CESC2020: Measuring the Economic Health of Blockchain Networks

2020 Ford F150. Hello everyone. Welcome to see esc2020. My name is Step, dr. Stephanie heard around the founding and kind of Mystic prism group aware and economics and government advisory specifically for blockchain project. Today is going to be talking about how do we sync about measuring the economic health, of blockchain networks, and black chain Base projects Sue a prism group we've worked with dozens of permissionless and permission blockchain-based, projects, and three other work, we get questions over and over again across platforms,

having to do with what we would call the economic health of the blockchain systems. These questions are things like, what are the levers? Driving my token price. Is it entirely speculation or does? My token have fundamental value? Are my mining rewards fair and sufficiently distributed right? At am I rewarding validators? Are minors in proportion to the resources that they're contributing is my platform user-friendly for consumers. And I don't mean from the UI point of view, which is obviously important. But from the economic value point of view, And so we thought a

lot about how do we think about measuring these and how do we think about measuring them in a way that's potentially comparable across different project? And as I said, we view these as questions of economic health is so economics. Has many different different definitions but we really think about it as the study of choice. So when you're thinking about economics and especially microeconomics, what you're thinking about is, how are people who in this case are using your block game platform interacting with the system and what decisions are they making

and are these decisions in line with what you want them to do. These decisions can be as simple as does a customer of your project return and use it again or are miners and validators colluding or anything like that. These are all choices that they're making and we think about economics is studying the reason why we make these choices, When we think about what leads to economic outcomes, there really, two different sets of behaviors and parameters that we focus on. So the first is a user individual preferences, right? So I am a

person and I have a stockpile of gpus. I'm trying to figure out how to make a return on them. Maybe I have specific constraints regarding my access to Capital regarding my access to low-cost electricity. And my goal is to make some money from Mining and this is going to interact with the economic design of the particular platform. What do your block rewards look like? What are incentive mechanisms, where Market mechanisms that you can't reduce and together these create economic outcomes? And so, it's important. When you think about your most projects, either explicitly or implicitly

have some set of economic outcomes that they want, right? It could be that they want $100. It could be that they want 50. It could be that they want their consumers to interact with other users to interact with them, every month, for a year, whatever it is. These are really a combination of the preferences and constraints of the people who are coming to use your platform and the economic design that you've chosen. And many of you have seen, our talks will be well, familiar with this framework. This is the house and these are the levers of economic design, and

I'm not going to dig too deeply into this, but at a high level, there are many more lovers that impact economic outcomes on your particular project than you would think. So, a great example of, for this, for example, a lot of people in button or thinking about the device space and defy projects tend to use a lot of options, right? They need a pricing mechanism, they want it to be relatively intact so that they use an option to die. And it turns out that there are books upon books upon books of how you can design options and how the change in the design

can impact the change in the behavior of the people who are participating in the auction. A really great example that I like is that it turns out if you're familiar with eBay, you know, the eBay auctions and after finite period of time. It used to be the Amazon would have similar auctions for decentralized sale of goods, but those options would continue until somebody stop bidding for there was no preset end times. And it turns out that this is a huge impact on how users and customers interact with the bullet. So the takeaway here is there's a ton of different design

decisions that impact the system and economic environment, you provide and therefore what people who interact with your project will choose to do. Until when we think about evaluating the economic health of a blockchain project, and this can be a protocol to, this doesn't have to be a consumer-facing. This can be something quite technical, we start with easy project, achieving the outcomes that you want, right? Let's sit down at the team and articulate, what is it that you want your project to do? What do you want people to do? What do you want users to? How do you want and users

to interact with each other? We get a lot of questions about benchmarking and this is one of the reasons that we start to think more about how do we think about key metrics, which is going to be talking about the rest of the talk, how did the outcomes and we get us all the time? How did the outcomes in my platform? The decentralisation, the token rate of return staking rewards compared to other platforms and then finally had to rethink about changing the design to improve. Maybe those metrics that we don't really love that much that aren't Up to what we want it.

