Stable demand for the network coin

Demurrage money creates an incentive for people to not hold the money due to the loss of value over time. This incentive can be problematic for Web3 digital currencies due to the speed and ease of exchanging the network coin for any other asset that doesn’t lose value over time. Without any compelling use cases and incentives to generate long term demand there is a risk that demurrage could lead to a lower and suppressed price for the network coin due to the constant sell pressure from people exchanging the network coin for other assets.

Transaction fee based demand problem

Transaction fees are one of the primary use cases for the network coin. Unfortunately these fees are not a compelling source of a meaningful amount of sustained long term demand for the network coin. Most networks should have an objective to reduce their transaction fees as low as possible. If reliable sybil resistant mechanisms are developed in the future, transaction fees could potentially be reduced to nothing! Unnecessarily high transaction fees are highly undesirable as they lead to transaction deadweight loss. But the problem with extremely low transaction fees is it could limit the income potential and reliability of that income for node operators. This is why alternative taxation models are compelling as it means the network won’t need to rely on transaction fee income to sustain itself, which means transaction fees can be lowered as much as possible.

Minimising transaction fees should help with facilitating as much network activity as possible. However achieving this objective would mean there is likely a need for other use cases that can help with maintaining longer term demand for the network coin. The two most compelling use cases identified so far include using the network coin as financial liquidity and as contract collateral.

Assessing the demand for the network coin

A Web3 network benefits from understanding how much demand there is for the network coin at a given moment in time so that it is able to balance and adjust any variables it can to sustain a certain level of demand as needed. There are a number of ways to try and asses the demand for the network coin within the ecosystem, and some of these approaches are more suitable than others:

• Total financial liquidity and contract collateral deposited - If people are depositing more network coins as financial liquidity and as contract collateral this could indicate there is more demand for the network coin. A simple approach to manage the demand for the network coin could be to target a certain percentage of the network coin supply that should be used as financial liquidity and contract collateral. If it drops below a certain percentage of usage the demurrage rate could be reduced to increase the demand for the network coin and potentially vice versa when the usage goes above a certain percentage. This could be an effective approach for determining the overall demand and influencing the demurrage rate. This kind of mechanism would likely need to be careful by using averages over a period of time rather than immediately reacting to sudden changes or spikes in activity. Another way that this approach could be potentially improved is by using lock-up incentives for any contract collateral. The percentage of the network coin supply that is locked-up as contract collateral could be another target metric that is used to influence the rate of demurrage to increase or decrease the demand for the coin.

• Token exchange volume - The network coin is suitable for being a liquidity pairing with other tokens for facilitating token exchange. The volume of swaps that use the network coin with other token pairings could be highly insightful information to understand the demand for the network coin as financial liquidity. It is difficult to rely on this information as people could easily spam the network with fake volume. It is also undesirable to add in a fee to prevent this behaviour as this results in deadweight loss and makes the market less efficient. So this makes this approach less desirable than using the total financial liquidity and contract collateral approach.

• Transaction usage vs liquidity and collateral usage - Transaction volume can be less predictable due to external factors that can influence how many transactions are submitted each day. So comparing the usage of the network coin for transactions versus for liquidity and collateral usage could be problematic. If there was an economic lockdown or major event the number of transactions could suddenly drop. Increasing or decreasing the rate of demurrage won’t necessarily create the desired outcome in these situations. This doesn’t mean there must be a concern about the network or that there will be any sustained periods of reduced demand for the network coin. So it doesn’t likely make sense for the network to make any meaningful adjustments to the network coins demurrage rate just because people haven’t transacted as much in the short term.

The usage of the network coin as financial liquidity and as contract collateral is a compelling data source for assessing the demand for the network coin as these are optional use cases. People are not required to use the network coin for these use cases so metrics that indicate whether these use cases are declining, sustaining or growing in adoption could represent a valuable data source for understanding the overall demand for the network coin.

Changing the rate of demurrage is one of the simplest ways that a network could increase and decrease the demand for the network coin relative to what else is happening within the network economy. Transaction related metrics are less compelling for determining overall demand for the network coin due to the multitude of reasons why this might change suddenly. The percentage of the network coin supply that is being used for financial liquidity or as contract collateral could be useful data points for understanding the trend of whether demand is increasing or decreasing for the network coin. It might be possible to use these metrics to create an automated solution for ensuring the network coin is always appealing enough as a form of financial liquidity and contract collateral. A sufficient amount of data points and metrics would be necessary to properly automate this system over the long term.

Approaches for creating or redirecting demand for the network coin

The primary use case for the network coin is to pay for transaction fees, which enables people to use and benefit from the network. The problem with the transaction fee use case is it doesn’t generate a sustained amount of long term demand for the network coin. A number of incentive mechanisms could be used for creating or redirecting demand towards other use cases that can be more effective at generating longer term demand for the network coin.

Network coin tax reduction incentive

Decreasing the network coin tax for certain use cases can be a powerful way to incentivise people to take certain actions over others. For instance leaving the network coin idle in a wallet could have a taxation rate of 5% but depositing it as financial liquidity in a token exchange could drop it down to 2%. This type of incentive can help to guide users to be productive with the network coin rather than leave it idle in their wallets. The desired demurrage rate is the rate that everyone would receive if they correctly followed the incentives that lead to more productive usage of the coin. Any changes to these types of incentives could have an immediate impact as a network coin tax would likely be charged on an hourly to daily basis.

