Controversial discussion about Burn-Mint Equilibrium!
Reasons to implement BME, Validating them ,and Different models & Tweaks that can be implemented. A deep dive!
Key insights:
BME offers price stability, adaptability, a way to incentive network participation trading it off by a crippled value capture model
Adding tweaks and adjusting BME to better suit your product & objectives is the best approach
Work token model is better in Value accrual but isn’t universally applicable. But with adding some adjustments you probably can implement it into your protocol
Staking helps with the token price support and adds stability/predictability to the network
In the infrastructure/DePIN sector, two token models prevail; the Work token model (Stake for Access) and BME (burn-mint equilibrium).
These models address the velocity problem associated with utility tokens, promoting value accrual and linking network growth to token price appreciation. Additionally, with its dual-token structure, BME provides regulatory benefits and attracts corporations and Web 2 users to the protocol without requiring them to hold cryptocurrency.
This article will focus on BME.
Before we start, The velocity problem refers to the inherent susceptibility of proprietary payment currencies to rapid circulation.
Some utility tokens may have velocities of 100 or even 1,000. For reference, the USD M1 money supply has an average velocity of 5.
Users lack incentives to hold tokens and typically only purchase them when accessing the service. Service providers then sell tokens for fiat currency, resulting in the network generating substantial value without capturing any of it.
What does BME even mean? (Burn-Mint Equilibrium or sometimes called Burn-Mint Economics)
It is a mechanism where users pay for services by burning tokens instead of directly compensating service providers. This process involves destroying tokens while publicly verifying (on-chain) that the provider completed the work.
Token amounts burned are based on the service's USD cost. For instance, in Helium, Data Credits (DC, the FIAT pegged token) cost $0.00001, regardless of the HNT price. The protocol periodically generates new tokens, distributing them proportionately among service providers. For example, if Service Provider A has 1 out of 50 burned tokens, they receive 2% of the new tokens.
The number of new tokens, X, may vary over time but should remain independent of the number of burned tokens to prevent circular reasoning and uphold the BME principle.
Why It is being implemented?
Most Actors in the DePIN space, have already implemented this model, Hivemapper in the Mapping sector, React which is leading in Energy, Helium leading the DeWI, Render leading computing, and many more.
It seems that BME is so tempting that makes all of these remarkable projects implement it, Let’s dive in!
We will first list the reasons to implement it, and then hit hard on them and Validate if they are correct.
There is no consensus about the no.1 purpose, The reasons for its popularity are varied and contested, in no order;
1- It enables the Two-Token model to work (One of them is FIAT pegged-Fixed price, non-transferable and no market value hence considered as a product, not a security, to peg service usage to FIAT and this comes with many benefits, actually so far this seems the most valid purpose.
2- It tackles the velocity problem and hence helps with Value accrual/capture of Utility tokens (a valid concern), This was first discussed by Multicoin Capital’s article Linking Network Growth with Token price appreciation. (Meh, a crippled model for Value accrual)
3- Price Stability: Promoting price stability by mitigating the volatility/fluctuations associated with utility tokens' velocity issues. (Meh, doesn’t quite work -yet-)
4- Adaptability: The BME model can be fine-tuned and adapted to suit the specific needs of a project.
5- A continuous way to Incentivize Network Participation: it creates sort of a positive loop and a way to always incentivize the supply side under a max supply cap. (can be done with many other models, so not special to BME)
6- Appropriately Reward contributors/service providers, tackling the underpaid/ overpaid issue that’s currently being experienced with many protocols
Before discussing the above points in detail = Every token model comes with its trade-off as anything else. It is a matter of what suits your project and its objectives.
1/ The 2-Token model, for BME to work as planned, it needs the 2-token model, every current BME project has the 2-token model in place,
The value proposition of the BME model is realized for users/enterprises who
Seek a predictable cost model so they can budget effectively.
Bypassing regulatory hurdles associated with cryptocurrency
Need the flexibility to price their services.
Disincentivize hacking (DC has no market value)
Most of the DePIN target audience are not native Crypto users, but people who are risk averse and web3 agnostic, who exactly needs the above features. At Onocoy (A web3 targeting the GNSS industry); They see this as the main reason why these models should be considered)
In this situation your hands are tied, the above might be must-have features for the success of your project that you cannot let go, and you are trying to capture as much value as possible at the same time, it would be understandable to choose the BME model.
