> For the complete documentation index, see [llms.txt](https://money.web3economy.io/llms.txt). Markdown versions of documentation pages are available by appending `.md` to page URLs; this page is available as [Markdown](https://money.web3economy.io/web3-network-coins/stable-demand-incentives-and-network-effects.md). # Stable demand, incentives & network effects A periodic charge creates an incentive not to retain the network coin. This is the intended effect of demurrage, but it also creates a potential problem for the network. Users can exchange digital assets rapidly. If the network coin carries a cost that alternative assets do not, participants may hold tokens, stablecoins or external assets and acquire the network coin only when they need to pay for network resources. If this behaviour becomes widespread, demand for the coin may be brief and transactional. Users buy it immediately before submitting a transaction, while node operators and other recipients sell it shortly after receiving it. The resulting sell pressure can weaken the coin’s market value. This can reduce the purchasing power of node rewards, make the network less expensive to attack and limit the value of treasury income. The network therefore needs to maintain long-term demand while discouraging excessive idle storage. Demurrage cannot be designed independently of the useful functions and incentives that give the coin value. ## **Why network coin demand matters** Demand influences the coin’s market value and the willingness of participants to accept it. This matters across several network functions. In a proof-of-stake system, the coin’s value influences the cost of acquiring consensus power. If the price is low, an attacker may be able to purchase a substantial stake more cheaply. The distribution of ownership remains important. A high price does not guarantee security if a small number of participants already control most of the supply. However, a severe decline in demand can still reduce the economic cost of acquiring influence. Demand also affects node compensation. Operators incur expenses in goods and services priced outside the network, including hardware, energy, connectivity and labour. They must be able to exchange their rewards for enough purchasing power to cover these costs. If the coin loses value rapidly, an unchanged nominal reward may no longer be sufficient. Operators may leave or increase the rate at which they sell their rewards, placing additional pressure on the market. If the coin contributes to governance, its value affects the cost of purchasing voting influence. A low market value may make governance capture easier, while concentrated ownership may allow existing holders to exercise disproportionate control. Demand also affects treasury funding. A treasury can hold a large nominal number of coins while possessing limited real purchasing power. If funded contributors immediately sell the coins they receive, treasury expenditure can add further sell pressure. The coin therefore needs enough sustained demand to support consensus, operation, governance and funding. ## **Physical and digital monetary demand** Demurrage affects digital assets differently from physical money because digital exchange is fast and can be automated. A person paid in physical money may retain it for some time before finding another participant and arranging an exchange. Holding multiple physical currencies is inconvenient, and converting between them may require travel or an intermediary. Digital assets can be exchanged from almost anywhere. A wallet can receive the network coin and automatically convert it into another asset within the same transaction sequence. Users can also receive information about prices and accepted assets immediately. They can minimise their network-coin balance and purchase only the amount required for an upcoming transaction. This flexibility strengthens competition between assets. A user can compare the demurrage rate, expected appreciation, liquidity and risk of the network coin with the properties of many tokens. A carrying charge that would produce gradual behavioural change in a physical system may produce rapid digital conversion. The network must therefore provide compelling reasons for users to maintain longer-term exposure to its coin. ## **Transaction demand is short-term demand** Transaction fees create a basic source of demand. Users need the network coin when they submit transactions or compensate the network for resource use. However, this demand may exist only at the moment of use. A participant can purchase the coin, submit the transaction and return any remaining balance to another asset. The problem becomes more significant as networks reduce transaction fees. Lower fees improve access and reduce transaction deadweight loss, but they also reduce the number of coins required for ordinary use. If transaction sponsorship and wallet-level conversion become common, users may not maintain any direct balance at all. Applications can obtain the required coin automatically. Transaction fees therefore provide continuing but potentially shallow demand. They establish that the coin is required by the protocol, but they do not necessarily give users a reason to hold substantial balances over longer periods. The network benefits from secondary uses that create durable demand without encouraging passive storage. ## **Too little demand** If demurrage is high relative to the coin’s benefits, users may avoid holding it. Node operators may exchange rewards immediately, users may maintain only minimal balances and liquidity providers may prefer tokens without a comparable charge. This can produce persistent sell pressure and price volatility. A falling price can then reduce confidence