership is a highly important factor for networks that want to use the network coin for governance decisions. Due to the adoption of demurrage, a network would now have a more reliable system for increasing the decentralisation of the coin over the long term, helping to prevent consolidating amounts of governance influence and control over the network.

Reliable node operator income

A network coin tax can be used to either subsidise or fully pay for the operational costs of running nodes. This would mean that transaction fees could be reduced or even potentially eliminated in the future as they would no longer be needed in order to compensate node operators. A network coin tax is a far more reliable source of income as the amount of income is fully known ahead of time. Transaction volume on the other hand could drastically change over time, which makes transaction fees a less reliable source of income. Using a network coin tax, transaction fees could be reduced or eliminated, making any Web3 network more competitive in the market. As a network coin tax is a periodic form of taxation, it represents a long term solution.

Flexible supply change mechanisms

Demurrage when implemented as a network coin tax does not involve any constraints on how the supply of the network coin is handled. Web3 networks could implement a network coin tax and then adopt any approach for making supply changes. These include fixed, expansionary, contractionary or elastic supply models. For example, for an elastic supply mechanism, a network could introduce more coins into the network via the treasury and then remove some of the supply from the income that is generated by the network coin tax.

Granular incentive mechanisms

Another opportunity with applying demurrage to Web3 networks is the granular application of network taxes towards different use cases. Tax rates could be higher when coins are sitting idle in wallets and lower when deposited in financial protocols. A more granular approach to applying the network coin tax creates an opportunity to incentivise the exact outcomes that are collectively the most beneficial for the network and its users.

As one example, creating more efficient financial markets is a desirable goal for digital asset networks. These incentive mechanisms could be very valuable for these networks as coin value might be mostly determined by their usage for transaction fees. Without reliable sources of demand the price of network coins could be more volatile due to changing amounts of transaction volume. Network coins could be used as liquidity for token exchanges or as lending and borrowing liquidity. These use cases could help to maintain stable prices for the network coins over the long term, especially if the coins are also locked up in these protocols for fixed periods of time. Network coins could potentially focus on being used for either transaction fees or as financial liquidity. The more effective network coins become at facilitating the exchange of tokens the more efficient the network's token market should become. A network coin tax could help with creating these more efficient markets by simply reducing the taxation rate when the network coin is deposited as financial collateral. Getting these incentive mechanisms right could help with creating powerful network effects that can help these networks thrive over the long term.

Treasury

Ecosystem funding

The income generated by a network coin tax would be reliable and predictable. This income can be used to fund ecosystem initiatives that introduce new use cases or that improve the network's infrastructure. Even a small percentage tax rate could generate a meaningful amount of income to help with maintaining and improving Web3 networks. Network coin taxes would be charged periodically, such as every day, meaning they would only collect a very small percentage amount. Over a year the aggregate taxation value collected would represent the annual percentage tax rate. The exact amount of income would be known ahead of time due to it coming from the existing supply of network coins. This predictability of income is beneficial for the ecosystem's funding process, as it can be taken into account when planning any larger initiatives. Ecosystem funding could help with creating a growth flywheel for improving and expanding Web3 networks. The better the return on investment is for funding ecosystem initiatives the faster the price of network coins could appreciate. More coin price appreciation would mean that the same network coin tax rate could pay for increasing amounts of ecosystem initiatives over time. This can create a growth flywheel that could persist until a network is globally adopted.

Accelerated ecosystem growth

The network coin tax could dramatically help with increasing ecosystems’ growth rates due to the initiatives funded via taxation income. The founding entities first need to prove that the funding process is sufficiently effective at improving, maintaining and growing the ecosystem. If the return on investment from the funding process is higher than its costs, it could be beneficial to increase the taxation rate. The higher the coin tax rate the larger the amount of income for the treasury, meaning larger amounts of funding for ecosystem initiatives. Holders of network coins might lose more coins from taxes but they could benefit from much faster coin price appreciation due to the initiatives that get funded and developed. Web3 networks operate in highly competitive markets, so increasing the growth rate of these ecosystems would be highly desirable due to the opportunity to rapidly increase adoption and increase network effects. Rapid ecosystem growth creates compelling investment opportunities for people hoping to benefit from that network growth. A network coin tax helps to capture some of the value from this growth and then reinvest it into initiatives that can further grow the network.

Society

Global public goods funding

A Web3 network that gains global adoption could eventually become a reliable source of funding for global public goods. Global public goods could include any initiative that is beneficial to society. These initiatives do not need to be related or beneficial to the network itself. Engineering, scientific, medical and environmental research and development efforts are just a handful of areas that could benefit from public funding.

Network coin taxes create massive opportunities to fund such large scale and highly impactful global public goods initiatives. If network coin taxes are adopted at scale there are two key reasons why an increasing amount of the resulting income could be used for funding global public goods.

The first reason is that ecosystems will eventually start to mature and thus require less funding for development efforts focussed on the networks themselves. This is not to say that funding will become no longer necessary, as research efforts would likely always be valuable for exploring even small potential improvements. Instead, what might happen is financial requirements for network research and development could plateau and stabilise instead of needing to continuously grow alongside the networks.

The second reason more funding should inevitably become available is that if ecosystems are successful, the value of the ecosystems would grow over time. This means that even a small percentage network coin tax could equate to a large and growing amount of available funding. For instance an annual 1% network coin tax for a $10 billion ecosystem would mean $100 million in treasury income each year. For a $1 trillion ecosystem this would mean $10 billion each year. A network coin tax could eventually lead to an increasing likelihood that global public goods are able to be funded using that income.

This is a huge opportunity for society. Web3 networks and their funding process could create highly aligned incentives where people can receive funding to work on global public goods. High performing contributors could be paid extremely well and their contribution efforts could be directed towards highly impactful initiatives that benefit society globally.