Creating stable demand for network money

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

Physical money vs digital money

Physical money, like gold, coins and banknotes have different characteristics when compared to digital money. Physical money means people would need to exchange or invest their money in person with other people. 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 more inconvenient to hold multiple forms of physical money to conduct exchange. So the issue around creating demand for a demurrage physical money is less problematic than it is with digital money.

Digital money is entirely different. With digital money, people can find out about goods and services online and find out the prices immediately and what forms of money the seller accepts. The buyer can exchange the money they have for something else almost instantaneously. Systems could also 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 would create an incentive for these solutions to be developed that can handle this for you. People are incentivised to hold other assets if the money they are holding is losing value. And with digital money, anyone is able to do this in a multitude of ways. People may still use the money to exchange and invest in businesses but they would only want to hold that money at the exact moment they are going to perform those actions. Outside of this they would likely prefer to hold something that will appreciate in value or retain its value like a digital gold representation or another similar type of asset.

Web3 money is programmable. The networks are increasingly becoming cheaper and faster. Introducing a wealth tax would create an incentive for people to avoid holding the network money until it was absolutely necessary to use it. This could create an ongoing amount of sell pressure for the network money due to this incentive to quickly exchange it. If no one wants to hold network money this could limit its price potential and overall value. 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 money could put the security of the network at risk as it is the network coin that is often used to influence governance and funding decisions in the network. Many of the assets and pieces of functionality that get built on top of the network could be highly valuable. Network money that has minimal demand could increase the opportunity for someone to quickly attain a large amount of that network money and then attempt to maliciously attack the network.

Introducing incentives will likely play an important role in maintaining stable demand for network money. In the later growth 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 money whilst also maintaining a sufficient threshold of demurrage that can incentivise enough money velocity.

Undesirable outcomes

Idle network money

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

Little demand for the network money

Only implementing a solution for demurrage could result in an ongoing amount of sell pressure. If the network money is used for network governance and funding decisions it will be important that enough demand exists for the network's money as otherwise it will be easier to accumulate network money and then maliciously influence or attack the network.

Short term demand for network money

The problem with transaction fee based demand is it is only short term demand. The demand for the money only happens at the point of the transaction and 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 money so that the price can remain more stable. Stable demand is also important as the demand for transactions could drastically change over time.

Loss of taxation value

Low demand for the network money is also problematic for limiting the value of any income that is generated for the treasury. The network money could be quickly sold by anyone that receives it from the treasury or from anyone else. This could make it more difficult to fund meaningful initiatives if the value of the network money is always suppressed due to constant sell pressure.

Approaches for creating or redirecting demand for network money

A problem with the transaction fee use case is it doesn’t generate sustained long term demand for network money. A number of incentive mechanisms could be used for creating or redirecting demand towards other use cases that are more effective at creating long term demand for network money.

Decrease the wealth tax

Decreasing the wealth tax would simply mean the network is changing from a demurrage based network to a hoardable one. This leads to all the problems with adopting hoardable money so we’re actively trying to minimise the need to reduce the wealth tax.

Transaction fee reduction incentive

Users could pay a higher transaction fee by default. An incentive that could generate longer term demand for the network money would be one that encourages people to deposit network money as financial liquidity. If they do this they could then receive cheaper transaction fees. This incentive would be useful for transferring demand from transaction fees into financial protocols as liquidity. It would not likely create much or any new demand for the network money beyond the existing transaction demand. However it could be effective at creating more long term demand for network money if the liquidity had any lock-up period based incentives.

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. For instance, the incentive could be to deposit $4 worth of liquidity to then receive the half price reduction in transaction fees that would give them $5 worth of value.

Token asset transaction fees or token asset wealth taxes

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

These approaches are unnecessary as having other forms of money on the network does not compromise the need for network money that is always needed for transaction fees. It is also very well suited for being used as financial liquidity. If demurrage was forced upon all assets in the network it would mean that no asset could have the store of value property. This would make other networks much more appealing and competitive as they could simply give the users this optionality around adopting the properties they want for their token assets.

Wealth tax reduction incentive

Users could pay a higher wealth tax amount by default when they are holding network money in their wallet. This wealth tax could then be reduced if they deposit the money as financial liquidity. This is desirable as it means that unproductive money is now being used productively. One of the worst outcomes for network money is that it is sat idle and not being used productively for things like financial liquidity or for transaction fees. This would help with increasing the productive use of network money.

Transaction speed reduction incentive

Users that deposit financial liquidity could benefit from prioritised transactions. This 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 incentive would likely require some 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. Poor users would have an incentive to adopt other networks.

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 that amount of liquidity.

Treasury participation incentive

The ability to participate in treasury decisions could be determined by whether someone has deposited a certain amount of financial liquidity or not. This is problematic as other people will still be contributing towards the network's treasury through fees and taxes yet they might not get to influence how their money is going to be used. Poor users would be forced to let other people make decisions about how their own tax contributions are being spent.

External initiatives & incentives

A number of different 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 incentivises the use of approved networks such as those that adopt a certain percentage of wealth tax to properly simulate demurrage. It is difficult to enforce these types of solutions properly as the network is global and each country competes with one another. So if these initiatives created a reason for people to move to another country it could create an incentive to not adopt these kinds of ideas in the first place. Although these example ideas might not be hugely compelling they might still be somewhat effective. There might also be other external incentive approaches that haven’t been identified and considered.

Financial liquidity approaches

Incentive mechanisms such as the transaction fee reduction incentive or a wealth tax reduction incentive were some of the most compelling approaches for transferring demand from using network money for transaction fees or as a store of value and redirecting it towards demand for using network money as financial liquidity. These incentives should help to ensure that network money would be used more productively and also these incentives could include lock-up periods to create longer term demand.

Network money could be deposited as liquidity across many decentralised finance protocols. A digital asset network needs to incentivise the most important use cases that are most aligned with making the network highly effective for creating, maintaining, using and exchanging token based digital assets.

A token asset exchange liquidity incentive currently appears to be the most compelling financial liquidity incentive for creating longer term demand for network money whilst also ensuring that the money is used as productively as possible. You can review the full comparison between the different types of financial protocol here:

Financial liquidity incentive options

Most promising approaches

A digital asset network benefits from network money being used for transaction fees and as token asset exchange liquidity. These two use cases are highly valuable for the network as they are highly productive use cases for network money. Increased financial liquidity could represent an effective network effect for a digital asset network. Idle and unproductive network money is one of the least desirable outcomes for these networks. Financial liquidity incentives should help with reducing and minimising this issue of idle network money.

Decreasing the wealth tax and reducing transaction fees for people that deposit network money as financial liquidity were the two most compelling ways to redirect existing demand for network money into demand for increasing the amount of deposited financial liquidity.

Many of the other approaches for redirecting or creating demand for network money were not as 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 give wealthier users a huge advantage.

External initiatives and incentives may also be possible for increasing the amount of demand for network money. However it is not clear whether these ideas would ever be reliable enough. It is more desirable for any incentive mechanism to be handled by the network itself as this is going to be more predictable and reliable over the long term.