and encourage additional participants to leave. Low demand affects more than investment returns. It can reduce operator participation, weaken consensus security and limit treasury purchasing power. The network cannot solve the problem merely by requiring the coin for fees. If each transaction requires only a very small quantity, the resulting demand may be insufficient to support a high total valuation. Creating artificial scarcity or increasing transaction fees would conflict with the goal of accessible network use. The network instead needs productive functions for which participants voluntarily choose the coin over alternative assets. ## **Too much demand** Excessive demand can create the opposite problem. If the coin appreciates rapidly, holders may expect further gains and remove it from circulation. Financial protocols may offer additional yields that make accumulation even more attractive. The coin can become an investment objective rather than an operational resource. Large holders may increase their positions while users needing the coin for transactions compete over a smaller liquid supply. Price appreciation can support network security in the short term, but it can also increase volatility and ownership concentration. Borrowers face more expensive repayments, and token markets paired with the coin require continuing rebalancing. The network therefore does not want demand at any cost. It wants demand connected to useful activity and broad participation. Balanced demand means the coin retains enough value to support operation and security while remaining available and costly to store without productive use. ## **Idle coins** Coins held idle provide limited direct utility to the network. They do not support token exchange, become available to borrowers, secure contractual agreements or pay for network resources. Passive holding can support the market price, particularly during the network’s early development. However, a mature network benefits more when longer-term demand is connected to positions that provide security, availability or liquidity. The challenge is to create alternatives that remain attractive after accounting for the demurrage charge and the risks of participation. A holder should be able to reduce the cost of possession by making coins available. However, the resulting incentives should not enable low-risk returns to compound ownership indefinitely. ## **Assessing demand** The network needs information about whether demand for the coin is weakening, stable or becoming excessive. Market price alone is an incomplete measure. A price may rise because of speculation while actual network use declines. It may fall during a temporary market contraction even though long-term use remains strong. Transaction volume is also difficult to interpret. A small number of participants can create many transfers between wallets they control. Low fees make this manipulation inexpensive. Changes in transaction activity can also reflect external events rather than changes in the coin’s desirability. A temporary economic disruption may reduce transactions without indicating a long-term demand problem. Metrics based on optional uses may provide more useful information. The amount of coin voluntarily supplied as financial liquidity or committed as contract collateral indicates whether participants choose the coin when alternatives are available. No single metric is sufficient. The network benefits from examining several measures across longer periods rather than responding to short-term spikes. **Financial liquidity and collateral** The percentage of the coin supply used as financial liquidity can provide insight into demand. Participants are not generally required to use the network coin in exchange or lending protocols. If they voluntarily supply it, they consider the benefits sufficient relative to demurrage, price risk and alternative uses. Contract collateral provides a similar signal. A participant committing the coin to a longer-term agreement demonstrates confidence that it will remain useful and valuable. Lock-up periods can make these measures more durable. Coins deposited for only a few minutes provide less evidence of long-term demand than coins committed for several months. The network could monitor the proportion of supply made available through recognised liquidity and collateral positions. A sustained decline may indicate that the carrying cost is too high or that the coin is losing usefulness relative to alternatives. However, these metrics can also be manipulated. Participants may deposit coins into inactive protocols or contracts they control. The network must distinguish between nominal deposits and positions that provide genuine availability or economic activity. **Token exchange volume** Exchange volume can reveal whether the network coin is being used as a common intermediary for token markets. A growing volume of meaningful exchanges may indicate strong demand for the coin as financial liquidity. However, a participant can generate artificial volume by trading between wallets they control or repeatedly exchanging a token they created. Adding higher fees to make manipulation expensive would reduce market efficiency and discourage legitimate exchange. Volume is therefore better treated as supporting information than as the sole trigger for changing the demurrage rate or coin supply. Measures of liquidity depth, duration and distribution may be more informative than raw transaction counts, although each remains open to some form of manipulation. **Transaction activity and optional use** Comparing transaction-fee demand with optional financial demand can help reveal how the coin is being used. If nearly all demand occurs immediately before transactions, the