The decentralized finance (DeFi) ecosystem has long struggled with how to effectively accumulate and retain value for its native tokens. Now is the perfect time to address this fundamental challenge.
This article explores why DeFi token economics need to evolve and what new, sustainable models might look like in practice.
The Case for Token Value Accumulation
While governance rights provide some utility for token holders, many tokens still fail to capture and maintain value effectively. There's growing consensus within the Web3 community that tokens must begin offering revenue sharing alongside governance capabilities.
Tokens that provide revenue sharing to holders may appear more like securities from a regulatory perspective. While this concern is valid, without this evolution, DeFi may remain largely a speculative market rather than achieving mainstream legitimacy.
If DeFi is to gain broader adoption, we cannot have all token prices moving in near-perfect correlation. Protocol profitability should be reflected in token valuation differences.
Current Approaches to Value Distribution
Protocols currently use two primary methods to distribute value to token holders:
- Buyback mechanisms: Repurchasing native tokens from the market to either distribute to stakers, burn, or retain in protocol treasuries
- Direct revenue distribution: Allocating protocol income directly to token holders
The fundamental goal of any DAO should be maximizing long-term value for token holders. As noted by researcher Hasu, "Every dollar a protocol owns or receives as revenue should be allocated to the use that is most beneficial to it."
Why Revenue Sharing Outperforms Buybacks
From a long-term perspective, distributing protocol revenue shares is superior to token buybacks. DAOs should only repurchase their native token when it's undervalued relative to its fundamental worth.
Protocols that provide revenue sharing to stakers enable proper valuation frameworks based on cash flows. By analyzing rewards paid to stakers, we can better value tokens while reconsidering incentives for liquidity providers.
When examining protocol revenue, we typically categorize it into two streams: protocol fees and LP rewards. Allocating revenue to token stakers reveals the true nature of LP income—it's essentially an operational cost rather than value accumulation.
Successful Implementations of Revenue Sharing
Several protocols have successfully implemented revenue sharing with governance token stakers. GMX has particularly pioneered this approach as a zero-slippage, decentralized perpetual futures and spot exchange on Avalanche and Arbitrum.
GMX stakers receive 30% of protocol fees, while LPs receive the remaining 70%. Notably, these fees are distributed in ETH and AVAX rather than GMX tokens, providing real value rather than inflationary rewards.
Some argue that distributing fees to stakers rather than reinvesting in protocol development harms long-term growth. However, GMX demonstrates this isn't necessarily true. Despite sharing revenue with stakers, GMX continues to innovate and develop new products like X4 and PvP AMM.
Generally, reinvestment only makes sense when a protocol or company can utilize accumulated capital more effectively than distributing it to stakeholders. Most DAOs should distribute revenue to stakeholders earlier than their centralized Web2 counterparts due to their decentralized nature and often less efficient capital management.
Learning From Past Models: Burns and Staking
The Terra Lesson
Despite its catastrophic collapse, Terra provides valuable lessons about token economics. In the short term, Terra demonstrated that token burns can effectively accumulate and capture value. However, manipulating $LUNA's burn rate through Anchor Protocol created an unsustainable reduction in supply.
Terra's collapse ultimately resulted from how easily $LUNA circulation could expand despite previous supply contractions, highlighting the dangers of artificial supply manipulation.
(3,3) Tokenomics
The rise and fall of (3,3) economics in late 2021 also offers important insights. OlympusDAO demonstrated that staking a large portion of a protocol's native token could lead to significant short-term price appreciation.
However, we subsequently learned that when stakers can exit with minimal consequences, they often do so at the expense of other participants. Rebasing mechanisms intended to incentivize staking ultimately benefited early entrants who used newcomers as exit liquidity.
For sustainable staking implementations, unstaking must carry more significant penalties. Additionally, those who unstake later should benefit compared to those who exit early.
ve Tokenomics
Curve's vote-escrowed (ve) model represents another widely adopted approach that incentivizes token holders to lock their tokens for up to four years in exchange for inflationary rewards and enhanced governance power.
While effective short-term, the ve model faces two primary challenges:
- Inflation acts as an indirect tax on all token holders, negatively impacting token value
- Massive sell-offs can occur when lock periods eventually expire
In essence, ve tokenomics resembles time-locked liquidity mining with similar sustainability concerns.
Designing an Ideal Token Model
Unlike previous unstable models, an ideal token economy would sustainably align incentives for users, investors, and founders. When Yearn.finance proposed their ve-based tokenomics plan (YIP-65), they built it around several key motivations that other projects might consider:
- Implementing token buybacks (distributing revenue to token holders)
- Building a sustainable ecosystem
- Incentivizing long-term perspective
- Rewarding loyal users
Considering these principles, we can propose a new token model that provides stability and value accumulation through taxation mechanisms.
