Tokenomics and Staking
Blog Article Series
Staking may be used as part of the core blockchain protocol, but in this blog article we look at how staking can be used within the business model to help create trust and to increase upwards pressure on the token price.
A token is issued by a digital platform upon a blockchain as the native currency of the platform through which participants get access to the different products & services offered on the platform or play different roles on it, receiving rewards and penalties. In other words, a token is the currency of the platform, circulating among its participants. When a token is exchanged, value is created, much like what happens today in the real world with fiat currencies. The difference being that the transfer of tokens happens from a wallet of a peer to another peer´s wallet whereas, with fiat currencies, in almost all cases, the transfer of value happens through intermediaries such as banks. So, a token-based platform combines the advantages of blockchain technology upon which a token is issued, transacted, recorded and stored, with the platform-based business model. The usability of a token is normally restricted within the boundaries of the platform and it cannot be used in other token-based platforms since they have their own native token. And this is also true with the majority of fiat currencies, whose use only extends to the issuance country's borders.

Tokenomics is concerned with the economics of the token, as the token is the native currency which participants use to exchange value on the platform. This implicitly suggests the role of platform owners as a governing actor in establishing rules, designing interactions as well as providing different incentives to the participants to benefit from the platform´s ecosystem. For this reason, there are authors who are suggesting that token-based platforms are creating "mini-economies" with their own set of rules, incentives and base currency.

One way to look at tokenomics would be to view the role of tokenomics in two distinct phases such as (1) tokenomics during the pre-ICO, ICO phase and (2), when the platform goes live. Below are some questions and points that one must consider in designing tokenomics during each phase.
Tokenomics during Pre-ICO, ICO phase
  • Will the token supply be finite or infinite?
  • How to set the price of token?
  • Which currencies (USD, EUR, BTC, ETH) are accepted to buy tokens?
  • How many fundraising rounds should be done?
  • What should be the limit of each fundraising round?
  • What is the minimum and maximum investment amount per participant?
  • What % of discounts is available in each fundraising rounds?
  • What % of tokens from "total token supply" will be kept to reward users for performing value creating activities?
  • What % of tokens will be kept for founders, co-founders, advisors and contributors?
  • How will the platform spend the funds in terms of marketing, platform development, etc.?
The long-term value of a token-based platform can only be achieved if there is a use case of the base token. With that in mind it is necessary to design as many value-creating activities as possible among the participants using the platform for the token to have its utility. So the questions are how to get token holders to hold the token once they receive it and how to design interactions for the token to have utility across the platform.

One of the ways token-based platforms are addressing these issues are through the introduction of staking. Staking is different to Proof-of-Stake (POS) and Distributed Proof-of-Stake (DPOS). POS and DPOS are consensus mechanism within blockchain, designed for validating transactions and producing blocks whereas staking is a method through which various incentives are provided for achieving different goals, such as validating a block in a blockchain. In order to ensure that a correct block is produced in a blockchain, staking is used to incentivize users to produce correct blocks and earn rewards, thus avoiding the risk of losing staked tokens due to incorrect validation of blocks. In this sense, staking is used within the POS and DPOS consensus mechanism to encourage good behaviour.

To further elaborate on staking, staking can also be used within the platform as a tokenomics element In this situation it is an act by which an individual holds a certain amount of tokens with the incentive to potentially receive the following benefits:

  1. Rewards.
  2. Access to exclusive features of the platform.
  3. Participate in value creating activities on the platform.
  4. Receive status/recognition on the platform.
Holding tokens could be incentivized through depositing a certain amount of tokens to a staking contract or wallet. This could also be implemented through the implementation of incentives, where individuals are encouraged to hold the tokens in their wallets to receive various benefits such as those mentioned previously. Staking could be classified into direct use of staking or an indirect use of staking. The difference between the two methods of staking is the following:

Direct use of staking

Direct use of staking can be described as follows, An individual deposits certain amount of tokens in the staking contract or wallet which is locked for a certain duration and is unavailable for any transactions and these tokens are forced out of circulation. Here, the individual also risk losing a portion or full portion of the staked tokens for misbehavior.

Indirect use of staking

Indirect use of staking can be defined as, when an individual is not required to deposit a certain amount of tokens in the staking contract or wallet but is incentivized to hold the tokens in his/her wallets or at exchanges, in order to receive the above mentioned benefits. Here, staking is not forced, but incentives are designed in such a way that, if the user wants to receive the benefits, then the user will have to hold the tokens or risk receiving benefits if the threshold is not maintained.

The different use cases of staking

Staking mechanism tied with holding tokens:

Incentivising users to hold tokens after the end of main-sale (better known as an ICO): Etheal uses staking to reward users for holding their tokens after the end of main-sale. The main sale is followed by a two week grace period. Here, they introduce another mechanism, which by default, will make it impossible for token holders to use the token. It's only after the grace period ends when participants get to use their holdings. At this point rewards are introduced for holding the HEAL token (native token), through staking. To receive the reward, the token holders will have to refrain from moving even the smallest portion of their tokens during the subsequent months after. This reward is only available to the participants of the pre-sale and main sale. By only providing this scheme to the select number of participants there is an incentive for people to buy during these phases, rather than after the sale concluded. The rewards are structured so that the longer a user holds their tokens, the higher reward it will receive. The argument for rewarding users who hold their tokens is to gain price stability. Below, I provide a description of the holding time period and the rewards for each holding time period.