coin may be functioning only as a temporary access asset. If a meaningful proportion is voluntarily supplied as liquidity, collateral or consensus stake, demand is more durable. Short-term transaction changes should not automatically produce monetary-policy changes. The number of transactions can vary because of economic cycles, application launches, technical disruptions and changes in user behaviour. A network should avoid rapidly altering the demurrage rate in response to noisy or manipulable data. A moving average across several measures is more consistent with predictable policy than reacting to each daily change. **Adjusting the carrying charge** The demurrage rate is one mechanism through which the network can influence demand. Reducing the rate makes the coin more attractive to hold. This may strengthen longer-term demand but weaken the incentive to circulate and disperse ownership. Increasing the rate discourages idle storage and can generate more treasury income, but it may cause users to move into other assets. A variable rate could respond to persistent changes in optional coin use, liquidity and collateral. However, automatic adjustment requires reliable data and rules that cannot be manipulated profitably. Community governance can make the decision instead, but global governance is slower and may become politicised. Large holders have an interest in reducing the charge, while treasury beneficiaries may favour increasing it. A relatively stable rate with infrequent, well-signalled adjustments may offer more predictability than a highly responsive mechanism. ## **Creating demand through useful functions** The strongest source of demand is usefulness. Participants should choose the coin because it performs functions that matter within the network. Transaction fees provide basic demand, while consensus, token-exchange liquidity and contract collateral can provide longer-term reasons to hold or commit the asset. The network can direct demand towards these uses by reducing the carrying charge applied to qualifying positions. This creates an incentive without requiring the protocol to issue additional rewards. For example, an idle balance might pay a higher rate than coins supplied as usable liquidity. The difference compensates the participant for making the asset available. The incentive must be large enough to affect behaviour but not large enough to create an automatic positive return that concentrates ownership. **Network coin charge reductions** A reduction in the network-coin charge is a direct way to encourage productive use. Suppose idle balances are charged 5 per cent annually while coins deposited into recognised liquidity positions are charged 2 per cent. The holder saves three percentage points by providing the coins. The participant may also receive fees generated by the financial protocol. Their total return depends on the charge reduction, protocol income, price changes and the risks of the position. This approach directs activity without creating new coins. The network forgoes part of its demurrage income in return for a contribution to liquidity, availability or security. The base rate should represent the cost of inactivity, while reduced rates recognise useful commitment. The network must define qualifying positions carefully. If any smart contract receives a reduction, participants can create contracts that merely store coins. If every token pairing qualifies, they can create unused tokens and inactive markets. Eligibility should depend on the function provided rather than the technical appearance of activity. **Transaction fee reductions** The network could reduce transaction fees for users who provide liquidity or collateral. This would redirect some demand from fee payments towards longer-term positions. However, its effect is limited when fees are already low. Suppose a user submits one thousand transactions a year at a cost of £0.01 each. Their total annual cost is £10. A 50 per cent discount is worth only £5. The amount the user is willing to commit to receive the discount will therefore be limited. As transaction fees continue falling, the incentive becomes even weaker. Fee reductions may improve the experience of active users, but they are unlikely to generate substantial new demand for the coin. A demurrage-rate reduction can have a larger effect because it applies to the value of the balance rather than to the comparatively small cost of transactions. **Charges on tokens** The network could attempt to strengthen demand for its coin by making tokens more expensive to hold or transfer. It might impose network-level transaction charges on tokens or apply a carrying charge to every token balance. This would reduce the relative advantage of moving out of the network coin, but it would also restrict the freedom of token communities to choose their own policies. A competing network could offer the same technical functionality without imposing the charge. Token issuers and users would then have an incentive to migrate. Tokens do not remove the protocol-level need for the network coin. The coin can generate demand through its own functions without making every other asset less attractive. Network-wide token charges are therefore less aligned with an open and permissionless environment than incentives that improve the usefulness of the native coin. **Transaction priority** The network could give faster or prioritised processing to users who hold or deposit a certain amount of the coin. This creates demand but gives wealthier participants an operational advantage. Users unable to commit substantial balances may receive a slower or less reliable service. Such discrimination conflicts with the goal of broad access. Competing networks can attract users