And so one of the fundamental challenges in answering some of these questions is that many of them require a common metric or common way of measuring to be able to compare across platforms, right? If you're thinking about decentralisation which I'll talk about in a little bit or staking rate of return or fairness or validator rewards, it's not enough to just say, well here's what I think this is. And therefore, by my personal standard, you know, my my platform is doing great. It's incredibly helpful to have a commonly understood set of measures that help you

gain both overtime and across different projects. She even what you set out to do. And this is something that's very, very common for National economies, right? So here I have a, a screenshot from one of the data products for the international monetary fund. IMF, they produced a report every 6 months, Which takes which puts together symbols, and publishes a set of basic economic health metrics, and you can see them here there, things you've heard of those things like gross domestic product inflation, unemployment rate and they're able to collect them for the vast

majority of nations in the world. Each of these metrics has its own problems. None of them is perfect. Obviously, there's been a lot of discussion about the pitfalls with GDP. The unemployment rate has problems, but just the act of putting understanding of how are these different metrics and how are they put together? And how do they compare is a great way to start a conversation about the relative health of different countries and different countries? Economies one of the things you'll notice about these different metrics that are used for countries,

is that all of them include some kind of behavior or choice? Decision made by people, right? So they have to do with, you know, it's a combination. For example, let's take the unemployment rate. Obviously, there's the state of the labor market but the unemployment rate is a function of the hiring and employment decisions that businesses are making, as well as the decisions made by people in the labor market. So, it's a combination of the surrounding their economic fundamentals, as well as decisions made by participants in the system. And that's what gives it

such force. It really is an economic outcome that combines both of those levers that talks about the economic fundamentals, as well as the decisions that people are making. And while there's been a lot of progress on metrics in the blockchain space, these types of outcome-based measures aren't really popular yet, right? So they're a lot of different projects that are working on dashboards in metrics hero. Taking a screenshot from the coindesk for do economics week, but this is, by no means you no comprehensive but here, for example, if you look at some of their Network metrics that

they're using their transaction counts, that's very helpful. There's transaction fees. But for example, if you wanted to say, you know, is my consensus process working, well is my consensus process decentralized on my block rewards doing what they're supposed to. This doesn't really answer any of those questions that we hear over and over again, right? So we're thinking about how do we, what are the economic outcomes that we need to measure that really take into account people's decision-making. And also, answer the questions that we hear from platforms over and over and over

again. So let me talk through an example to add some concrete mix. So Perhaps, if you wanted to list. So the fundamental goals of blockchain is it is an industry or set of projects centralization. If it's not the first, among the top goals that almost every project you list, And when we talked to projects about you, when you say, you want to be decentralized, what exactly do you mean? We get a huge number of answer. So we had one client who was building a protocol and that they wanted to have a highly

decentralized consensus process. We should. What was that mean to you? And they said what we need? At least a hundred validators, Another one that I actually like is a project team said that you were decentralized if we the founders could disappear in the platform would still run. Another definition, we here is no one entity controls the system, right? And these are great answers. And I think particular, the second one is a great framework. But if you wanted to actually sit down and say, okay, let's measure how decentralized, let's say the consensus

process is for different, protocols and see how they measure up. None of these dancers is really getting you anywhere in terms of being able to quantify and compare And this is the problem that we worked with the Oakland application Network, the o on with. I'm so the other one has a token call Dan. They launched as a proof of work Network. And originally, you just had a standard proof-of-work consensus mechanism. And what they found a few months after launch, was that their consensus process was very, very Central. I said,

they basically had three mining tools that were providing all of the block production. And this was not what they wanted. So they went through the process of developing something called the unity consensus mechanism, which alternated between proof of work and proof of stake. That one of the main goals of introducing, this new consensus mechanism was to expand the number of different participants who were able to produce blocks and game block report. So we worked with them on the design of this and one of the questions that they had for us back in the fall. And when

