Utilities for a Well-Designed Token

One of the keys to a well-designed token is that it provides a core utility to create or provide something of value – a use for the token outside pure speculation.

Underlying utility is critical - once your token is up and running, most of the levers to influence the price of the product is on the supply side (e.g. buy-back and burn features). There’s also a limit to how often and how much you can pull those levers.

With only speculative or artificial demand, token prices inevitably fall. A big crash in token price can kill a project. A falling token price erodes belief in the project and reduce demand.

Ensuring non-speculative demand through true utility is one of several crucial pillars to creating a sustainable token. Below, we explore the different available utilities.

• Fee for utility
• Revenue capture & sharing
• Insurance/Collateral
• Governance
• Discounts and other benefits
• Economic incentives to perform/penalize actions

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Fee for utility (smart contracts & compute)

A particular set of tokens were designed as a fee for utility/service. These tokens can be paid as a usage cost for a benefit, utility, or desired outcome.

Ethereum (ETH) is used to execute smart contracts, which are a programmatic way of settling transactions between multiple parties. The Ethereum blockchain eliminates counterparty risk and removes the need for a trusted third-party to facilitate these transactions.

These transactions require a validator gas fee, paid through with ETH. As a result, users and developers on the Ethereum network are required to own and use ETH.

Solana (SOL) and Polygon (MATIC) perform the same functionality as Ethereum but have the added benefit of lower transaction fees (also paid through their native tokens) and can handle a higher number of transactions per second than Ethereum.

Helium (HNT) provides utility for a fee in the more traditional sense of the word “utility” – wireless network bandwidth. Users burn Helium tokens to acquire Data Credits. These Data Credits are then used to send data on the network and pay for blockchain transaction fees. On the other end, an individual can set up a Helium Hotspot and start earning HNT tokens. The end result is bandwidth consumers using HNT for secure and decentralized data transfer, rewarding bandwidth providers.

With all of the above tokens, their utility comes from being a payment facilitator for their underlying project or protocol.

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Revenue capture & sharing

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Building revenue sharing into tokens is a powerful utility for projects. Tokens become cash-flowing assets for their owners.

A notable example is GMX.

GMX is a decentralized exchange which offers both spot and perpetual trading for a small selection of cryptocurrencies: ETH, WBTC, LINK, UNI, DAI, USDC, USDT, and FRAX. In perpetual trading, instead of buying and selling the underlying token, traders take long or short positions and deposit collateral. Unlike other exchanges, market prices are based on data from Chainlink oracles, which collect data from top exchanges for greater price stability.

GMX has two tokens, both of which capture revenue from the platform: GMX and GLP.

GMX is the exchange’s governance token. Staked GMX receives 30% of fees generated from the exchange, along with other boosts and rewards. It’s not backed by any asset, and its price is subject to natural supply and demand - a portion of its value is speculative in nature.

GLP is the liquidity provider token, which receives 70% of platform fees when staked. GLP is granted in exchange for providing liquidity to GMX, and is backed by the very crypto used to buy it. Yield on GLP comes from leveraged trading, so GLP holders lose if traders win. However, traders have historically lost, which has resulted in a ~19% yield on GLP in ETH.

Source: https://medium.com/coinmonks/gmx-a-brief-explanation-a1f6ade01b04

Source: https://zerion.io/blog/what-is-gmx/

Other decentralized projects which reward liquidity providers with generated fees include dYdX (edit: currently goes to dYdX trading, and not directly to tokenholders), LooksRare, and Sushi, and Uniswap. Of note, there has been a ‘fee switch’ proposal submitted on Uniswap, which would allow a portion of LP fees to be routed to other parties, such as UNI token holders - similar to GMX.

Revenue sharing tokens face regulatory risk with regard to securities classification because they resemble cash-flow/dividend properties. These assets may be subject to additional compliance requirements, especially in the US.

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Insurance/Collateral

Insurance and collateral utility can be implemented to align on-chain incentives and discourage bad actors.

For example, it's possible for blockchain users to facilitate bad transactions or fail validator functions when staking ETH, which hurts the overall ecosystem. To prevent and discourage this unwanted behavior, projects can require collateral to ensure that all parties have a financial incentive to uphold the integrity of the blockchain and positively contribute to the project.

