Stable demand for network money

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 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 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 network coin 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 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 that help to maintain stable demand for network money will likely play an important role in these emerging Web3 networks. 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 rate of demurrage that incentivises ongoing coin 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 same 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 take advantage of 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 and attack the network. When the network money is a big contributing factor towards the security of the network, the ongoing demand for network money is of high importance.

Too much demand for network money

Network money that has too much demand causes the issue of higher storability. People could become incentivised to hold and leave network money idle in their wallets due to ongoing price appreciation or income potential. A demand balance for network money needs to be struck with the other token based assets in the network. Network money 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 money would be increasing in price when compared to external currencies and assets. Network money needs to have enough demand that people want to use it for other use cases such as financial collateral. Network money also wants to avoid being in too much demand so that it doesn’t become increasingly storable, which can result in hoarding, stagnation and concentrations of wealth over time. Getting the rate of demurrage right to balance the demand for network money with other token based assets in the ecosystem will need to be an ongoing focus and concern.

Short term demand for network money

The problem with transaction fee based demand is it is only short term demand. The demand for 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 network money so that the price remains more stable. Incentives to improve demand are also important due to the fact that demand for transactions can drastically fluctuate over time.

Loss of taxation value

Low demand for the network money is also problematic for limiting the value of any income that’s generated for the treasury. The network money could be quickly sold by anyone that receives it from the treasury or that receives it 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.

Assessing the demand for network money

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

• Total financial liquidity deposited - If people are depositing more network money as financial liquidity this could indicate there is more demand for network money due to it being used as a form of financial collateral. This could be a defensible approach for determining overall demand and influencing the demurrage rate if it takes an average over the previous weeks or months rather than responding too quickly to any recent changes. One concern with this approach is how people could deposit liquidity with fake token pairings that no one uses or that has fake volume.

• Token exchange volume - Network money is highly suitable as a collateral pairing with other tokens as exchange liquidity. The volume of swap transactions that use network money against other pairings that don’t could be highly insightful information to understand the demand for network money. Similar to financial liquidity deposits, when using exchange volume, it would likely need to be based on a rolling average to prevent an attacker from easily being able to manipulate the data using fake exchange volume. Long term trends of token exchange volume could be highly insightful for understanding the overall demand for network money.

• Transactions vs liquidity usage - Comparing network money usage for transaction fees against its usage as financial liquidity can help to show demand increasing or decreasing for financial use cases. Users have to use network money for paying for transactions, but they don’t have to use it as financial liquidity. So this ratio could be used to influence the demurrage rate. For instance if the financial liquidity use case for network money was falling over time when compared to its usage for transaction fees the network could respond by dropping the demurrage rate to make it more appealing as a form of financial collateral. The network could try to maintain a balance of demand between usage for transaction fees and its usage as financial liquidity.

• Incentive lock-up duration - Network money could be locked up for a period of time as collateral in financial protocols. This can create more sustained long term demand and can help with reducing price volatility in the short term. If network money is locked up in a token exchange protocol, liquidity cannot be withdrawn suddenly during periods of stress. This helps keep liquidity more stable, making it easier to handle sudden shocks and facilitate smooth swaps. The total amount of network money that is locked up could be an indicator in the demand and trust in network money. A network could try to reach a certain percentage of locked up network money to improve financial market stability and efficiency.

It’s hard to reliably know whether there is a growing or decreasing amount of demand for network money using any of the approaches above. A drop in total transactions does not necessarily mean there is anything wrong with the network or a decreasing demand for network money. External factors like an economic lockdown could be a good example of situations that could cause different usage patterns. Changing the rate of demurrage, such as through a network coin tax, won’t necessarily improve the demand for the network coin in some of these situations. These types of events could make it look like network money is being used more as a form of financial liquidity even though it was just the result of a drop in transaction volume due to an external factor. If this was the case the transaction volume might return to its normal levels later or be suppressed due to these factors for a period of time. Trying to increase or decrease the demand for network money when these situations occur could be problematic and have undesirable knock on effects due to the lack of context the network has about why those changes are actually happening.

Human behaviours and habits might also change over time, such as spending habits or how people bundle transactions together, any changing behaviours could influence the volume of transactions and usage of network money. These changes won’t necessarily mean there is a need to change the rate of demurrage to increase or decrease demand for network money.

It may be the case that changing the rate of demurrage could be one of the most effective ways for increasing and decreasing the demand for network money relative to what else is happening within the network economy. However, this doesn’t mean any of the metrics mentioned above are truly reliable in determining how much demand there is for network money. It is likely that a multi-factorial approach will be necessary to understand overall demand, and this might be difficult to automate into an on-chain solution due to off-chain factors that can influence demand for extended periods of time. A lot of data and trends will be necessary to support any suggested algorithms and implementations to automate changes in the rate of demurrage.

Approaches for creating or redirecting demand for network money

The primary use case for network money 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 network money. A number of incentive mechanisms could be used for creating or redirecting demand towards other use cases that could be more effective at creating longer term demand for network money.

Decrease the network coin tax

Decreasing the network coin tax would simply mean the network is changing from a demurrage based network into a storable based one. This leads to all the problems with adopting storable money so generally this is not desirable. Increasing and decreasing the network coin tax over time can still be an effective way to increase or decrease the demand for network money when necessary. As a small amount of the network coin tax would likely be charged each day the impact from these changes would be felt very quickly.

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 new demand for network money beyond the existing transaction demand. However it could be effective at creating longer term demand for network money, as the liquidity could 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. For instance, 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 network money 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.

These approaches are unnecessary as having other forms of money on the network does not compromise the need for network money - as it is always needed for transaction fees. Network money 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 be storable and 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 tokens.

Network coin tax reduction incentive

Users could pay a higher network coin tax amount by default when they are holding network money in their wallet. This network coin 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 usage of network money.

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 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 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 can be 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. There might be a number of other external approaches that might exist that should be considered.

Financial liquidity approaches

Incentive mechanisms such as the transaction fee reduction incentive or a network coin tax reduction incentive appear to be some of the more 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 be effective at ensuring that network money would be used more productively. The incentives could also 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 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 incentives for creating longer term demand for network money whilst also ensuring that network money is being used as productively as possible. You can review the full comparison between the different financial protocol incentives here:

Financial liquidity incentive options

Most promising solutions

A digital asset network can highly benefit from network money being used for transaction fees, as token exchange liquidity and as liquidity in a borrowing and lending protocol. Token exchanges are a very important protocol for digital asset networks. Single asset lending and borrowing protocols are also important for enabling people to lend network money in a risk free way. These three use cases can help with creating an environment that enables the productive use of network money. Increased financial liquidity should also help with creating more effective network effects for a digital asset network. Idle and unproductive network money is one of the least desirable outcomes for any digital asset network. Financial liquidity incentives can help with reducing and minimising this issue of idle and unproductive network money.

Decreasing the network coin 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 policies, initiatives and incentives may also be possible and important for increasing the amount of demand for network money by encouraging people to use certain networks over others. It is not clear at this stage whether external initiatives would ever be reliable enough in practice. 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.