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Placeholder Partners: Token destruction model is obsolete, DeFi needs a new approach

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Instead of burning tokens, consider more creative ways to recycle the money.

Original title: "Placeholder Partners: Token Destruction Model Obsolete, DeFi Needs New Approach"

Source: Babbitt

In most "repo and destroy" scrip models, networks generate revenue from a single currency scrip and use the proceeds to buy back and "burn" their own scrip. The aim was to increase the value of the scrip by reducing its supply as income grew. In practice, "buy-backs" tend to achieve this goal, but "destruction" affects money and capital assets in different ways. When it comes to money, reducing supply can increase the unit value of money, but when it comes to capital assets such as governance tokens, issuance can be key to capitalization, and destruction can hinder the growth of the underlying value.

First, we will clarify whether tokens are money or capital. We will then study the buyback and destruction of the components and consider their consequences. Finally, we will outline an alternative "buyback-and-make" model that preserves the benefits of buy-backs without the drawbacks of destroying capital.

Money and capital tokens

When an asset's value comes from exchange: when it is used to consume goods or services (such as dollars), it is money. ETH, for example, is a currency because you can use it to consume Ethereum services, and you can use it to buy other assets. On the other hand, when an asset's value comes from governance or equity participation in a pool of resources, it is capital. For example, company shares are basically voting instruments that control the distribution of power and profits.

When a network generates income in a currency and reallocates its value in any way to its scrip holders, we know that it is a capital asset because its basic value comes from these flows. MKR and ZRX are good examples: both generate revenue from ETH and redistribute value to their (governance) token holders. Maker USES a buy and destroy model, while 0X is a prorated redistribution of ETH to users and market makers who pledge ZRX over the Internet. But both tokens are capital assets whose value comes from the flow of money.

Assets can be money or capital -- think of cryptographic network governance as capital. ETH 2.0 will be converted to money and capital assets in the transition to proof of equity.)

How does the buyback work

With these differences in mind, let's talk about buybacks. In the stock market, buybacks are a popular way for large companies to boost their share prices by buying their own shares in the market. Share repurchase plays a role by increasing the participation of outstanding shareholders in the capital of the organization. However, buybacks do not automatically destroy themselves. By default, they continue to be held by companies as stock shares. Unlike tradable shares, inventory shares cannot vote or participate in organized economic activity. Both are cyclical: there is no point in dividing the profits among yourself, and you cannot buy what you already have.

By reducing the number of shares outstanding, buybacks increase the specific valuation ratio of all remaining outstanding shareholders in the market (e.g., earnings per share). That justifies paying a higher price per share. But actually destroying stock after a buyback is not economically useful. Buybacks alone can do all the work, because prices are affected by how many shares participate, not how many shares exist, and inventory stocks are not.

From a governance point of view, destruction does guarantee that these particular shares will never be issued again. But the people who have the right to burn stock are usually the ones who have the right to issue new shares. For example, Maker burns MKR when it earns revenue, but in the event of a solvency emergency, such as March 2020, it can issue a new MKR. What ultimately controls the supply of tokens is the governance agreement and the social contract between stakeholders, so destruction does not actually guarantee against dilution.

Crucially, the removal of capital units from circulation has been achieved by increasing the participation rate of good stakeholders, not because assets have become "scarce" or necessarily because the total value of equity has increased. Reducing the number of shares may boost share prices, but it won't change the value of the whole system. The same is true for tokens of capital in encrypted networks: buybacks do have a positive effect on prices, but destruction does not create new value, it only redistributes current value among a smaller group of people. There is a reason why companies that do a lot of buybacks are associated with low growth.

Issuance, capitalization and growth

Many cryptocurrency cultures associate "inflation" with value erosion. In the monetary world, this may be true. Note, however, that inflation and deflation are monetary concepts that do not really translate into the capital world, where the issuance of participating shares is the key to capitalizing the equity capital of the system. Issuance is the cheapest way to obtain capital to fuel growth. For example, in a start-up, how entrepreneurs can pool human and financial capital (talent and money) at a lower cost.

Issuing capital equity is how you get the resources you need to scale up. For more decentralized systems like DAOs and protocols, they work the same way. We know that tokens can be used to compensate various participants in an encrypted network who contribute different kinds of capital: the work of producers, the continuing operations of users, the capital and liquidity of investors. In all cases, issuance helps to increase the fundamental value by increasing the capital of the system, which in turn translates into better token prices.

