Token Value Accrual
Token Buyback & Burn, Staking Rewards, Incentives and More
The underlying business is growing and receiving payments — how to accrue value created to the token entity so token holders can benefit from the existing or future success of the underlying business? What are different mechanisms to accrue value and what are their pros & cons?
We answer all those questions in this piece. We have a 3-step approach at Vader Research on token value accrual:
Step 1: Define Inflow Channels
Step 2: Determine Inflow Payment Currency
Step 3: Determine Value Accrual Mechanism
We will cover:
What is Value? How is it Created?
Step 1: Define Inflow Channels
Step 2: Determine Inflow Payment Currency
Step 3: Determine Value Accrual Mechanism
Bonus: Value Accrual Timing
What is Value? How is it Created?
Value = Revenue or Volume. We talk about value accrual in our token cap table allocation piece. Anything that represents existing or future revenue represents value.
In other words, value is created through inflows to the ecosystem. These inflows may be in any currency (stablecoin, L1 blockchain, native token) and can accrue 100% (primary NFT sale, upgrading fees, etc.) or X% (secondary royalty fees) to the protocol.
E.g. Crypto Vnicorns sells 100 primary NFTs for $1m. Assuming the proceedings go to the token entity, the token entity accrues $1m worth of inflows regardless of the currency of the sale (which might have been in USDC, ETH or the native Crypto Vnicorns token).
E.g. Degen A buys $100k worth Gigidaiku NFT from Degen B. Gigidaiku creator Kimit Break charges 10% royalty fee on all secondary transactions. Assuming the proceedings go to the equity entity, Kimit Break accrues $10k worth inflows regardless the currency of the sale.
Whether these inflows should be recognized as revenue or not (due to the time period where the value is created or to the payment currency) is the problem of accountants not us. We are concerned about designing a sustainable NFT economy, efficient allocation of resources and measuring the effectiveness of business decisions.
Revenue is a tricky and abstract concept that can be recognized based on various subjective parameters such as the payment currency and the period when the revenue is actually “earned”. E.g. If Adam pays $120 for a 1yr Netflix subscription upfront, $10 will be recognized as revenue in month 1 and $120 will be recognized as cash inflow in month 1. Additionally, payment received in a protocol’s native currency might not be recognized as revenue.
For our modeling purposes, we prefer to use inflows rather than revenue — inflows are closer to a traditional accounting cash flow inflow (cash flow statement) than revenue (income statement). However we also include non-stablecoin flows such as inflows in non-stable currencies and outflows in native tokens or non-native currencies (NFTs, etc.) in our adjusted inflow statement table.
The traditional 3 financial statements, valuation methodologies (DCF), KPIs (retention, DAU, LTV, CAC) do not directly apply to web3. They all need to be adjusted to more accurately represent the health and performance of a web3 protocol. At Vader Research, we have been working on proprietary statements and metrics to better account for value creation and accrual.
Step 1: Define Inflow Channels
We explained inflows above. Now let’s look at some of the common inflow channels and web3 examples
Some of the common inflow channels seen in games are
Primary one-off NFT sale of in-game characters, items/weapons or land
Ongoing primary NFT sale (breeding/minting/crafting)
Upgrading/Repairing/Energy Fee
Battle Pass
Wagering/Tournament Buy-In Fees
Although games give a sense of control to players by enabling players to “mint” or “breed” the NFTs, in reality the prices are set by the developers (or DAOs and inflows are going directly to the protocol. Some of these NFTs might be permanent or consumables. Consumables NFTs are likely to be sold more frequently, resulting in more sustainable and recurring inflows.
Axie Infinity Classic Inflows:
Primary NFT Sale
Primary Land Sale
Breeding Fees — Breeding fee is sort of an ongoing primary NFT sale. Breeding cost caps the NFT price, so whenever the secondary market NFT price is higher than the breeding fee, there is an arbitrage opportunity for anyone to breed/mint a new NFT.
Royalty Fees — Secondary marketplace transaction fees.
Skyweaver:
Conquest Entry Fees
Royalty Fees
Primary Non-Card NFT sale (Hero Skins, etc.)
Splinterlands:
Primary Card NFT Loot Box Sale
Card NFT Upgrading Fees
Royalty Fees
Tournament Organizer Fees
STEPN:
Primary NFT Sale
Minting Fees
Repairing/Upgrading Fees
Royalty Fees
Ethereum:
On-Chain Transaction Gas Fees
Step 2: Determine Inflow Payment Currency
One or multiple payment currencies should be determined for every inflow channel. The end user could have the option to choose a currency among all options or could only have 1 option. The inflow currency decision making process should consider end user experience, treasury inflow diversification, value accrual and legal/regulatory topics.