One of the worst outcomes for the network is network coins being sat idle and not being used productively for things like financial liquidity or for transaction fees. These types of incentive would help with increasing the productive usage of the network coin.

Transaction fee reduction incentive

Users could pay a higher transaction fee by default and then an incentive could be used to encourage people to deposit the network coin as financial liquidity to benefit from cheaper transactions. This incentive could be useful for transferring demand from transaction fees into financial protocols as liquidity. It would not likely create much new demand for the network coin beyond the existing transaction demand. However it could be effective at creating longer term demand for the network coin, as the liquidity could also have lock-up period based incentives as well.

As an example, if someone submitted 1000 transactions annually and those cost $0.01 each this would equate to $10 worth of transaction fees. So offering this user an incentive to receive half price transaction fees would only be worth $5 to this user. This means the incentive would likely need to ask for less than this amount for it to be a viable incentive. So for this example the incentive could be to deposit $4 worth of liquidity to then receive the half price reduction in transaction fees, this then gives them $5 worth of value in reduced fees.

Token transaction fees or token taxes

The network could try to increase the demand for the network coin by making other assets in the ecosystem less appealing to hold. Increasing token asset based transaction fees is one approach. Another is to introduce a tax that is applied to all tokens.

Either of these approaches are unnecessary as having other forms of money on the network does not compromise the need for the network coin - as it is always needed for paying for network usage. The network coin is also very well suited for being used as financial liquidity and as contract collateral. If demurrage was forced upon all assets in the network it would mean that no asset could be storable and have the store of value property. This would make other networks more appealing and competitive as they could simply give the users this optionality around adopting the properties they want for their tokens.

Transaction speed reduction incentive

Users that deposit financial liquidity could benefit from prioritised transactions. This incentive is problematic as it gives wealthier users an advantage over poorer users as they might be able to greatly benefit from faster transactions. Poor users would have an incentive to adopt other networks that don’t adopt this approach.

Subscription based access

Users could be required to subscribe to the network by paying a fee. This is problematic as it punishes the poorest users who may not have enough to pay for this fee. Poor users would have an incentive to adopt other networks where they can use it without needing to pay an upfront subscription fee.

Restricted feature access incentive

Access to features could be restricted to those that have provided liquidity into the ecosystem. This type of incentive would likely require a minimum threshold of liquidity. This is problematic as it punishes poorer users as they won’t be able to benefit from the same functionality as wealthier users.

Governance participation incentive

The ability to participate in governance decisions could be determined by whether someone has deposited a certain amount of financial liquidity or not. This is problematic as it disincentivises people from participating in governance which could centralise control of the network into the hands of people that are both willing and able to deposit a certain amount of liquidity.

External policies, initiatives & incentives

A number of different policies, initiatives and incentives could be introduced that are handled outside of the network. Some examples could be reduced national taxes for people that deposit liquidity in the network or legislation that requires people to use only approved networks such as those that adopt a certain rate of demurrage. It could be difficult to enforce these types of solutions properly as Web3 networks are global and each country competes with one another. So it would need to be a universally accepted understanding that storable forms of money are problematic and harmful for society. If that becomes increasingly provable with more demurrage based experiments it becomes more compelling that legislation could be introduced and be effective. There also might be a number of other external approaches that could be effective that have not been considered.

Financial liquidity approaches

Incentive mechanisms such as a network coin tax reduction incentive and a transaction fee reduction incentive were some of the more compelling approaches for transferring demand from using the network coin for transaction fees or as a store of value and redirecting it towards demand for using the network coin as financial liquidity or as contract collateral. These incentives could be effective at ensuring the network coin is used more productively. The incentives could also include lock-up periods to create longer term demand for the coin.

The network coin could be deposited as liquidity across many different types of decentralised finance protocol. A digital asset network will want to incentivise the most important use cases that are most aligned with making the network as effective as possible for creating, maintaining, using and exchanging token based digital assets.

A token exchange liquidity incentive as well as a single asset borrowing and lending incentive appear to be the most compelling financial liquidity use cases for creating longer term demand for the network coin whilst also ensuring that the network coin is being used as productively as possible. The full comparison between the different financial protocol incentives can be found here:

Financial liquidity incentive options

Summary

A digital asset network can highly benefit from the network coin being used as financial liquidity and as contract collateral. For financial use cases, token exchange liquidity or liquidity for a borrowing and lending protocol were some of the most compelling use cases.

Token exchanges will be a very important protocol for digital asset networks. Single asset lending and borrowing protocols are also important for enabling people to lend network coins in a risk free way. These use cases can help with creating an environment for the productive use of the network coin. Increased financial liquidity should also help with creating more effective network effects for a digital asset network. Idle and unproductive network coins are one of the least desirable outcomes for any digital asset network. Financial liquidity and contract collateral incentives can help with reducing and minimising this issue of idle and unproductive network coins.

Decreasing the network coin tax and reducing transaction fees for people that deposit network coins as financial liquidity and that also use it as contract collateral could represent some of the most compelling ways to generate longer term demand for the network coin.

Many of the other approaches for redirecting or creating demand for the network coin were not very compelling as they would often mean punishing poor users unnecessarily. Other networks could simply duplicate the network and remove these restrictions if the existing incentives gave wealthier users a large advantage.

External policies, initiatives and incentives may also be possible and important for increasing the demand and reliability for the network coin. It is not clear at this stage how reliable these external initiatives will be in the short term. It is desirable for reliable demand based mechanisms to be handled by the network itself when this is possible as this is going to be more predictable and reliable over the long term.