by offering equal processing rules. Transaction priority should reflect resource conditions and transparent fee mechanisms rather than a requirement to maintain large long-term holdings solely for preferential treatment. **Subscription and restricted access** A network could require users to pay a subscription or hold a minimum balance before accessing particular functions. This creates continuing demand, but it disadvantages users with limited resources. It also makes the network less permissionless in practice. Restricting features to liquidity providers creates a similar problem. Wealthier users receive greater access because they can commit more capital. These mechanisms generate demand by limiting service rather than improving the coin’s utility. A competing network can remove the restriction and offer the same technical functionality more broadly. For that reason, subscription and restricted-feature incentives are less compelling than voluntary financial uses. **Governance incentives** Governance participation could be limited to people who provide a specified quantity of financial liquidity. This would create demand but concentrate governance among participants able and willing to commit capital. It could exclude users, developers and node operators whose contributions take other forms. Coin-based governance already carries a risk of wealth concentration. Adding a liquidity threshold can intensify that problem. Providing liquidity may contribute to the network, but it should not necessarily determine whether a participant is permitted to express a view on every network decision. Governance mechanisms should be evaluated according to the legitimacy and security of the decision process rather than used primarily as tools for creating coin demand. **External policies and incentives** Governments and other institutions may create external demand for the network coin. A country might recognise it as acceptable collateral, reduce particular taxes for participants providing network liquidity or require certain digital services to use approved networks. External policies could significantly affect adoption and demand, but they are not controlled by the protocol and may change with political conditions. Different countries may also adopt conflicting approaches. A global network should not depend entirely on external legislation for its economic security. Policy support can supplement demand, but the most reliable sources should arise from functions performed by the network itself. ## **Financial liquidity incentives** Financial liquidity incentives can create longer-term demand while improving the practical utility and availability of the network coin. A position that locks coins without making them available may increase measured demand while reducing access. A useful incentive should connect longer-term commitment with a service provided to other users. The network should also avoid spreading incentives across too many protocols. Fragmented incentives can divide liquidity and make each market less effective. The strongest candidates are functions closely connected to the purpose of a digital-asset network: * Token exchange liquidity, which improves markets for assets hosted on the network. * Single-asset lending, which makes the network coin available to borrowers without requiring exposure to another asset or reliance on cross-asset price oracles. Other financial applications may use the network coin voluntarily, but this does not mean they should all receive a network-level reduction. A detailed comparison is provided on the financial liquidity incentive options page: {% content-ref url="/pages/sWyaRxk8duDtEKVtHe9y" %} [Financial liquidity incentive options](/web3-network-coins/stable-demand-incentives-and-network-effects/financial-liquidity-incentive-options.md) {% endcontent-ref %} ## **Network effects** Network effects occur when a service becomes more valuable as more people use it. A Web3 network may benefit from the adoption of its assets, applications, identities and financial markets. These effects can make it more difficult for a competing network to attract users even when it offers lower costs. Strong network effects can help sustain a demurrage charge because users receive value that is not immediately available elsewhere. However, Web3 networks are open and increasingly interoperable. Assets, applications and data may be copied or moved. Not every form of adoption creates a durable network effect. **Token and user adoption** A network containing many widely used tokens is more useful because users can access a larger range of assets in one place. However, token contracts can be deployed on other networks, and representations of assets can be moved through interoperability mechanisms. Token adoption therefore creates some stickiness but may not prevent migration. A large user population also increases value. Applications prefer networks containing potential users, while users prefer networks containing useful applications. Wallets and automated agents may nevertheless make it easy to interact with several networks. A user does not always need to make a permanent choice. Token and user adoption contribute to network effects, but their strength may weaken as cross-network tools improve. **Application data** Applications can accumulate user histories, settings and other data. This can make continued use more convenient. In a self-sovereign system, users should be able to move their data or use it across different applications. Open-source applications can also be deployed on competing networks. Data belonging to an individual therefore creates limited lock-in if portability works as intended. Group applications may create a stronger effect. A collaboration or