That is why tools such as mining, equity certificates and liquidity incentives can be so effective. In DeFi's new world of liquidity mining, the effect is obvious: deals that reward users in exchange for system capitalization through the provision of liquidity (e.g., Compound, Balancer) are growing much faster than deals without such capital incentives (e.g., Maker). Of course, the basic concept can be traced back to Bitcoin itself, and even to the invention of joint-stock companies as sharing organizations. Dilution can be used to buy growth as long as the value of the stock grows faster than the rate at which it is issued. As the value of equity rises, the cost of dilution to obtain more capital becomes lower and lower.

This is not to say that there can be no growth without issuance, but that there will be no incentive to continue capitalizing the system without any new issuance. As a token holder, if there is some dilution, it is more likely to increase than if there is no dilution. Adding incentives is even worse, because you're increasing the participation of token holders without requiring them to invest more. And, as long as the price of tokens doesn't immediately grow at the same rate as destruction (which is most of the time), destruction actually reduces the overall market value of the network.

Over time, reducing the supply of shares or tokens discourages capitalisation, just as deflationary money discourages consumption. Moreover, if the rate of destruction exceeds the rate of fundamental growth, you run the risk of excessive concentration of ownership leading to a reduction in systemic capital, at the expense of liquidity and long-term value. The benefits of smart publishing go beyond scarcity. For example, you could reissue inventory assets to continually stimulate productive capital, resell them to raise financial capital, or even use them as collateral for credit. We have to overcome the notion that increasing scarcity necessarily means more value. So instead of burning the tokens, think of more creative ways to recycle the money.

Buybacks and market making

To summarize our view, buybacks are a good way to socialize profits to token holders, but destruction limits the network's ability to reinvest itself. Buyback and Make is an alternative that USES automated market makers to preserve the financial benefits of buybacks and issues without the disadvantage of "burning" them or permanently increasing the supply of tokens. This can be done through a protocol library that ACTS as a net-owned Balancer "smart pool" that can be used as an automatic repurchase machine, a token issuing pool, and a liquidity provider.

This is a similar setup to the crypto economic circle. The protocol/DAO intelligent contract coordinates production and standardizes the exchange of production and financial capital between producers and consumers. Producers put work and resources (productive capital) into the network under distribution agreements in exchange for capital tokens. Users consume and pay for network services by spending a certain currency or token of fees. We have added a smart vault that is implemented as a Balancer pool controlled by the protocol/DAO contract. From now on, assume that our network revenue is ETH and our token name is TKN.

Balancer is a programmable liquidity protocol and decentralized exchange. First, it allows you to create a pool of assets of up to eight tokens, and you can choose the weights of the assets according to your requirements. In our case, we have chosen 10% ETH (our currency token) and 90% TKN (our capital token). We also configured the asset pool so that only controllers (that is, protocols) could add and remove liquidity from the pool, and assumed that we produced a maximum total supply of 10 million TKN and placed it in the pool with some ETH. Our new Balancer network vault pool can perform a number of operations:

1. Automatic repurchase machine. By pooling all (or part) of the ETH revenue generated. Whenever the ETH value in the network Treasury exceeds 10% index, our Balancer pool will automatically seek to balance by selling TKN's excess ETH in the open market until the 90/10 index recovers. Since the only other token in our pool is TKN, the only way to restore balance is to buy TKN from the market (or add new TKN to the pool). If there is no seller, the pool will respond at a higher TKN price. Since our pools are owned by the network, this process is equivalent to a buyback - and has the same positive effect on price. Buybacks occur in real time as revenue flows into the network and into the smart Treasury, and are automatically managed by the Balancer agreement. This is more efficient because it eliminates the need for core developers to maintain complex buyback and destroy code, and also eliminates the need for special "keeper" robots and incentives to provide needed liquidity for buyback and destroy operations. Balancer, an existing arbitrager in the market, was offering it for free in real time, which greatly simplified the deal.

2. Token issuing pool. An agreement with an incentive to issue either new tokens as capital enters the network or a certain number of tokens are minted in a single event and then distributed according to the issue schedule. Our model USES a pre-coinage method (although there is nothing to prevent a hybrid approach), and the amount of tokens to be distributed from the start is stored in the smart vault. Since only contract agreements can increase or decrease liquidity in the pool, the network can earn the TKN rewards it needs by simply withdrawing it from the smart vault. As with any other approach, the distribution model of the network can be executed through an intelligent contract.