we work with them again and was okay, we feel like we've decentralized our protocol. How do we know that block production is now more decentralized? Is there a way that we can actually measure whether the consensus process and specifically black production which is what we talk about when we think about Distributing power and influence is actually more decentralized than it was before, And their number of different ways that we measure this but one of the measurements that we focused on was called the hhi and this is a standard measure when you study the economics of an economy. And you're

trying to understand to what extent is a particular industry run by a monopolist until we taking the HHR and adapted it to make a little bit easier to use. But the basic idea here is that when you have an hhi one, it means that your entire industry is run by a monopolist in the terms of consensus and black production. This would mean that a single address or single minor was participant was producing all of your blocks like you only have one move toward zero you become more highly decentralized. Until you know what you're saying? You really want to be. Highly decentralized is

getting your hhi as close to zero as you can and this is a message that you can compute using Unchained it up, right? You take the past. Text number of blocks and you compute the particular formula and you can tell from, you know, just the history of black production on chain. Exactly what this something that's both comes from economics, has a long history in a long intuition but also is relatively easy to compute. And so, in working with the o on, and one of the motivations for this project was that

together with the Oman and Flipside crypto, which is a leading blockchain data company, we developed the dashboard for the o on to think about measuring some of these. These questions. I'm going to go back and forth between the dashboard and my my slime. So you can see here, here's the dashboard will be coming back and forth but what we have here is actually this metrics. So we worked with the team and we computed this particular metric of centralization for their block production. I'm in here, we have the hhi and again of the closer you

get to zero. The more decentralized, your block production is. So if you're very close to zero, it means that a wide variety of different participants are getting to produced blocks that are added to maintain if you're getting close to one. It means you have relatively few remaining pool or sticking pools or validator pools. Whatever you want to whatever your particular particles using we worked with the and was that we were able to quantify just how much their decentralisation had improved by changing consensus mechanism. So this purple line here is their measure of

centralization and decentralization for proof of work only. So this is the consensus protocol that they had before. I'm at once they added in proof of stake to their proof of work. They were able to decrease their decentralisation are improve their decentralisation down to this green line. So they drop from .3 to 24. Closer 2.10, this looks like a substantial Improvement and so the other question that they had for us was how this is compared to the aetherium Bitcoin. And because we have a standard well-defined measure of, how do you say centralized is black production in

mining? We can compare to. This is the actual number for aetherium. It's about .17 and this is the actual number for Bitcoin is about .09. And so you can see that the change in consensus mechanism, took us from a relatively centralized lock production down to something that's more competitive with ethereum. I mean just having is well-defined economically motivated measure, that could be computed and compared gives us a lot of information, right? I mean, the skips as a benchmark of what is it there? And look like, one of the

things that that we noticed having gone through this was that even the numbers for aetherium and Bitcoin are still not super decentralized. This is bitcoin's. Number is approximately equivalent to having 10 black producers. Like, if you had 10 block, producers in a row in each produced Block, in order to get about the same number there and if your arm is closer to having 5 or 6. So, even though this is far more decentralized than Bo on and they've improved, it's still not a hundred miles, a hundred miners would be very, very close to Durant.

so, going back to slides, I think this is a great example and you know having worked with a particular project to think about what exactly do they want to answer and why is it important to them? Was very helpful. Again, as I mentioned on, one of the things we've been working on a prism group is moving towards the shares standard set of economic metrics, right? But how can we put together a set of measures that apply across projects that let us address those cheap questions that we have in the front that I talked about in the front of the presentation.

So we are working with side crypto again, deleting data analytics platform, they specialize in shame walking which is on the collection and standardization and Analysis of Aunt. Shane. And sometimes off Shane data, And we built a tool called the crypto crypto economic analytics. Sweet. The answer some of these questions. We think about economic health specifically in a blockchain network. One of the key things were trying to get away from which you seeing a lot of metrics that are commonly used. Is it the

metrics that are used in the industry? Tend to focus only on the Shogun right here about to remark about? How do you think about measuring things like decentralisation of black production, which are fundamental to security? But not necessarily choking related, we were thinking about how do we measure economic health. Only think about the value of whatever the platform is, two different groups of stakeholders. So, obviously, there's certain older. So can holders get

