Web3 Incentives Are Misaligned
The power and promise of web3 comes from user ownership & advocacy. Individuals become more than just “users,” and their participation is usually rewarded by economic stake. But not all incentives are the same, and misalignments are common.
This topic was one of many discussed with Carl Hua, CTO and Investment Partner of Shima Capital in the context of staking — watch here.
“Not a Ponzi”
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Early DeFi staking programs were a mess. Beautifully astronomical four-digit APRs promised lofty riches if only you’d lock in your tokens and promise to not sell them for a year. Everyone was getting rich, on paper.
The problem, which is native to all pseudo-Ponzi social experiments, was that as soon as that one-year lock period is over and everyone tries to sell, the buyer of last resort vanishes, and your paper gains are now very real physical losses. These staking programs, wherein users are asked to not sell some token today in return for the promise of more tokens gained tomorrow, overwhelming prey upon 1) murky deception around real value accrual to the base currency, intentional or not, 2) misunderstanding the real rate of inflation of sovereign digital assets, 3) and retail’s confusion around the fundamental difference between instantaneously compounding APR and APY. Big number go up, right?
The result was a status quo where user & retail incentives were hilariously misaligned with project founders and seed investors.
We Had Good Intentions, Promise
But it’s not an insurmountable problem. Staking is grounded in a philosophically sound argument. The original variant of staking, consensus staking to support a blockchain, involved participants actually putting staked assets at risk to validate transactions, and earning yield in return for that very important operation. The “big line go up” free money staking that DeFi adopted shortly thereafter was not originally prescribed.
I’ve written at length before about the different types of staking, and I won’t belabor those points here. Instead, let’s chat solutions and incentive plans broadly across web3, and what builders and investors should be considering.
Incentives With Purpose
You Work for World of Warcraft?
As a thought experiment, imagine a world where instead of paying World of Warcraft a monthly subscription fee in USD, you would instead purchase World of Warcraft tokens & stake (promise to not sell) them for a period of years. Let’s also posit that if you were to stake enough, you could run nodes¹ to operate some critical computational functions of the World of Warcraft game distribution network and receive some reward for that.
And, finally, let’s assume that you could sell those extra reward tokens to other users for premium features on the World of Warcraft platform.
Weird? Definitely. But not impossible. Users in this hypothetical scenario would be part-time owners of the platforms they use, both likely helping to improve the native KPIs (e.g. game data streamed & daily active users) as well as actually running the fundamental infrastructure behind the systems, which may reduce operational costs. World of Warcraft itself would obviously have some revenue gymnastics to perform, as they’d need to liquidate their own tokens in the open market to convert between their sovereign currency & the globally accepted fiat rails.
The jury’s still out on if this is even a valid approach. We have no long-running presentable examples to-date. But the thought experiment in itself should highlight the level of creativity available to builders in the space. These models aren’t proven, and I can’t promise that they’re going to work. There’s no guarantee that the alternate-universe World of Warcraft above will be able to capture revenue by liquidating tokens. And World of Warcraft could be hamstrung if its token price nosedives.² But the upside here is immense. An endless flywheel driven by user adoption, advocacy, and recruitment where your clients become your biggest fans and, in a sense, employees.
The Value of You
When Votes Are Bought and Sold
Another notable future incentive structure could rely on the active liquidity of votable representation or participation. Specifically, if you’re a tokenholder and you’ve staked your tokens, you could receive a certain number of “votes” which may be able to be sold as you see fit. This was popularized largely by Curve Finance, where users vote to assign higher reward distributions to certain pools of assets. In conjunction with Convex Finance (which essentially made user votes tradeable), this resulted in a historic period known as the “Curve Wars” in which advocates of certain token assets bought votes and jockeyed to secure higher positions on the reward totem pole for their favorite projects.
This implementation promotes better alignment between the users and the core project itself than something like single-sided emission-only staking, inasmuch that participating in voting on a platform should, at the very least, support governance KPIs and ostensibly lead to a more robust set of product features.
But as benign as user voting is, even this incentive scheme occasionally resulted in perceived “governance attacks,” in which project contributors ultimately halted certain reward functions due to a series of complex and pseudo-exploitative loops executed by savvy users around levering up their voting power. Tough draw.
Building Forward
There’s no clear-cut panacea around web3 incentives at large. Each has a number of edge cases that make for juicy targets in the eye of mercenary capital. But that doesn’t mean we should default to the status quo, or stop building creative systems to push user and protocol alignment.
The promise of a reproducible flywheel of user advocacy, ownership, and adoption is too strong to give up on, and I fully expect the next year to bring a slew of new vectors to align incentives with real user activity. I’ll certainly be participating.
¹Nodes are essentially computer programs (sometimes also hardware) that perform some rote functionality at the base layer of a protocol, often consensus or data distribution.
²Though, notably, having platform pricing schemes pegged to stablecoin values (e.g. “this always costs $800 USD, which is a floating number of World of Warcraft tokens”) is one way of dealing with this.
Sam is the CEO of Playground Labs, a web3 protocol dev organization, and Partner & Head of Interactive at Hivemind Capital, a crypto-focused multi-strategy fund. Follow him on Twitter.
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