There are 3 common payment currency options:
1. Stablecoin (USDC, USDT, $, €, etc.)
Stablecoin is the most convenient option for end users as they don’t need to deal with additional friction points such as exchanging stablecoin into another currency on a decentralized or centralized exchange.
Additionally, fiat-to-crypto on-ramp tools such as Moonpay enable the end users to make payments directly with their credit cards without setting up or connecting a Metamask wallet. This is critical as a good % of users drop out throughout the payment funnel due to additional friction points. The fewer the friction points, the lower the dropout rate.
That said, stablecoin payments might cause legal problems as there are regulations in certain jurisdictions that disincentivize players to make payments in stablecoins.
2. Blockchain Currency (ETH, SOL, AVAX, MATIC, IMX, etc.)
Underlying blockchain’s token is the 2nd most convenient option for users. Since users need to hold the underlying blockchain’s token to pay gas fees for any on-chain transaction, users are assumed to hold a minimum amount of these tokens. Additionally, most centralized exchanges have direct blockchain currency deposits/withdrawals to non-custodial wallets such as Metamask.
3. Native Token (AXS, GMT, MANA, GALA, SLP, etc.)
The protocol’s native currency is another option. It is more inconvenient for the end users since they must go through the additional friction points mentioned at option 1. That said, it gives a concrete utility for the token and trains the end user’s subconscious mind to purchase the token (admittedly this argument has no scientific backing).
The payment currency can be made in one or two native token(s). Axie’s breeding cost was paid in both AXS and SLP so players had to hold a sufficient amount of both tokens to execute the breeding transaction. Making protocol-related payments in the native tokens provides a real “currency” utility for the token.
Step 3: Determine Value Accrual Mechanism
Once the inflows are defined and payment currencies are determined, we can now explore the options to accrue value to the token entity. Keep in mind that not all inflows necessarily need to accrue to the token entity. Some developers would like to accrue value to a mix of equity entity, other token entity and various classes of NFTs.
Axie’s breeding cost is a great example of value accrual to multiple entities. There are 2 main inflow sources; marketplace fees and breeding fees. 100% of marketplace fees accrue to a wallet address controlled by the AXS token entity. X% of breeding fees are paid in SLP which are automatically burnt — accruing value to the SLP token entity. 1-X% of breeding fees are paid in AXS which accrue to a wallet address controlled by the AXS token entity.
Axie NFT owners can earn SLP through play-to-earn rewards and Land NFT owners are able to earn AXS through staking. In other words, value accrued to SLP indirectly accrues to Axie NFTs whereas value accrued to AXS indirectly accrues to Land NFTs. There are many other parameters such as what % of AXS staking rewards are reserved for Land NFTs, what is the breeding cost, what % of breeding cost is consisted of SLP vs AXS and whether Axie NFTs are permanent assets.
Let’s look at token value accrual options in each inflow currency:
1. Inflows Received in Stablecoin or Blockchain Token
A. Buyback the Native Token
Token buybacks are very similar to share repurchases. The token entity purchases native tokens from the open market through a centralized or decentralized exchange. Value is accrued to all token holders on a pro-rata basis as the circulating token supply that is being traded is decreased.
Buybacks can be executed in regular intervals and fixed figure — e.g. use 70% of monthly stablecoin inflows to buyback the native token OR buybacks executed on a non-regular basis to have a more dynamic treasury management.
B. Distribute Stablecoin or Blockchain Token to Users
The inflows are used as marketing/engagement spend and are recycled back to the economy to incentivize specific actions with the aim of boosting growth/retention/monetization and creating long-term value. Unlike option 1, value is accrued to active protocol participants rather than the token holders in the short term with the expectation that this will yield larger benefits in the longer-term for the token holders.
C. Distribute Stablecoin to Stakers (similar to dividends)
Staking rewards are very similar to dividends. The token entity airdrops stablecoin or blockchain token to token holders. Value is accrued to staking token holders on a pro-rata basis as the token holders end up with more monetary assets than they were before the staking rewards. This model can be further enhanced by distributing a higher % of tokens to token holders that timelock their stake longer.
A good practice could be a blend between all options. Executing small buybacks while distributing stablecoin or blockchain token rewards to users that are eligible due to protocol activity & native token ownership could be an effective way to distribute rewards.
2. Inflows Received in Native Token
A. Burn Native Tokens
Reduce maximum token supply by permanently burning X amount of tokens from the circulation. The burn can occur automatically as inflows occur, regularly on a monthly/weekly basis or arbitrarily based on developer/DAO decision. Value is accrued to all token holders as the maximum token supply is now lower.
