Alex Fatuliaj
August 29, 2023
Tokenomics Tuesday

What is a dual-token economy?


Tokens are vehicles for transacting any form of value, meaning that a token can serve a multitude of functions at once (i.e. it can have different utilities); this makes tokens unique to traditional financial instruments that can only transact one form of value at a time.

More details about tokens can be found here: https://thoughts.simplicitygroup.xyz/p/token-utilities

A dual-token economy is a term used to describe crypto projects that utilise two separate tokens within their ecosystem.

When to implement a dual-token economy?


A token’s versatility opens a world of opportunities and benefits, however, it also leads to three main concerns:

  1. Price volatility - fluctuations in demand for one token utility affects the price of the token as a whole, leading to volatility and uncertainty for users and investors that want to use the token for its other utilities;
  2. Regulatory challenges - in some jurisdictions, different functions of a token may be subject to different regulatory frameworks which creates conflict and uncertainty;
  3. Contradictory policies - different token functions require different rules governing them. For instance, a token used as a medium of exchange has different unit economics to a security token, in that the former needs to be constantly liquid with high velocity, whereas the latter doesn't.

These issues can be countered by introducing a dual token economy that allows the project to separate token functions into multiple tokens.

What are the benefits of a dual-token economy?


There are a few benefits to the dual-token model that are worth highlighting in particular as evidence to how it solves the above problems.

  1. Control inflation and volatility: by using a 'soft' and a 'hard' currency, the project can create a reward mechanism that doesn't affect the sustainability of the rest of the project. The soft currency typically has an unlimited supply and is minted to reward users; this token is often used as a medium of exchange for everyday transactions within the ecosystem, and is generally not tradeable on exchanges, meaning the token’s volatility isn’t a problem.

    The hard currency would have a limited supply and is reserved for more important or significant transactions. This is the token that is tradable on exchanges and the token investors use for investment (at VC and retail level).

    The idea is that the the soft currency absorbs the volatility and inflation whilst the hard currency acts as the relatively stable utility token.

  2. Regulatory compliance: most jurisdictions define what falls under securities law and regulations differently. Some utilities, such as tokens that represent ownership in an asset or company, would be regulated differently in different regions

    By separating token utilities and incorporating token issuance entities in distinct countries, projects can avoid the legal complexities and risks associated with particular utilities.

  3. Flexibility: by separating out the functions between different tokens allows each token to be optimized economically, regulatorily, or in any other way, for its specific use case - facing different policies, having different rights, and so on. This allows for greater flexibility when designing an ecosystem that can meet the needs of different users and use cases at once.

  4. Incentives and rewards: a dual-token economy can allow for a more targeted incentives and rewards system for users who contribute to the ecosystem. For instance, a payment token can be distributed to users who provide liquidity to a decentralized exchange while a governance token can be distributed to users who use said exchange.

  5. Stability and predictability: by separating out stable and predictable functions, such as payment or asset-backed tokens, from more volatile and speculative functions, such as governance or reward tokens, the overall value and stability of the ecosystem can be improved. This can provide greater confidence and trust in the ecosystem, which in turn attracts more users and investors.

Overall, a dual-token economy that separates token functions can provide a more flexible, transparent, and efficient ecosystem that can meet the needs of different users and corresponding utilities without conflicting mechanisms. This gives projects freedom to innovate and create new solutions for old problems.

What are the drawbacks of a dual-token economy?


Even though there are many benefits to using a dual token model, there are a few problems. Firstly, you have higher development costs and more tech-related considerations. Secondly, it’s tougher to explain the economy to investors and users. But most importantly, there is one drawback to be wary of:

Perpetual possibility of conflict of interest between those who hold either token. For instance, when comparing the goals and incentives of those who hold security tokens to those who hold utility tokens, it is clear that there is a distinction between the two groups' ideal future because the former care more about profit whereas the latter care more about protocol functionality and experience.

An example of this conflict occurring is an issue that emerged with MakerDAO on September 2020. When $DAI holders lost about US$2,500,000 from their vaults on the system due to a hack, a governance vote was held on whether to reimburse the loses with the $MKR treasury. The governors, $MKR holders, decided against compensating the losses. This shows a clear misalignment of incentives between different token holders and how that can impact the overall ecosystem.

How do I get around this problem?


The fundamental key here is that $MKR holders are not aligned enough with the users of $DAI. This isn’t a fault of the dual-token model inherently, but more so that of the project.

$MKR holders gain nothing (in the short term) by using treasury funds to reimburse $DAI holders.

If the project intertwines the incentives of both token holders by making them dependant on one another, that would resolve the concern of conflict of interest. It’s a classic prisoners dilemma where if both parties work together, they get the most reward (or the least benefits), however, with one key difference…

The project can prevent one party “confessing” and one party “remaining silent” - i.e. the project can enforce alignment by attaching the success of one party to the rewards of the other, in essence creating a situation where if one party confesses and one remains silent, then they both still get 5 years each.

A project' can enforce cooperation


Should I implement a dual-token model in my token economy?


You need to assess the financial status and the corresponding monetary and fiscal policy of the token first. Let’s look at an example:

If token is used for governance and a medium of exchange on the project’s platform’s marketplace, then the financial status of the the token will be different for the two distinct parts of the ecosystem.

  • The governors want the token price to go up so they get rewarded more.
  • The users of the marketplace want the token price to stay stable so they have a reliable unit of account and store of value.

This means the monetary policy (primarily money rules governing the money supply) for the governors is ideally to have a maximum supply and longer vesting schedules.

However, for the marketplace it would be better to have a Burn and Mint mechanism for the supply that adapts to the demand and velocity of the tokens within the marketplace.

If you decide that your economy utilises a token for functions that contradict each other when it comes to the monetary or fiscal policies, then it could be good to implement a dual-token model.

Some examples of dual-token models


Axie Infinity
: $AXS is used for governance and staking with a limited supply, whereas $SLP is infinite and is used for in-game transactions.

GMX: $GMX is a governance and utility token, whereas $GLP is a liquidity provision token used as a decentralised B-Book for swaps and leverage trading (more info).

Curve: $CRV is a governance token, whereas $veCRV is an escrow token that gives users extra platform benefits.

Conclusion


Dual token economies allow for the separation of different token functions which comes with great benefits, but also some risk. These ecosystems require careful consideration, but have fantastic effects if implemented correctly.


All posts: https://www.simplicitygroup.xyz/blog

Twitter: https://twitter.com/SimplicityWeb3

Telegram: https://t.me/SimplicityGroup

Newsletter: https://thoughts.simplicitygroup.xyz/subscribe