The Revenue and Taxation Model
An ideal token design should grant holders governance rights and a share of protocol revenue when staked. In this model, users would pay a "tax" to unstake rather than facing lock-up periods. While unstaking penalties aren't unique to this model, the specific taxation mechanism proposed here is innovative.
The unstaking tax would be calculated as a percentage of the staked token amount. A portion of the taxed tokens would be proportionally distributed to other stakers in the pool, while another portion would be burned.
For example, if a user stakes 100 tokens with a 15% tax rate, unstaking would cost 15 tokens. In this scenario, two-thirds (10 tokens) would distribute to other stakers, while one-third (5 tokens) would be burned.
This system rewards the most loyal users—those maintaining their positions longest benefit most. It also reduces downward volatility during market sell-offs.
Theoretically, people unstake when revenue has declined or is expected to decline soon. When protocol revenue decreases (the "pie" shrinks), distributing taxed tokens to remaining stakers increases their share, reducing their losses.
The burned portion creates deflationary pressure on token supply, supporting overall token price. Long-term, burning would cause token supply to follow an exponential decay pattern.
During market sell-offs, if holders continue staking, their losses might be mitigated. The burned portion further reduces losses for all token holders, whether staked or not.
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Addressing Potential Limitations
The worst-case scenario for this model would occur if protocol revenue dramatically declined and whales decided to unstake and dump their tokens. If most tokens were previously staked, even with taxation, this could temporarily crash token prices.
This highlights a fundamental truth: No matter what staking/burning mechanism a protocol implements, if the underlying protocol cannot generate revenue, the token remains worthless.
However, assuming protocol revenue might rebound after such an event, those remaining staked would benefit from increased future revenue shares due to reduced total supply.
Since whale dominance is inevitable, a potential improvement to this taxation model could involve progressive taxation based on position size. While challenging to implement, protocols might leverage analytics tools or develop internal solutions to execute this fairly.
Implementation Timing Considerations
Whether implementing a flat or progressive tax, protocols should only adopt this revenue-sharing and taxation model after accumulating significant TVL. Early in a protocol's lifecycle, priorities should include bootstrapping liquidity, distributing tokens, and building momentum.
Token models built around liquidity mining might positively impact long-term development during early stages. However, as protocols mature, priorities must shift from bootstrapping TVL to creating long-term, sustainable token value accumulation. This requires adopting different token models that better align economic incentives with new objectives.
Compound exemplifies a protocol that didn't evolve its token design to match its maturity stage. Despite accumulating substantial TVL and generating significant revenue, little of this value creation was captured by $COMP holders. Ideally, a protocol's profitability should reflect in its token price, though reality often differs.
Frequently Asked Questions
What's the main problem with current DeFi token models?
Most struggle with value accumulation and retention. While governance rights provide some utility, many tokens fail to effectively capture and maintain value, often resulting in speculative trading rather than fundamental valuation.
How does revenue sharing benefit token holders?
Revenue sharing provides direct value accrual to token holders rather than relying solely on price appreciation. This creates more sustainable economics and better aligns holder interests with protocol success.
Why are token burns considered valuable?
Burns create deflationary pressure by reducing token supply. When demand remains constant or increases while supply decreases, basic economic principles suggest price should increase over time.
What's the difference between staking rewards and revenue sharing?
Staking rewards typically come from inflationary emissions (new token creation), while revenue sharing distributes actual protocol earnings. The latter represents real value transfer rather than dilution.
How does the proposed taxation model improve sustainability?
By penalizing early exit and rewarding long-term stakers, the model encourages holding through market cycles. The burn mechanism additionally creates permanent supply reduction benefiting all holders.
When should a protocol implement revenue sharing?
Typically after establishing product-market fit and sustainable revenue generation. Early-stage protocols often need to prioritize growth and liquidity over value distribution to stakeholders.
Conclusion
The most crucial aspect of this proposed token model is its sustainability. Staking incentives are more sustainable because they benefit those who "enter first and exit last" rather than following first-in-first-out principles.
The token burn element further enhances sustainability since it's unidirectional (supply can only contract). If there's one lesson from recent market turbulence, it's that sustainability matters tremendously.
While Web3's development path will be led by disruptive innovation and increased adoption, none of this will be possible without more sustainable token models that effectively accumulate and retain value. The future of DeFi depends on economic designs that align incentives across all participants while creating lasting value capture mechanisms.