Benefit: The reverse operation of the buyback operation allows the smart vault to be used as an automatic capitalization machine. Just as adding the ETH (or any token of expenses) to the pool triggers an automatic buyback, the economic effect of withdrawing money is the same as that of issuing TKN from a vault and selling it for money. If necessary, you can use this feature to continuously raise funds for spending. For example, daOs could draw money to pay for development costs, or agreements could use the balance of scrip in the vault as an "insurance fund" backed by online scrip. This is useful for agreements that use tokens as insurance of last resort (such as Maker's MKR "), but again do not require special Keeper or auctions to ensure that tokens are minted and sold at the correct market price -- Balancer offers these guarantees for free.

3. Liquidity provider. Finally, our smart vaults can also act as liquidity providers. Since assets in the Balancer pool are also available through its decentralized exchanges, this means that TKN buyers and sellers are assured of liquidity, as they can always trade with the agreement itself - scrip holders have certainty about the economic value of these trades. Balancer enabled us to customize the economic parameters of the pool to adjust the liquidity provided by the pool. Such as:

(1) Pool assets: Balancer allows you to hold up to 8 assets in a pool. In our case, we have only TKN and ETH. But if your network supports multiple tokens (such as ETH plus various stabilisation COINS), you can increase or remove the liquidity of TKN and other tokens by changing the index. For example, you could set the asset pool to 80 per cent TKN, 10 per cent ETH and 10 per cent Dai, and then deposit any form of income into the pool. It also means you can make market TKN and multiple assets.

(2) Pool index: The key innovation of Balancer lies in its ability to maintain a set index. In our example, this allows us to create an asset pool of 80-90% TKN and 10-20% scrip. But you can easily change the ratio to any weight. This will affect the overall liquidity of TKN in the pool. In general, a higher proportion of TKN will increase its sliding point, making the price of TKN more sensitive to changes in its supply and demand, thus making transactions against the pool more expensive.

(3) Transaction fees: For the benefit of the Treasury, we can set our asset pool to charge transaction fees of up to 10%. This allows us to program the market premium for buying or selling tokens. Changes in transaction costs have made the vault pool more or less competitive in the marketplace. If you want to block buyers to protect the TKN balance of the network, you will have to pay a higher fee.

These parameters can be set and permanently fixed, programmed through an intelligent contract, or updated through A DAO vote, depending on the requirements of each network. Essentially, you can program how much liquidity the network provides to the market. The more liquidity you want to create, the cheaper you will be to trade in the pool -- for example, by increasing the proportion of currency tokens to reduce slippage, and by reducing transaction costs.

The ability to change these Settings through THE DAO allows the network to simply vote on changes to these Balancer Settings to influence the economy of its tokens in response to market conditions. For example, in a bull market, it may be necessary to increase the balance of TKN reserves in the pool, as well as transaction fees, to accumulate more TKN for the vault. In a bear market, TKN liquidity may be more important to network health - and then it would be more useful to reduce trading costs. This is not very different from how central Banks manage the economic cycle.

The Upside: Like automatic buyback and capitalization, our smart vault is also useful for clearing shares or collateral in a network. Here, protocols like MakerDAO rely on Keeper bots and incentive mechanisms to manage clearing, while using Balancer pools offers the same functionality for free.

To sum up, this is "buy back and make a market" in the source of the "make". Now, we have some very interesting solutions, rather than to burn scrip. On the one hand, as the reward tokens, release, the agreement will TKN is put forward from the intelligent vault. On the other hand, with the increase of network utilization, any excess revenue in entering the pool will automatically for automatic repo TKN and to fill the pond. They no longer burn the buyback tokens, but according to reissue the same incentive mode. Buy back and make a market not like destruction of damage value. In addition, Balancer offers a number of features that greatly simplify code, protocol, and mechanism design.

What I like most about the model, however, is that it allows us to create a permanent incentive model while maintaining the maximum supply of tokens. During the boot phase of the network, the TKN leaving the repurchase pool may be more than the TKN brought by the repurchase. But as the network matured, TKN found a balance between incoming and outgoing. By recycling the returned tokens into constant returns and liquidity, we ensure that there is always an incentive to continually capitalise the system. This is great because it allows the network to always take advantage of the benefits of issuance, while maintaining the economic benefits of buy-backs and the certainty of the largest known supply of tokens.