communication system is valuable because several people use the same shared state. Moving requires coordination across the group rather than a decision by one person. Even group data may be copied when the application and records are open. The effect is meaningful but not necessarily permanent. **Commerce and identity** A growing number of businesses accepting assets from one network can increase convenience. Users know they can spend their balances across more places. Businesses can also accept the same token on several networks or support multiple forms of money. Commerce adoption does not require exclusivity. Identity credentials and connections can create additional network effects. Users may rely on endorsements, reviews and histories linked to a particular identifier. Self-sovereign credentials should remain portable, but some identifiers and connections may be tied to a particular ledger. Migration can require renewal, coordination and trust in new representations. These effects can increase the cost of moving but are not necessarily strong enough individually to prevent it. **Mediation services** Web3 applications may reduce reliance on central intermediaries, but disputes can still require mediation. A marketplace may use escrow for a purchase while relying on mediators when a buyer and seller disagree about delivery or quality. A large community of trusted mediators can make one network more useful. Their histories and reputations take time to reproduce. Mediators can still participate across several networks, and mediation protocols may be interoperable. The effect contributes to adoption but does not create an absolute barrier to competition. **Financial-liquidity network effects** Financial liquidity is one of the strongest network effects available to a digital-asset network. A market with greater liquidity can process larger exchanges with less slippage. This attracts more users, whose deposits and transactions can deepen the market further. A small competing network may copy the same exchange software but cannot immediately reproduce the existing liquidity. Participants moving individually receive worse prices until enough other liquidity providers move with them. Lock-up periods can strengthen this effect by reducing the speed with which liquidity leaves. Longer commitments also provide more certainty to users relying on the market. The network coin can connect these markets as a common pairing. Its liquidity makes tokens easier to exchange, while the number of token markets increases the usefulness of holding and supplying the coin. This produces a reinforcing relationship between coin demand, token adoption and financial efficiency. ## **Combining network effects** No single adoption factor guarantees that users will remain on a network. Tokens can move, applications can be copied, credentials can be renewed and mediators can operate across multiple systems. The combined effect can nevertheless be significant. A user considering migration may need to account for liquidity, applications, data, identities, business acceptance and social coordination. The more useful services accumulated within one ecosystem, the stronger the reason to continue using it. These network effects should arise from genuine utility rather than deliberate incompatibility. A network that traps assets or data may create short-term retention but weaken trust and invite interoperable competitors. Financial liquidity is especially compelling because its efficiency results naturally from scale. ## **Demand and the sustainable demurrage rate** Network effects and productive functions determine how much demurrage the coin can sustain. A network with weak utility cannot impose a high carrying charge without losing users and capital. A network providing deep liquidity, reliable operation and widely used applications may sustain a higher rate because participants continue receiving substantial value. This does not mean the network should charge the highest rate users will tolerate. Excessive charges create an incentive for competitors to copy the technology and offer a cheaper alternative. The sustainable rate must correspond to the benefits produced through circulation, security and treasury expenditure. Demand management is therefore not a matter of making the coin as expensive or desirable as possible. It involves maintaining a stable economic role in which the coin remains valuable, available and productively used. The supply policy and price behaviour of the coin also affect this balance. A fixed supply may produce appreciation that offsets demurrage, while expansion can weaken demand and increase the incentive to move into other assets. ## Most compelling solution for long-term demand Demurrage discourages passive storage, but digital users can rapidly move into alternative assets. Transaction fees alone may therefore produce only brief demand at the moment of network use. The network needs sustained demand to support consensus security, node compensation, governance and treasury purchasing power. However, it should not pursue demand in ways that restrict access, privilege wealthy users or turn the coin primarily into a speculative asset. The strongest source of demand is useful functionality. Reducing the carrying charge for qualifying positions can encourage holders to make coins available without issuing additional rewards. Financial liquidity is particularly compelling because it can: * Create longer-term demand * Improve access to the network coin * Increase the efficiency of token markets * Support lending and other productive activities * Strengthen network effects through deeper liquidity Token exchange and single-asset lending are the leading candidates for network-level incentives.