Holding Time Period vs Rewards
3 months after the grace period
1 Million HEAL tokens to be distributed
6 months after the grace period
2 Million HEAL tokens to be distributed
9 months after the grace period
7-17 Million HEAL tokens to be distributed
Binance also has a similar mechanism with its Binance Coin (BNB). BNB has a total supply of 200 million but the circulating supply is restricted and some portion is burned to increase its price. To incentivize users to stake BNB discounted fees are given depending on the amount they stake, for example a lower trade fee, which can be lowered by if the user opts to use BNB. By using this tactic Binance is increasing the scarcity of the coin and further drives up the price and benefits the platform and its users.

Staking mechanism tied with an activity:

Omisego uses staking to reward users for performing validation of transactions in its platform. So, if a user wants to earn a reward for validating a transaction, the user will need to first stake a certain amount of tokens and if selected, the user may perform the validation. Before explaining how staking works at Omisego, let us first lay out the process of validation and explain how platforms design the process of validation and then elaborate on how staking is used in the validation of transactions at Omisego with an illustration.

The process of validation follows four stages, which can be seen below:
First, there is a "Task" which requires validation and interested validators stake tokens to perform the task. The process of "Selection" can vary: in some cases, the validator who stakes the most is selected, in other cases a random selection is used to select the validator. In some cases the owner of the task could choose the validator among the pool of interested validators. The selected validator "Performs" the task as per the requirements. After the validator performs the task, there is a "Result" of the performance. In this stage, the rewards and penalties are determined depending on the performance, if the result of the performance of the validator is deemed correct there is a reward and return of the stake to the validator´s wallet. If the result is deemed unfaithful, incorrect, misleading, dishonest, etc. then there is a penalty, which could be the following:

  • The validator loses a certain portion of the staked amount.
  • It could also be a loss of the full staked amount.
Below is an illustration of how staking is used by OmiseGo to validate transactions using the process of the validation model
As illustrated by the figure, the validator needs to deposit OMG tokens in a staking contract address and stake the tokens to validate the transaction. Omisego selects the validator based on who has staked the highest token to validate the transaction and it performs the task. Depending on the result of the performance of the validator, the validator will either receive rewards for performing the task or receive penalties if the work is deemed incorrect or dishonest.

Numerai (an AI-run, crowd-sourced hedge fund based in San Francisco) has a validation prediction model built by a network of data scientists. A user must stake a certain amount of Numerai tokens and a best guess probability of beating the benchmark while submitting their prediction model if they want to win rewards. The user can also submit the model without staking, but this means that even if the model is successful, the user will not receive a reward. Because of this Numerai incentivises its users to stake tokens in order to receive rewards. The prediction model has to beat a certain benchmark. So users engages in the activity of building a successful prediction model that can beat the benchmark and receives a reward, if successful. The prediction models that are unsuccessful in beating the benchmark will have their potential stake burned.

Below, is an illustration of how the staking mechanism is tied to an activity (which is to submit models to predict outcomes) and receive rewards or penalties

VentureFusion, an innovative decentralized incubator platform also uses this model, with an interesting twist. Selection happens twice and a single task is divided into two parts. A solution part and a validation part. First let us focus on the validation. Resident IEs (independent experts) apply to validate a solution to a task (the criteria changes depending on the task). They stake VF tokens (the native token on the platform) and through a selection process a validator is selected to validate the task. The solution requires resident participants (the freelancer) to apply for the selection based on various criteria (again this is task dependent). Then the participants go through the selection process and a single one is selected to perform the solution. The task is then performed and a stake has been placed. This is where the two parts meet, as the validator performs the validation of the task. Upon finishing the validation a performance evaluation is given to both the freelancer and the validator. Depending on the quality of their work they are penalized or rewarded, as shown in the diagram below.
Staking mechanism tied with the features of the platform:

BnKtoTheFuture uses staking to provide access to different membership plans and each membership plan unlocks new functions users can use and perform on the platform. The membership plans not only provides access to new features, but also allows the user to perform special actions for which there is a need to have a certain additional amount of staking balance. If the user is found violating the rules, then some portion of the user's staked balance is burned. The use case of staking at BnkToTheFuture is complex, because, with the different membership plans users get access to new features on the platform as well as the option of playing different roles simultaneously upon having an additional staked balance. Users can also stake tokens in order to receive access to special reports with valuable insights. So, BnkToTheFuture ties staking with both features of the platform and activity performed on it.

Staking mechanism tied with the status of participants:

BnkToTheFuture is also using staking to identify participants of the platform as qualified investors. These individuals will need to have a certain amount of tokens staked in order to remain classified as qualified investors.

The use of staking in designing interactions among participants and with the platform provides the following benefits:

  1. It increases the utility of the token.
  2. It incentivizes users to hold a certain amount of tokens as balance if they want to get involved in the platform and perform value-adding activity. So, there is value in holding the tokens.
  3. It allows platforms to address the velocity problem because with every transaction, the circulation of tokens is increased. With higher velocity, the token price is pressured to fall, because there is an inverse relation between price and velocity. With the introduction of staking, not all tokens will be available for transactions. If it is required to stake, the staked tokens will be out of circulation with every transaction. With every transaction, the circulation of tokens is increased and as well as the staked tokens. This reduces velocity since due to staking, some tokens are held, while some tokens are being transacted. With the inverse relation between price and velocity, the reduced velocity due to staking prevents the price to fall.
  4. It incentivizes users to behave properly and correctly when carrying out certain actions on the platform in order to avoid losing their staked tokens.
  5. In cases where the participants' staked tokens are burned for inappropriate behavior, staking indirectly affects the price of the token. The act of burning tokens reduces the supply of tokens, and assuming that demand is constant or increasing, the price of token will increase.

Written by Dipendra Limbu