Importance of network coin demand

The demand for the network coin will directly influence its current value. Demand for the network coin is an ongoing concern for any Web3 network. The following are some use cases where the value of the network coin is of importance:

• Consensus mechanism - In Proof of Stake networks the amount of staked network coins that someone owns will influence the amount of control they have in the network. If the value of the network coin is low it becomes easier to accumulate a large amount of the coin. They can then use those coins to attack the network such as through double spending or transaction censorship.

• Network governance - The network coin could be used to influence network parameters as well as for deciding how network treasury funds get allocated. If the value of the network coin was low it would make it easier to attain a large amount to maliciously influence these governance processes.

• Compensating node operators - In both Proof of Stake and Proof of Work networks the network coin is used to compensate node operators who verify and store transactions. If the value of the network coin is low it could limit the amount of node operators that are willing to participate due to the profitability.

• Network usage - If the network coin is used to pay for network usage the price of the network coin will be of importance. A low network coin price would mean the cost of transacting on the network could be very low. This could make it easier to spam the network and attempt a denial of service attack unless sybil resistant identity solutions exist or other deterrents.

A Web3 network does not strictly require a network coin to determine who has what amount of influence in the consensus mechanism, nor does it need to use the network coin for governance. The larger problems to avoid is the reliance on the network coin to pay for network usage and for compensating node operators. Due to its importance for aligning these incentives around how people operate the network the value of the network coin could always be of high importance. If the network coins value suddenly dropped it could lead to a systemic failure - node operators could stop running their nodes due to a lack of incentive to participate.

Use cases and incentives that help to maintain stable demand for the network coin will play an important role in these emerging Web3 networks. In the later growth and maturity stages of these networks, where coin velocity becomes an increasingly important factor, there will be an ongoing need to sustain a sufficient level of demand for the network coin whilst also maintaining a sufficient rate of taxation to maintain and incentivise higher coin velocity.

Physical money vs digital money

To better understand the importance of demand for the network coin it is worth understanding the differences between physical money and digital money. Physical money, like gold, coins and banknotes have different characteristics to digital money. Physical money means people need to exchange or invest their money in person. This means there would always be some period of time where they are holding money that they receive before then meeting with another person they want to exchange with. The process of exchange and investment would be slower and more gradual with a physical monetary system. It is also more inconvenient to hold multiple forms of physical money to conduct exchange.

Digital money is entirely different. With digital money, people can find out about goods and services online and find out the prices immediately including what forms of money the seller accepts. The buyer can exchange their own money for another form of money almost instantaneously from anywhere in the world. Systems could even be created to automate the process of exchanging any money you receive into other assets the moment you receive digital money. Implementing a demurrage money can create an incentive for these types of solutions to be developed. People are incentivised to hold other assets if the money they are holding is losing value. Generally people will prefer to hold assets that retain or appreciate in value over time like a digital gold token or a similar type of asset.

The key difference with physical and digital money is the speed in which changes to the incentives will impact the system of money. Physical money is more difficult to change when a system is adopted as it is inconvenient to hold multiple forms of physical money that others might not accept in person. Digital money enables people to buy and sell goods and services in an instant and exchange their existing money into any other type of money or asset rapidly. Web3 networks only further increase the amount of choice and flexibility people have to use different forms of money. Users will be able to immediately change from one system of money to another, meaning any Web3 implementation of money will need to regularly consider why people are going to continue using a demurrage based system of money when compared against any alternatives.

Web3 money is programmable and these emerging networks are increasingly becoming cheaper and faster. Introducing a network coin tax could create an incentive for people to avoid holding the network coin until it was absolutely necessary to use it. This could create an ongoing amount of sell pressure for the network coin due to this incentive to quickly exchange it. If no one wants to hold the network coin this could limit its demand and therefore its price. People might accept the money during exchange but then immediately exchange it for another asset that doesn’t lose value. Limited price value of the network coin could put the security of the network at risk as it is the network coin that is commonly used for node operator compensation, governance and funding decisions in the network. A network coin that has minimal demand increases the opportunity for someone to quickly attain a large amount of the network coin to maliciously attack the network.

Undesirable outcomes

Idle network coins

It is not desirable for anyone to leave network coins idle for any extended period of time. The network coin always needs to be available so that people can use it to pay for network usage. The incentives to generate demand for the network coin shouldn’t also result in it also being left idle in someone's wallet. The network coin needs to be used as productively as possible if it is competing with other digital asset networks that are also incentivised to take advantage of any opportunity to improve the network by using the network coin as productively as possible.

Little demand for the network coin

Implementing a demurrage based network coin could result in an ongoing amount of sell pressure. If the network coin is used for network governance and funding decisions it will be important that enough demand is sustained for the network coin over the long term.

Too much demand for the network coin

A network coin that has too much demand causes the issue of increased storability. People could become incentivised to hold and leave the network coin idle in their wallets due to ongoing price appreciation or due to income potential. The network coin doesn’t need to be overly concerned with what is happening outside of the network in the short term, however over the long term a successful network could become highly valuable. In that event the network coin would be increasing in price when compared to external currencies and assets. The network coin needs to have enough demand that people want to use it for other use cases, such as within financial protocols or as contract collateral. The network coin also wants to avoid being in too much demand so that it doesn’t become increasingly storable, which could result in hoarding, stagnation and concentrations of coin ownership over time. Getting the network coin taxation rate right can mean a balancing act of generating enough demand for the network coin when compared to other assets that exist both in and outside the ecosystem.

Short term demand for the network coin

The problem with transaction fee based demand is it is a form of short term demand. The demand for the network coin only happens at the point of the transaction being submitted. There is little reason to hold it beyond this use case. A network needs to think about how it can incentivise long term demand for the network coin so that the price remains high enough to reliably secure the network. Incentives to improve the long term demand for the network coin will be important due to the fluctuating amount of demand for transactions and due to the fact that each network is trying to reduce its transaction fees as low as possible - which could eventually reduce demand for the network coin if only a small amount of network coins are needed to pay for transaction usage.

Loss of taxation value

Low demand for the network coin is also problematic for limiting the potential value of any income generated for the treasury. The network coin could be sold immediately by anyone that receives it from the treasury. A low network coin price could make it more difficult to fund meaningful initiatives if the price is always suppressed.

Summary

A problem with demurrage and its implementation in a Web3 network is it will likely reduce the demand for the network coin. The higher the rate of demurrage the faster the loss from holding the network coin. This can lead to a reduction in the demand for the coin when compared to other digital assets that the user could hold instead. Users might be required to use the network coin to pay for network usage, however they are not required to use the network coin for other use cases that help with generating longer term demand. These other use cases will likely need to incentivised however the rate of demurrage will influence how effective those incentives are and the likelihood of whether people choose to use the network coin or not for these other use cases.

Having a network coin that is in too much demand could also be problematic, especially if this meant that the concentration in coin ownership could increase over the long term. This can lead to systemic failures within the network due to economic stagnation and a lack of availability of the network coin.

So a balancing act for Web3 networks is trying to create long term demand for the network coin so that it can sustain a high price and keep the network secure whilst also not creating too much demand that results in increasing concentrations of coin ownership.