One example for this utility is Rocket Pool (RPL) – a protocol that gathers several portions of ETH from Rocket Pool stakers and combines them into 32 ETH chunks. These chunks are then assigned as mini-pool validators, offering compute resources for Ethereum’s Proof of Stake (PoS).

To ensure that these validators maintain adequate up-time and performance for PoS, RPL requires collateral in the form of RPL in case they’re penalized for poor performance.

In the event of a penalty, this RPL collateral is sold to cover losses in the ETH stake. This mechanic incentivizes validators to maintain high performance and up-time on their nodes, while also preventing socialized losses.

As a benefit for putting up collateral, the staked RPL accrues interest between 5% and 20%.

Overcollateralized lending also falls into this bucket as well to create a financial incentive and mechanism to cover the value of the borrowed asset (e.g. Synthetix and the SNX tokens).

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Governance

One of the most common utilities is governance. While many tokens don’t have a clear path to utility, they can use governance to create utilities over time by passing proposals within their governance structure.

Here are two examples of tokens where governance is actually the driving utility:

— Curve

CRV and veCRV are two tokens that govern the Curve stablecoin automated market marker (AMM) protocol. An automated market maker replaces traditional buyers and sellers through an autonomous trading liquidity pool. veCRV is the governance token counted in governance votes and can only be obtained by staking CRV (locking it up for some period of time).

As made famous by the Curve Wars, demand for CRV skyrocketed because Curve allows its community members to decide which liquidity pools are subsidized with token rewards. This creates more participation, leading to more liquidity, and ultimately, greater adoption of tokens within its different liquidity pools. Token providers and other DeFi protocols fight to earn more governance voting tokens so that they can influence token reward allocations and increase the engagement of their chosen stablecoin.

The governance token itself is not what generates value. Value accrues from the power to influence the protocol’s decision on which pool to subsidize rewards for. This creates incredible engagement within the Curve community.

— Gitcoin

Another example is GTC, a governance token created by Gitcoin, which allows token holders to vote where capital is allocated for open-source projects (funded by Gitcoin and development of the GitcoinDAO). Having a say in which projects get funded is the driving incentive to own this token.

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Discounts and other benefits

Two examples of discount-based utility are BNB and FTT. This mechanic naturally lends itself to closely affiliated product pairs: a revenue-generating product and a token which interacts with it.

In the case of BNB, tokenholders receive a 25% discount on trading fees incurred on the exchange when they pay using BNB. Staking and holding FTT allowed FTX customers to take advantage of discounts when trading, greater airdrop rewards, waived blockchain fees, and bonus votes in polls.

Binance and FTX are effectively offering a reward in one product (discounts when trading on their exchanges) when users buy into their other product (the token). Rewards in the first drive demand for the other.

Braintrust uses BTRST governance tokens which come with the added benefits of free and discounted software, products, career resources, and community perks. These perks act as an incentive to maintain loyalty to the brand, leverage the rewards from other actions, and keep users in the ecosystem.

These benefits make it easy for protocols to partner with other companies to attract more users and grow their communities.

This isn’t the purest form of utility, since the token cannot live without the value creation of its related product, but it’s a strategy nonetheless.

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Economic incentives for performing or penalizing certain actions

Broadly, tokens can also act as a way to drive a certain behavior, through carefully crafted design and game theory.

Financial incentives can be created to buy/sell a token (and lock-in guaranteed profits through arbitrage) to create a price floor of $1 and liquidity for assets like Olympus protocol’s OHM.

Terra Luna is another famous example for creating economic incentives where traders can arbitrage profits while also achieving the protocol’s objective of maintaining a US dollar peg (albeit, Terra Luna did have its famous crash). Nonetheless, game theory and driving different actions using financial incentives is another way tokens can be used.

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TL;DR

To summarize, possible utilities to include into your token are:

• Fee for utility
• Revenue capture & sharing
• Insurance/Collateral
• Governance
• Discounts and other benefits
• Economic incentives to perform/penalize actions

While it’s difficult to predict how any given token venture will do in the long term, careful design with utility and incentive mechanisms offers the best shot for positive, long-lasting change in the real world.

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