The demand side of tokenomics
breaking down demand, demand influencing factors and market analysis
Tokenomics play a crucial role in most projects. They have a considerable impact on the price of a project and ideally should have a strong connection to the value creation within the project.
When evaluating tokenomics, we look at both supply and demand. Similar to analysing a country's economy, this includes what drives demand i.e. who wants to buy and what drives supply i.e. who wants to sell. The supply-side design of tokenomics is a well-covered topic - we recommend Nat’s article and Alex’s introduction to tokenomics for further reading. The demand-side of tokenomics, however, is a topic not quite as well covered, so we want to explore it in this article.
Why demand is important
While the supply-side of tokenomics matters, a token’s price collapses if no one wants to buy it. After all it needs two parties to make a sale; a buyer and a seller. If there is no demand for buying the token the abundance of sellers will drive the price down. A plummeting price would quickly lead to an unsatisfying project outcome.
Many protocols misdesign the demand side, paying too little attention to the incentive function of the token. The incentive function can be seen as the function that drives demand or incentivises people to buy and ideally hold the token. It is often tied to some utility the token might have such as governance, yields or access to some type of service. Curve’s veCRV lets you vote on protocol decisions, xSushi gives yields from Sushiswap and LINK lets you use Chainlinks oracle services.
A demand-side analysis, helps identifying possible failures within a tokens design and enables builders or investors to spot loopholes and make better decisions.
Buying point analysis
We start by asking a simple question: what do people buy a token for? Do they buy for the utility or for speculation? Do they believe in some function of the token or do they think the price will increase and they will find someone to sell it for a profit. Going forward, we’ll call this the buying point. People buy BNB to pay the gas fees, CRV for governance participation, and ETH for staking.
Curve, whose unique feature is the low slippage in swapping, is a decentralised exchange (DEX) for stablecoins to swap pairs like USDT - UST or USDC - BUSD.
CRV is the native token, whose main utility is governance. People need to lock CRV to get veCRV to vote on decisions. The most important one is voting on allocation of rewards. Monthly CRV unlocks from the release schedule and the trading fees generated on the platform are distributed to each pool's liquidity provider. Additionally, veCRV holders can vote on proposals and pool parameters.
As CRV’s main utility is governance, the demand for CRV is related to the demand for governance on Curves platform. Joel Monegro’s in governance is capital, says that all forms of capital offer some kind of control over the distribution of economic resources across a group of people – in effect, governance across Curves pool of resources (emphasis added throughout):
Productive and human capital, for example, influence which goods and services are offered in the economy (and thus how income is ultimately distributed), financial capital determines the distribution of purchasing power, and equity capital presides over how a company’s resources are used. Intangible forms of capital also exhibit this quality: political capital, for example, governs the rules of markets, and social capital drives human attention (and thus behaviour).
This insight that governance is capital (and vice versa) leads to the source of its intrinsic value. Whoever has control over a pool of important resources also has the potential to direct some of those resources to their own benefit. So the value of a system’s capital is proportional to the value of the resources it governs.
Considering Joel’s concept, the demand for governance should be related to the governance token's power to change resource allocation. In CRV’s case, this is changing the reward allocation of each pool.
The demand for the CRV token can be interpreted as the demand to change the Curve reward allocation to liquidity providers of each pool. Changing reward allocations certainly benefits liquidity providers most, who, we assume, would try to distribute rewards in their favour and by that increase their own profits.
The demand of liquidity providers to increase their profit is a meta demand. Meta demand is the most basic demand that cannot be divided any further. From the above buying point analysis, we could conclude that people buy the CRV token to increase income.
Meta demand analysis
The meta demand of the CRV token seems fundamentally valid as seeking profits is tied to our human nature. But that’s just a bit of theory.
If Curve’s rewards go to zero, no one will buy the token, and our meta demand is not that valid anymore. Curve will only attract liquidity providers, if it offers a great return on investment and only then will liquidity providers attempt to get as much of the income from trading fees and CRV monthly releases as they can. Only then will there be demand for governance tokens to vote for distribution of rewards.
The combined reward consists of two parts 1) the preset monthly CRV release and 2) the trading fees, which increase with trading volume. There’s not too much that happens on the monthly release side, but the trading volume has a strong impact on the combined reward and therefore our meta demand of having profits (the diagram shows the influencing factors from left to right).
Our analysis shows that trading volume is an essential factor affecting the demand of the CRV token. But what will affect trading volume?
The answer is Curve’s unique selling proposition (USP): low slippage trading of stablecoins, that save traders money. Curve is the first protocol to focus on stablecoins trading, and with that has the network effect of being first. Curve's USP and network effect attract many people to use the platform.
The meta demand for increasing the ROI is thus ultimately influenced by Curves USP, meaning the demand for CRV is backed by the product’s created value i.e., the low slippage that saves people money.
Our described process so far has shown the meta demand and what influences it. The trading volume is influenced by Curve’s USP, so we can see the demand for CRV is related to the project’s unique features. Obviously this is what most products should have: a demand linked to the USP. If you fail to recognise this pattern in a crypto project it should be a red flag to further investigate.
The CRV token has other utilities like staking and boosting that can be analysed in the same way to create a more complete picture of the demand.
Trading volume leads to demand and trading volume, in Curve’s case, comes from the unique offering: low slippage stablecoin trades.
But what if the unique selling proposition of this project is not attractive to users? To answer this question, we need to check Curve’s competitive advantage in the market. We’ll focus on market demand and competitors' situations.
Market demand can be described with the following questions: Is there a market demand for stablecoin swaps? How much is that demand going to grow? What is the trend (up or down) of this market? What might affect the demand of this market?
A factor that could bring this market down is the unlikely possibility that one day only one stablecoin holds the majority of market share. Should this happen, the market demand for swapping stablecoins would drop.
The second issue to look at is competitors. If competitors can do better than Curve, the demand for using Curve might drop. If Uniswap were to offer an even lower slippage on stablecoin swaps, users of Curve might move to Uniswap instead. If the competitor beats the USP of Curve the demand for using Curve to swap plummets, and the demand on the token also decreases.
If the market situation changes, the demand might change as well. It’s always good to keep an eye on what is happening.
We’ve tried to show a systematic approach to evaluating the demand side of a token usable by investors and builders alike. Starting with the buying point to circle in on the meta demand - the demand that can’t be broken down further. Meta demand can then be evaluated by defining its influencing factors, which might lead to the project's USP. The unique selling proposition can then be tested with a market analysis to look for competitors and other impacting events.
We used the CRV token as an example to better articulate the process. Starting from its governance utility as the buying point, we broke down the demands to CRV’s meta demand.
The meta demand is related to the project's USP - in Curve's case, the low slippage. This is a good design as it enables the project’s competitive advantage to be the driving force for the demand for CRV. The market analysis helped us test under which market situations the USP will work i.e., if Curve does not have a major competitor entering the game.
Curve’s competitive advantage is the driving force for the demand of the token. Investors should monitor the competition to get a better understanding of how at risk this USP is.
In the next part of our demand analysis, we’ll look into the incentives and utility mechanism and how the demand side could affect the supply side.
This post does not contain financial advice, only educational information. By reading this article, you agree and affirm the above, as well as that you are not being solicited to make a financial decision, and that you in no way are receiving any fiduciary projection, promise, or tacit inference of your ability to achieve financial gains.