Demurrage risks & challenges

Implementing demurrage in a Web3 ecosystem does have its risks and challenges. The most compelling one we’ve identified so far is the challenge around maintaining a sufficiently high wealth tax.

Difficulty sustaining a wealth tax that is above the operational costs 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 wealth taxes. The problem with this is it would likely mean that the impact of demurrage would be reduced and the hoardability of the money could become an issue again. A 0.1% wealth tax would be much less effective than a 3% tax for preventing the hoarding of network money. Wealth can more easily concentrate and be hoarded when the wealth tax is reduced. Collectively it is beneficial to keep the wealth tax sufficiently high to prevent this. Individually it would still be beneficial to find the cheapest and most lucrative way to store wealth and transact.

Counter arguments

Network effects will play a big role in retaining users over the long term. The most compelling solution for resolving the challenge of sustaining a high wealth tax is to maximise the amount of liquidity in the network to create increasingly efficient markets. Creating efficient markets is hard to duplicate when capital is already available and deployed in one network. How effective any network effects are over the long term will influence how high the wealth tax could remain.

Difficulty attracting initial capital

Implementing demurrage into a Web3 ecosystem could result in an increased difficulty in attracting capital investment. People that invest would immediately start losing portions of their wealth 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 money would be rewarded by being able to benefit from no wealth 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 wealth tax to simulate demurrage that can also help with funding ongoing initiatives. During a growth phase the holder of the network money could benefit from ongoing price appreciation that outpaces any loss from the wealth tax.

It is only in the late stages of the ecosystem where the impact of demurrage will have the desired effect of preventing coin hoarding. Approaches such as financial liquidity incentives would then likely be useful for generating more long term demand for the network money.

Treasury influence risks

The wealth 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. If the wealth tax from demurrage results in a suppressed coin value it could become easier to capture enough influence in the network. If someone can accumulate more than they lose from the funding process they might be able to perpetually increase their wealth through the funding process.

Counter arguments

This is a potential risk for the network to consider, especially as the network money will likely be hoardable in the growth phase due to price appreciation. One way this risk of growing influence could be reduced is by allowing the founding entities 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 by making sure that funding isn’t distributed as a lump sum to a single address. Paying contributors 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 would become increasingly problematic due to the loss from demurrage.

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 money does not need to compete to be the most desirable medium of exchange. It could solely focus on being used for paying for node operation and as financial liquidity. 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 could 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 money. A Web3 ecosystem only needs a moderately sized community to endorse this approach for the ecosystem to demonstrate the potential of a wealth tax that simulates demurrage.

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 is provably generating a great return on investment for people that are investing into a demurrage based money it will make it much easier for them to accept that approach for the system of money whilst the network is scaling up.

In the later stages of the network the incentives change as it will no longer be profitable to hold the network money as an investment. This is highly desirable at this stage as the wider community needs ongoing access to this money to use the network. The users don’t need to adopt the network money as a medium of exchange. They only need to use it to pay for transactions or when they are incentivised to use it such as for financial liquidity incentives.

Network money does not need to be concerned with whether people want to hold or use the money for different purposes beyond its core responsibilities. Network money can focus on being widely available to pay for node operation and being widely used for financial liquidity 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. Users are also able to create their own token based moneys and adopt them as their medium of exchange whenever they want to.