lots of attention but there's also, validators, are validators being rewarded fairly for their contributions. Just any particular validator have excessive Market power. I'm are the incentives. They're being provided strong enough to keep an attract validators, who had security to your particular project. And then for users, if I'm a user using a token with a means of payment token, you how convenient is it for me to send money? How much am I paying and fees compared to the amount? I'm sending is the pricing mechanism for the fees work. These different things

are new, is our fees excessively volatile. These are all economic outcomes that materially impact whether people actually find Value in using a particular Black Tape Project. I'm going to talk a little bit more about some of the other standard metrics that we are working on that. We've stopped the room. We think are very helpful in applying to a particular project overtime and then also comparing across different protocols for the token economics. What we hear what everybody wants to know is what is driving to the price is right?

And if you see movement in token price, is it entirely driven by speculation is their fundamental value driving. This is this changing over time. I'm so getting it an economically motivated token. Price decomposition is really, really helpful to a lot of projects in particular. In this was something that we was emphasized a lot. When we were working with you, if you're thinking about developed, if you're a founding team thinking about developing and moving forward or particular project, it is really difficult to manage a choke and whose entire value speculation, right? If you're

trying to think about what is the size of the block, reward and tokens that I'm going to give to attract validators are minors having a token whose price is jumping all over the place because it's entirely speculation. German makes your life a lot harder, right? It's also harder to manage expectations of investors. If your entire token is speculation, that this is something that has a lot of of secondary impacts on a different stakeholder groups doing thinking about measuring economic health of a token. One of the

things we did before jumping into what's driving, the token price was, we wanted to set up a system or a set of metrics that would allow you to compare it to get into a regular currency, right? So Friday, major currency to Euro the dollar. The Central Bank, in this case, is the St, Louis fed off of the dollar, but this occurs everywhere maintains databases of different metrics, right? So of the total currency in the economy of how much of it is a different levels of liquidity, that's M1 M2. Those are different levels of liquidity of of currency. What's the

what's the currency bloc's city? Right? Right now in the US we are suffering from a severe economic merrily to a reduction in velocity of the dollar. And then digging into what is basically, the equivalent of GDP for particular token. How much actual economic activity as opposed to speculative? Trading is occurring. I'm and how do we measure serve the total value in terms of goods and services, sold that a project is currently taking place. And this allows you to really start to think about these tokens as a currency, right? Which many cases,

that's what the token wants to be. The founding team wants the token to be a currency. So let's start to look at its members, like we would do with any major currency and then once we have these different pieces of decomposition, of a tokens fundamental value is going to be depending on what the token is used for. Every token is a little bit different. But for example, you have a token that's a means of payment for the value of the fundamental value of the token. In terms of his economics, are going to depend on. Whether how much how often is used to pay for goods and services,

taking returns would add to the fundamental economic value of a token. There's a whole bunch of different uses that any token can have to be exact formula and algorithms that are used to figure out speculative versus not speculative activity or a little bit different. However, for a on, we have a combination means of payment and staking token. I'm just digging in here. Let me briefly switch over back to the dashboard. When we took a look at what was driving. The fundamental value of the Aeon token. We actually found that they had done a really great job

building up their economic fundamentals. So this navy blue line is there 90 days trailing token price. Only found it probably 70% their token price could be attributed to users wanting to use the token to interact with deaf to buy goods and services as opposed to speculating through an exchange. And there was also a modest contribution of staking. So they offer staking rewards on the order of a couple million dollars a year and that was providing, not a huge but a almost descent bump to their token price. And

this green line, green line here was the speculative remainder I'm so what we found is we worked with the an team was that they had actually done a really good job and they're a team that's very focused on developing their, dap ecosystem. So perhaps it wasn't surprising that this was in there. Soaking is relatively fundamentals driven and its price but as I mentioned this gives them at this. Lets them know first of all that their strategy is working and it gives them more levers to think about how did they control the token price as opposed to finding out that your