B. Recycle Native Tokens to Users
The inflows are used as a marketing/engagement spent and are recycled back to the economy to incentivize specific actions with the aim of boosting growth/retention/monetization and creating long-term value. Unlike option 1, value is accrued to active protocol participants rather than the token holders in the short term with the expectation that this will yield larger benefits in the longer-term for the token holders.
Since the monetary incentives are in the form of the native token currency to loyal/engaging users, this can potentially be considered as a better currency for rewards than stablecoin or blockchain token as % of native token reward-earnings users who don’t sell the native token will likely be higher than the % of non-native token reward-earnings users who go to a centralized or decentralized exchange to buy the native token.
Additional frictions to sell the native token DISINCENTIVIZES users from selling the native token while additional frictions to buy the native token DISINCENTIVIZES users from buying the native token.
C. Distribute Native Tokens as Staking Rewards
Staking rewards are very similar to dividends. The token entity airdrops native token rewards to token holders. Value is accrued to token holders on a pro-rata basis as the token holders end up with more native tokens than before the staking rewards.
D. Hodl Native Tokens
Instead of burning tokens immediately or redistributing them back to users/stakers, hodl the tokens in the treasury entity and make the value accrual decision later. Compared to simply holding native tokens in the treasury, burning native tokens gives additional trust to retail investors that there is a tangible, measurable token burning mechanism.
Bonus: Value Accrual Timing
Once a publicly traded company generates earnings and accumulates cash, it can use the cash in 3 ways:
Invest back in growth/marketing/operations
Pay dividends to shareholders
Buyback shares
If management decides that the business is mature enough and there are not attractive business investment opportunities such as hiring new employees, building a new line of service or spending more on marketing, then management can decide to distribute the excess cash back to the shareholders.
Typically, early-stage or fast-growing startups do not pay dividends to their shareholders. They rather reinvest earnings back into growth via user incentives, subsidies or further marketing spend. Facebook was founded in 2004, became profitable in 2009, went public in 2012 and has never paid any dividends. Amazon was founded in 1994, went public in 1997, became profitable in 2001 and has never paid any dividends.
These are still relatively fast-growing companies compared to mature businesses such as those in oil&gas or industrials. Facebook and Amazon executives would rather invest the excess cash to expand into new business areas rather than pay it back to shareholders as the longer-term value creation opportunity is much bigger than the short-term dividend payments.
The timing of short-term token value accrual decisions such as staking rewards, buying back native tokens or burning tokens is crucial. Token incentive rewards (whether in native token or another currency) is one channel for overall user acquisition and engagement. There are other strategies as well such as performance marketing, influencer marketing, tournaments, etc. Web2 startups employ a head of growth/marketing who tracks the cohort retention CAC and LTV metrics per acquisition channel to decide on the optimal marketing or incentive capital allocation.
E.g.
Users acquired through FB ads cost $20 per user and returned $5 in LTV.
Users acquired through influencer marketing cost $10 per user and returned $12 in LTV.
Then it is a no-brainer to pour in more marketing dollars to influencer marketing as long as the numbers stack up. The same comparison could be applied to token incentives but by making careful adjustments since token incentives are not always used for user acquisition but also for engagement and retention.
Uber has a dynamic incentive pricing model for drivers — taking a passenger from specific areas pay better than others and this pricing changes dynamically based on the traffic in that area, time of day, available Uber cars in the area and existing/estimated passenger demand. Uber wants to minimize the waiting time as a long waiting experience typically results in the passenger switching to other apps.
Thus, an early-stage crypto startup burning tokens or distributing staking rewards before the product-market fit is hit or even during a fast-growth period might not be an efficient allocation of resources. In the previous piece, we discussed why token vesting periods should be longer than they currently are.
If the token incentives do not result in a long-term benefit for the protocol, then it might make sense to reduce the size of token incentives and potentially exchange tokens for fiat/stable in order to finance other marketing/engagement/operational activities.
Conclusion
Value creation is defined through ecosystem inflows and developers/DAOs should be able to determine what % of the overall value created should accrue to which tradable asset (native token 1, native token 2, NFT collection 1, etc.). The ideal token value accrual mechanism will depend on whether the inflows are received in the native token or another currency. The timing of value accrual is as important as the chosen value accrual mechanism.
None of this is financial or legal advice. If you want to learn more about Web3 Gaming, follow Vader Research on Twitter, YouTube and Spotify. If you want Vader Research to consult with your team on economy & token design, please fill in this form.