Some projects approach it in reverse! where they don’t care about having a token at all, they want FIAT pegged revenue and addressing web2 users, but they want to leverage web3 mechanisms to easily bootstrap the network at the early stage, add governance, staking, etc, So they put a value-seeking token and link it to the FIAT one.
Also important to mention; the above points benefit Enterprises more, Purely B2C and targeting retail by your service, you should carefully consider the reasons for adopting this model.
2/ Value accrual; DePIN projects often implement the Burn-Mint Equilibrium (BME) model for improved value accrual.
However, its effectiveness is limited due to the inherent “equilibrium point” In the two-token system, which the Token design aims to achieve somehow.
Borrowing Kyle Samani’s example;
“Let’s walk through an example that assumes no market speculators. I’ll assume the following:
Tokens minted per month: 10,000
Cost of token in USD: $10.00
Unit cost of service: $.001
The system will be in equilibrium—meaning that the number of tokens in circulation remains unchanged— if 10,000 tokens are burned per month. Since the cost of using the service is $.001, the system will be in equilibrium if the service is used (10,000 * 10)/.001 = 100,000,000 times per month. If usage grows and 15,000 tokens are burned in a month, then total supply will decrease, creating upwards price pressure. This upwards price pressure means fewer tokens need to be burned to purchase the same amount of service from the network, bringing the system back into equilibrium. This works in reverse as well.”
With Minting declining across the years and demand (burn) increasing, it should Capture value from the growth.
As if, The price action bar raised a bit with every additional buy pressure than usual, and then set back to the equilibrium to be capped again, and so on.
It doesn’t by any means create an ideal linear relationship between Network Usage(Value creation) and Token price appreciation (Capturing some of that value)
But Founders may choose BME for the other benefits mentioned while relying on market dynamics and speculation to support the token price
In certain cases, BME may be the best available solution, with no viable alternatives providing an optimal balance of benefits.
3/ Velocity problem and price stability
If you think having a fixed supply, While demand increases with time, the token price should increase= you are wrong, cause you are not taking into consideration the Velocity problem.
Because of the velocity issue that utility tokens suffer from; We fear that users have no incentive to hold the utility token, they only buy it when they intend to use it and nothing more. And therefore we fear token price bleeding.
Here comes the price stability benefit of the equilibrium point.
Assuming no market speculators, The BME model can help in maintaining the price stability of the utility token as the burning and minting mechanism ensures that the token's supply is controlled, which can lead to less price volatility and a more predictable token value.
So while the equilibrium point might be seen as a limitation of the BME model, it's important to consider the trade-offs it provides in terms of price stability and network participation incentives.
But does BME help with price stability as -theoretically intended?
Hmmm, it needs statistic calculations and modeling, But this should be reviewed again and validated, We are not dealing with closed-looped systems. Humans, emotions & speculation comes into play, so what works theoretically might not work in a permissionless open market like Crypto.
6th man ventures did a study, Simulating Token Economies (of both Fil, HNT, and LINK). One of the key insights they reached:
“Although the strongest factor in token price performance is macro changes, they show that token design decisions can help mitigate downward price pressure during bear markets. Poor token design helps accelerate crashes in bear markets while smart token design increases stability and token price performance, even in volatile markets.”
Comparing HNT price action with Fil one (Filecoin is using the work token model, which is considered a rival to BME)
It seems Filecoin demonstrated better price protection during bear markets. (Just arbitrarily mentioning this to initiate a re-think for this point.
Yeah, Crypto is all speculation now and many factors go into this. but the above finding suggests that the intended benefits of the BME model may not materialize in practice as expected. Before choosing a model, it is crucial to ensure that the objectives of the models are achievable in real-world scenarios.
4/ Adaptability: Currently, There are more than 3 different forms of BME, some teams tweak the design to better suit them.
-For example, React doesn’t have the burn function instead, all KWH used to get the Data tickets, goes to the DAO treasury, They see Token burns as capital in-efficient, referencing the popular article by Placeholder
-Another example is Accumulate where the burnt amount goes to unissued pool (isn’t counted in the circulating nor the total supply) where 16% of the unissued pool gets minted yearly, Refer here.