token price is 90% speculation and there's really nothing you can do suicide from social media activity to manage the price in a way that's useful for you. I'm finally just briefly. As I mentioned, you know, we talked a bit before about decentralisation in Block production, but there's a lot of questions regarding validator and minor influence that don't tend to get captured in standard industry metrics but a really useful to have and to compare across different platforms, are the types of qualitative questions that

we've turned into numbers, are things like does a single block reducer disproportionate influence are the remaining rewards. Efficient is the allocation of rewards across miners Fair. In that are minors, who contribute more resources such as hash power or staking and taking at work, getting proportionally, more rewards as part of this process. And so these are so we thought through and these are some of the metrics that we've developed. If we had more time, I'd walk through, have their put together in the

example we put together but these are numbers that can be computed using Unchained data that give a a better idea that really can be compared across different projects. And let me see. I think I have time for one more. This is one of my favorites when we were working with the an team back in November of 2019, one of the questions that we got from their team. All the time was are staking rewards big enough? Are we providing a competitive return? And in this case is not just compared to other projects is it compared to other investment opportunity, right? If you're thinking

about a sticker was deciding whether to stake tokens or the cash out and go get return from something else you want to understand, are you giving sufficient return to attract the capital that you want? Should we build a set of metric? Measuring real and nominal incentive power. So this is the rate of return that is. Staker gets in this particular case in the o on for staking their token and we have it in USD and we have it in a on currency. I'm like to come see us that this has changed over time with the equilibrium, staking return, or stay here in this system is right around

5% in real terms. What's so interesting about that is this is basically exactly what you would want. I'm so, if you think about the, you know, benchmark rate of return to Capital, it's typically between 5 and 10%. What's the news about blockchain Platforms in this one in particular, is that the rate of return to station is determined in part by how many people are staying, right? So if you're offering 20%, you're going to get more tokens stage. The rate of return is going to go down because the total amount of rewards is fixed. So what you can see here is that in equilibrium of

the staking return has really balance out to about 5%, which is exactly what you would expect. And so one can imagine that it's not going to do much below this because 5% of sort of the minimum or eternity to offer. And if you were to increase the amount of awards given and steak and and you would see you would expect to see an increase in participation, this would go up sort of temporarily and then come back down. As more people choose to stick their Capital to get some of the additional reports that not only can be computed for blockchain platform,

but can be Computer for NES. And so it starts to add quantification to this. Very fuzzy. Question of m, i giving enough rewards and what is the return to being a stapler on my platform? And I think it won't have time to go through these. But just the last set that we we thought about her what it was about ease of use and if I'm a consumer who wants to use a token particularly as a currency, how does it compare to PayPal, right? If I'm constantly having to worry about changes in speed, transaction

fees where I can go to PayPal and do exactly how much I'm going to pay this number. If so, how do we think about? Making sure that this is the platform is cost-effective that there's not excessive volatility, I'm putting numbers on these. Do we can quantify them. Compared not only to watch in projects but to Alternative currency transfer systems, like venmo like PayPal, which eventually many blessing projects want to be able to compete with. These are some of those. I just want to,

you know, anyone in particular note, I think as I mentioned before, when we thought about decentralisation, one of the things that was most interesting to us as a team was not only thinking about the particular project we were working with but thinking about the state of the industry and I mentioned this before but it was really surprising to us ever all of the discussion of decentralization and heralding ethereum and Bitcoin. But you're obviously pioneering platform that there's still a ways to go in terms of achieving decentralisation for the industry as a whole most of the

projects that we've worked with that. We see are much more centralized than the aspirations of their teams and the industries would want them to be I'm and going through the process of computing. These metrics of thinking critically about them really hammered that home for us and so I think you do not only our projects like this very useful to individual founding team but they help set expectations for the industry as a whole and point to where there needs to be additional work. Anyway, as I mentioned I'm Stephanie harder. I am the founding Economist at resume group, we

do economics and governance advisory for blockchain projects. If you would like any additional information about the dashboard product that I showed you, which is now on offer or anything about anything, I talk to about, please don't hesitate to reach out. Alright, thank you.