Demurrage risks & challenges

Implementing demurrage in a Web3 ecosystem does have its risks and challenges, however all of these risks and challenges have reasonable solutions or counter arguments.

Difficulty sustaining a network coin tax above the low risk yield rate over the long term

Once a Web3 ecosystem is mature and well developed there is an incentive to duplicate the network and strip it of any taxes that exceed the cost of operating the network. Some people would individually benefit from this duplicated network as they might save money on network coin taxes. The problem with this is it would likely mean that the network coin tax would be very low and this could greatly increase the storability of the coin. If wealth can easily concentrate and be stored there is an increased risk of systemic failure. Collectively it is more beneficial to keep the network coin tax high enough to prevent wealth concentrations. Individually it could still be beneficial to create and market a network without this taxation approach, however the adoption of these networks can lead to the same low coin velocity and wealth concentration problems that can be seen in historical forms of money.

Counter arguments

To prevent systemic network failures due to ongoing wealth concentrations the network simply needs to ensure the coin will disperse over time. To achieve this the network needs to ensure the taxation rate is above the average low risk yield bearing rate such as from staking and providing liquidity for financial protocols. The low risk yield bearing rate might be 1%. If the network coin tax rate is 1.1% it will become increasingly hard for someone to accumulate large amounts of the network coin due to the loss of coins from taxation. The network coin still has very desirable properties such as being globally used and highly predictable and reliable. More experimentation and data points will provide evidence on how high the taxation rate can be before the demand meaningfully decreases.

Difficulty attracting initial capital

Implementing demurrage into a Web3 ecosystem could result in an increased difficulty in attracting capital investment. People that invest could start losing portions of their coins to taxation. In the beginning stages of the network there will also likely be less functionality, applications, use cases and general adoption. Web3 ecosystems have a chicken and egg problem where it is difficult to get people to build use cases on the network without users and users can’t easily adopt the network if there are no use cases.

Counter arguments

Demurrage does not need to be implemented at the start of a Web3 network. A genesis allocation of coins can be an effective way to allocate enough funds for building up some initial use cases and applications for people to use. This approach means early capital investments into the network coin would be rewarded by being able to benefit from no network coin taxes in the earlier stages.

When the network has grown and the genesis funds are nearing depletion the community could then consider introducing a small network coin tax that can also help with funding ongoing initiatives. During a growth phase the holder of the network coin could benefit from ongoing price appreciation that outpaces any loss from the network coin tax.

In the late stages of the ecosystem the impacts of demurrage become more important for ensuring that the coin is not highly storable. Approaches such as financial liquidity incentives will be useful for generating more long term demand for the network coin beyond its usage for transaction fees.

Treasury influence risks

The network coin tax could mean there is a large amount of income generated for the treasury each year. Community members could greatly benefit financially from this income which creates an incentive for people to try and game the system or increase their wealth to influence over how this funding is used. Another concern is if the network coin tax results in a suppressed coin value it could become easier to capture enough coins to influence the network. If someone can accumulate more than they lose from the funding process they might be able to perpetually increase their coin ownership through the funding process.

Counter arguments

This is a potential risk for the network to consider, especially as the network coin will likely be storable in the growth phase due to price appreciation. One way this risk of growing influence could be reduced is by ensuring the founding entities are able to moderate the funding process in the genesis and growth stages of the network. This would allow them to identify any bad actors and manually prevent those actors from gaining any financial advantage over others in the funding process. Another way that this problem could be minimised is through the design of the funding process. Distributing large lump sums to a single address is an obvious risk factor that could be avoided. Paying contributors directly and individually and adding in checks and balances for any fixed costs would be an important part of making sure the funding process isn’t easily abused by malicious actors. As the ecosystem grows and becomes more decentralised the cost and difficulty of maliciously influencing the funding process could also increase as well. The cost of holding a larger amount of coins should become increasingly problematic due to the ongoing loss from the network coin tax.

Lack of understanding or awareness

The idea and benefits of demurrage are not widely understood or known in society today. There have only been a few small experiments in the history of money. People may reject any ecosystems that adopt a demurrage currency due to their preference to hold another form of money that holds its value.

Counter arguments

The network coin does not need to compete to become the most desirable medium of exchange. It could solely focus on being used for paying for node operation and being used as financial liquidity and as contract collateral. Token money is able to experiment with a variety of different ideas to create a broadly adopted medium of exchange. New forms of money can be introduced and adopted over time.

Education will still be a meaningful barrier for the adoption of demurrage. The quality of educational resources will be an important part of convincing people that demurrage is actually highly preferable and a more effective approach for fungible assets like the network coin and systems of money. A Web3 ecosystem only needs a moderately sized community to endorse this approach for the ecosystem to demonstrate the potential and advantages of a network coin tax.

Acceptance

The concept of demurrage is not well understood by the general public, and it might clash with traditional economic thinking. People and businesses may be hesitant to transact, fearing a loss of value in this new currency.

Counter arguments

In the short term, the return on investment potential could be a strong incentive for people to consider when deciding whether they are going to invest in a Web3 network or not. If the network can prove it generates a great return on investment for people that are investing into a demurrage based network it will make it much easier for them to accept that approach as they would benefit from it. The network could be particularly lucrative for investors in the growth phases.

In the later stages of the network the incentives change as it will become less profitable to hold the network coin as an investment. This is highly desirable as at this stage the wider community needs ongoing access to the network coin to use the network.

The network coin does not need to be concerned with whether people want to hold or use it for purposes beyond its core responsibilities. The network coin can focus on becoming widely available to pay for node operation and being widely used for financial liquidity and as contract collateral due to network based incentives. As long as these responsibilities are handled effectively there is little need to try and get the public to accept demurrage as the approach for money as the benefits will already be evident and holders can still financially benefit from holding the coin. Users also have the freedom to create their own token based forms of money and adopt them as their medium of exchange whenever they want to.