This article will give Web3 product designers an understanding of the role that Web3 tokens play on cryptonetworks. Stay tuned for future Web3 Design Courses where we deep-dive into products in the Web3 ecosystem.
Tokens native to a cryptonetwork incentivize nodes to secure, and maintain, that cryptonetwork. These nodes can be thought of as network service providers. They dedicate their resources to provide a decentralized blockchain database for dApps to build on top of, and are rewarded with that cryptonetwork’s native token.
Additionally, native tokens are staked by these nodes to ensure that they act according to the best interest of the cryptonetwork. This secures the cryptonetwork from attack because stakes can be slashed. The cryptonetwork is also protected from denial of service attacks by requiring users to pay for their usage of the cryptonetwork with its native token. This makes spamming the network with unnecessary transactions prohibitively expensive.
In other words, the native token coordinates, and incentivizes, globally distributed, independently-acting nodes to maintain the blockchain, while at the same time protecting it from attack. This is all kind of complicated. You may notice this is unnecessary in the world of Web2 because companies cover the cost of the centralized databases their applications run on. But, as we already talked about in the previous section, there are hidden costs with centralized gatekeepers who have unilateral control over the platform, and its data. Simply put, tokens make possible the decentralized, open, and neutral properties of Web3.
Think back to what we learned about internet protocols. They were developed over 30 years ago by independent researchers and non-profit organizations, and haven’t changed much since. In the beginning, before the enormous commercial value of the internet was realized, it was difficult to get funding to build out the protocols. Now, protocol developers can create a cryptonetwork and hold on to a portion of the native token. If the protocol provides value, and is adopted, then the token price will increase in value, because the token is required to use cryptonetwork in the first place (see above). Also, the founding team can sell off some of the tokens to fund initial, or ongoing, development. Thus, Web3 tokens provide a direct value capture, and funding, mechanism for open-source protocols.
This brings us to the next point – Web3 tokens help bootstrap cryptonetwork adoption. Remember, networks are proportional in value to the number of users in the network. Facebook is much less compelling with only 100 users, and AirBnB just isn’t that useful with only 100 hosts. So it’s difficult to get things off the ground; however, cryptonetworks can reward its early-adopters – whether that be developers or end-users – with its native token. If the network succeeds then the early-adopters profit greatly, rewarding them for the value they provided to the network early on. Also, now that they are token holders, and have a financial stake in the network, early-adopters are incentivized to help grow the network through word of mouth, or social media promotion.
Think about the internet as divided into two layers: the protocol layer (e.g. HTTP, TCP/IP, etc.) and the application layer (e.g. Facebook, Instagram, etc.). In Web2, all of the value accrues to the application layer, which has led to some of the most valuable companies in the world today. Remember there was no effective way to capture value from open-source protocols until Web3 tokens came along.
The fat protocol thesis posits that value will consolidate at the protocol layer in the Web3 era. As dApps, built on these Web3 protocols, go mainstream and attract hundreds of millions of users, the protocol’s native token will increase in value. This is because the native token is required to use the dApps – a classic example of utility tokens, discussed in the next section. An increase in token price signals a growing ecosystem, which will attract more developers to build out additional functionality on the blockchain, which will attract more end-users. Web3 tokens are responsible for positive feedback loops like this.
As mentioned before, internet protocols have not changed much since their initial release back in the 90’s. There were efforts to make modifications, but it was too difficult as there was no clear ownership over the protocols. Now, cryptonetworks are beginning to build governance, and upgradeability directly into the protocol. Token holders can vote on protocol improvement proposals. The more tokens they have the more their vote counts. Some believe this is unfair, especially when individual users hold a disproportionately large share of the protocol’s token; however, it is important to point out that the more token you hold, the more financial stake you have in the protocol. All token holders are incentivized to vote for the good of the protocol because the token value can appreciate or depreciate depending on the outcome.
In this section we talked about many of the dynamics brought about by Web3 tokens. To summarize, Web3 tokens get distributed to all cryptonetwork stakeholders: protocol developers, third-party dApp developers, end-users, and network service providers. This is why cryptonetworks are sometimes referred to as “community owned and operated” networks. Everyone in the cryptonetwork is aligned to the same goal – for the cryptonetwork to grow and prosper so that the value of the token increases. This is vastly different from the misalignment characteristic of the current Web2 system.
If you enjoy videos over reading when it comes to online learning then checkout the course on YouTube. This is part 3 of 7 in the Crypto Design Trends 2022 series. Also, make sure to stay tuned for future Web3 Design Courses where we will get into more interesting topics about emerging dApps.