Alex Fatuliaj
January 23, 2024
Tokenomics Tuesday
Investor Insight

Bold claim. Requires a bold approach. Let’s look at the extreme.

If 100% of the total token supply was unlocked at TGE, everyone who has tokens will sell them - investors, team, advisors, etc. But once they start, the token price collapses down to near $0 rather quickly. So, they all stop and won’t sell again until the token price is back up.

Now, why go through all of that trouble of volatility when we can just skip it by introducing vesting schedules that prevent people from selling more than the market can absorb? Well, herein lies our first problem…

How do you predetermine how many tokens the market can absorb, accurately?


Well, first things first, why does it need to be accurate in the first place?

  1. If there are too few tokens unlocked, you face two predicaments: the token price pumps too high to unsustainable levels, and the insiders (investors, team) can’t sell to maximise returns.
  2. If there are too many tokens unlocked, you face two predicaments: the token price falls below its fair value, and the insiders (investors, team) can’t maximise returns when selling.

Hence, in order to achieve price stability and return maximisation, which is important for investor satisfaction as well as efficiency of capital in the form of token-funded OPEX costs and user acquisition strategies, you need to accurately predetermine how many tokens to release into the market.

So, how do you make it accurate?


You can’t.

There is hubbub around modelling, but in reality you can’t model complexity no matter how much cash you throw at token engineers. Fundamentals, speculation within your community, speculation on macro scale, institutional sentiment, economics, geopolitics, intertwined entities (market makers, exchanges, etc.), and infinitely more factors make it impossible to predict anything accurately beyond a very short term.

The world is a complex system, so even if you get incredibly lucky and make assumptions with only a 5% margin of error in the first month of calculations, by the end of the quarter the error would compound to the entire model being completely wrong. It’s similar to weather forecasting - accurate within reason for today, but by the end of the week it’s practically useless.

PSA: modelling is meant to be used to see how different policies (e.g. different tax rates on different interactions) affect the economy, ceteris paribus; not to predict price.

Thus, the only reasonable solution on the horizon is to facilitate some ability to edit the amount unlocked in the case of faster or slower growth of market absorption. But this comes with a thorn:

  • We can’t give this power to the third party (the team) because of the subsequent problems with optics and the fact that this would likely class the token as a security as per the Howey test, or anything similar; and
  • We can’t give the power to the first or second parties (the token buyers/traders) because aligning incentives between different parties using the thing (tokens) the incentives are meant to protect (tokens) is as useful as giving prisoners the keys but asking them to not leave prison.

So how about we remove this trust and create a formulaic approach towards vesting based on key performance indicators (KPIs).

What is KPI vesting?


Given the whole idea is to unlock as many tokens as the market can absorb to maximise price stability and capital efficiency, it makes sense to base the amount of tokens being unlocked on performance which is tied to market demand. Below are some examples:

Micro KPIs:

  • Exchange listing
  • Partnership announcement
  • Integration with another protocol
  • Development update
  • App launch
  • Real user numbers
  • Revenue
  • TVL

Macro KPIs:

  • Bitcoin price
  • Altcoin market cap
  • Volume across entire narrative
  • Growth of infrastructure protocols you’re built on
  • Interest rates in country where most of your users are

However, let’s look at extremes. If no KPI is hit one month, should we unlock 0 tokens? If micro KPIs are not hit, why should collective responsibility be imposed due to the actions of a minority? If macro KPIs are not hit, why should everyone pay the cost of exogenous events? Sure, we can point and blame the designers of the KPIs, but business is hard and people make mistakes.

A well-rounded approach will be to have a minimum monthly unlock quantity per tranche that is supplemented by additional token unlocks if KPIs are hit.

This minimum monthly unlock quantity can be based on the raw fundamentals of the project, and the KPIs can be achieved to create greater stability in the face of speculation.

How do you create KPI Vestings?


Technicalities

Well, in terms of technicalities, one would need to use oracles to get the data from the real world into smart contracts that would govern the KPI unlock.

KPI itself

What KPIs are best has been in debate for a while but the agreed upon, most critical element that no KPI must bear victim to is susceptibility to manipulation. A KPI based on volume can be manipulated by a market maker. A KPI based on Unique Active Wallets can be manipulated by bots. The best KPIs to use are still, and will be for a long time, in heavy discussion, but one thing is for certain - one need to make sure the performance is real.

How many tokens it unlocks

This is a bit more tricky. There hasn’t been much comprehensive market research on how different market scenarios impact token price. Moreover, given the complex nature of our reality, it is arguably impossible to predict the impact of a particular event on market demand for a token. But, given enough research, we can calculate the average with the upper & lower bands, and cross-reference similarities and differences between the market average and our own project to determine whether we should aim towards the upper or lower band of tokens unlocked.

Conclusion


KPI vesting can revolutionise the way tokens are vested, and great progress has been made in their research. But it is crucial to explore all logical paradigms when approaching KPIs to make sure the fundamental reasoning behind them comes from a place of benevolence and mutual gain. We hope this article can serve as the baseline when thinking about KPI vesting.


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