-The 3rd and most popular one is helium and following it= the rest of the projects, where tokens get burnt permanently.
Also, the supply side schedule/emissions differ significantly from each other.
So there isn't a default optimal design to use.
Speaking of which, it is really important to think again of the burnt tokens and whether this is the best for the protocol interest or some other ways like the above ones might be considered as better options.
Another tweak to add; Staking is a nice-to-have feature, it adds a stability/predictability layer to your network, Helium had 25-30% of their tokens staked(locked for a few months) before the migration, Filecoin targets 40-50% of their tokens to be locked at any given time, etc.
Though, Staking is much more crucial in the Work token model, as every participant in the network stake for access. In a way it helps with Value accrual to the token, and more importantly; the system can use this information to determine who has a vested interest in the network and is therefore more likely to act in its best interest. This can help to improve the overall security and reliability of the system.
Extending the talk about React's approach, which is interesting;
They explore an alternative to the deflationary burn and mint model, inspired by Joel Monegro's article on the buyback-and-make model. This model retains the benefits of buybacks(demand) without the drawbacks of burning capital. However, its success in the DePIN space is uncertain.
To explain more about the 2 models here in a detailed precise way;
Deflationary burn and mint economy:
Pros:
Scarcity: Burning tokens reduces the circulating supply, potentially increasing the token's value if demand remains constant or increases.
Price stabilization: By balancing the burning and minting rates, the model can help stabilize the token's price and avoid extreme price volatility.
Cons:
Capital inefficiency: Burning tokens can be considered wasteful, as the value of the burned tokens is not utilized for the project's growth or development.
Potential side effects: A deflationary economy may discourage spending and reduce the velocity of tokens, leading to decreased network activity.
DAO treasury model:
Pros:
Capital efficiency: Instead of burning tokens, they are channeled into a DAO treasury, which can use them to fund future growth and development.
Incentivizing growth: The DAO treasury can allocate tokens to incentivize network participation, driving adoption and fostering a healthier ecosystem.
Cons:
Inflation risk: Accumulating tokens in the DAO treasury might create inflationary pressure if the token supply increases faster than the network's growth.
Governance complexities: The management of the DAO treasury requires a well-designed governance model to ensure the tokens are used effectively and aligned with the project's goals.
Another option I see that might be interesting: A middle ground could involve burning an equivalent amount of minted tokens and sending the rest to the DAO treasury, balancing inflation and capital efficiency.
On the other hand, Professor Mark Ballandies from Onocoy pointed out that this is an age-old debate in economics where the Austrian school mostly favors deflationary currencies, whereas Keynesian favors the inflationary.
There is no right answer here, and as we speak about this;
Uros Kalabic made a first principle attempt to value a Burn-Mint economy and concluded that by introducing a sufficient deflationary factor, the token would succeed in capturing value and avoid failure.
Oppositely, 6th man ventures in their simulation above; They reached an early finding:
“In our models, adjusting token emission rates (e.g. deflation) did not meaningfully affect a protocol’s performance. Instead of using deflation to drive token price, we recommend protocols to prioritize value drivers.”
Surprisingly, through the simulation, they found that the control run (~ +8%) emissions had the highest stability, which contradicts the intuitive understanding of scarcity in token economies (The study was across 90-days so the effect of inflation most probably will appear later on)
This aligns with Placeholder’s view of “buy back and make” instead of burn, with a focus on value drivers and long-term growth.
If the BME model isn’t so good and attractive to implement, Why do most of the DePIN projects still use it?!
Yeah, Although the Work token model works better in terms of value accrual (Work token model captures all network participation’s value to be reflected into its native token price instead of just the protocol usage(demand) in BME’s case)But, the work token is not universally applicable.
The work token model only works if the service being provided is a pure undifferentiated commodity (Computation, File storage, Video encoding, Rendering). If suppliers compete on other variables, such as marketing, customer service, go-to-market strategies, etc. then the work token model doesn’t work well.
Yet React, Render, and Helium used BME although they can somehow use the work token model (at least I assume so!)
To be continued in another article!