9. Building Networks with Token Incentives
Show me the incentives and I will show you the outcome.1
Incentivizing Software Development
It’s telling that the most successful protocol networks were funded by government programs in the 1970s and 1980s, before the arrival of the commercial internet. Email and the web prospered absent corporate network competition. To quote The Cluetrain Manifesto,2 a book published in 2000 that describes how the internet had changed business (and much else): “The Net grew like a weed between the cracks in the monolithic steel-and-glass empire of traditional commerce.” The internet flourished, the authors continue, “largely because it was ignored.”
Imagine if email and the web had, in their nascency, faced off against corporate startups. The protocol networks might never have endured. Probably, they would have gone the way of other fizzled protocol networks, like RSS. Corporations were able to steamroll protocol networks in part because they had so much more funding to support software development. Tech companies could build large teams of world-class developers by offering them attractive compensation and financial upside that protocol networks couldn’t match.
Networks don’t build themselves. Any network design that seeks to challenge corporate rivals needs to offer competitive compensation and financial upside. Someone needs to put in the work; that this is a truism doesn’t make it any less true. Incentives matter.
Protocol networks generally don’t have the resources to provide developers with competitive compensation. They lack self-sufficiency and depend on the goodwill of volunteers instead. Like protocol networks, blockchain networks rely on third parties, either individuals or companies, to build most of their software components, but there’s a key difference between the two: Blockchain networks don’t rely solely on volunteers. They have a built-in mechanism for funding developers.
Blockchain networks use token incentives to motivate developers. Recall that tokens are general computing primitives for representing ownership and that they can represent units of value underpinning the economies of blockchain networks. (We’ll cover principles for designing blockchain-based economies in “Tokenomics.”) Tokens used for this purpose are usually called native tokens; for example, ether is the native token of the Ethereum blockchain. Sometimes, in addition to being a financial incentive, native tokens can confer governance rights to their holders. (More on this in “Network Governance.”)
By doling out token incentives, blockchain networks bring outsiders into their fold, encourage software development, and stay competitive. The funding source enables blockchain networks to create modern software experiences that rival those of corporate networks.
In corporate networks, employees perform almost all software development. Work to be done at a company like Twitter includes developing and maintaining the app, tweaking algorithms that sort and rank tweets, and creating filters to fight spam. Blockchain networks, by contrast, externalize these tasks. They get outside developers and software studios to do the work. Jobs held captive in corporate networks become external, market-based tasks in blockchain networks. These outside developers are often compensated with tokens, turning them into stakeholders with partial ownership and governance rights in the network.
Token incentives for developers have multiple benefits. First, anyone in the world can contribute, widening both the talent funnel and the base of network stakeholders. As contributors earn tokens and become partial owners, they have an incentive to help the network succeed, by building software, creating content, or helping the network in other ways. Second, token incentives create competition for each task, which means users get to choose from multiple software options, the way they get to choose from multiple web browsers and email clients. Third, the tokens can be disbursed transparently and programmatically, unlike corporate stock, in a way that’s fairer, more open, and more frictionless than analog systems. (More on this in “Regulating Tokens.”)
The goal of any project is to recruit a broad community of contributors, but it takes time to get there. At the earliest stage, projects usually consist of a small group of developers pursuing a new idea. Sometimes the early contributors collaborate informally, and other times they create formal relationships using legal entities. The early developers are usually compensated, at least partially, with tokens. A well-designed network distributes these token rewards such that the team will have some ongoing influence and upside after the initial work is done, but not too much.
When the semiautonomous code is ready to run on a blockchain, the early developers launch the network. In doing so, they relinquish control. Early developers often continue to work on apps that provide access to the network, but these are typically just one of many such apps. Networks work best when they are supported by a broad and diverse community. Blockchain networks are permissionless, and when designed properly, they privilege no app developers—even the original inventors of the network—above any others.
Postlaunch, blockchain networks fund ongoing development through token grants. Several blockchain networks have treasuries worth hundreds of millions of dollars from which grants can be distributed3 either by community decision or in an automated way based on predetermined metrics. Grants can go, for example, to independent software developers for building front-end applications, infrastructure, developer tools, analytics, and more. In a healthy ecosystem, for-profit investors will supplement these grant programs with additional funding for new projects, apps, services, and other businesses that build on the network. (Recall from the last chapter how predictably low take rates encourage blockchain network investment because builders and investors know that if they succeed, they will receive the upside of what they build.)
Blockchain networks’ ability to disburse token incentives to software developers puts them on a level playing field with corporate networks. Grants, plus outside investments, allow blockchain networks to credibly compete with the sizable investments that corporations make in software development. But token incentives can have other advantages too. The same rewards that attract developers can also attract users, creators, and other network participants.
Overcoming the Bootstrap Problem
Early network participants create significant value for corporate networks, yet they rarely receive fair compensation for their efforts. Just look at the video creators who built YouTube, the social groups who built Facebook, the influencers who built Instagram, the homeowners who built Airbnb, the drivers who built Uber—the list goes on. Without participants, there’s no network.
Almost invariably, corporate networks consolidate wealth and power in the hands of a small group: investors, founders, some employees. To a lucky few go the spoils. The network effects accrue to the company that owns the network, often resulting in winner-take-all outcomes at the expense of other contributors. As corporate networks grow, early users get burned. A few corporate affiliates make money while everyone else who helped build the network gets passed by. Early participants become embittered. They’re left out.
Blockchain networks take a much more inclusive approach. They grant tokens to early users who build and participate in networks. A blockchain social network might reward users for creating content that is popular with other users, for example. A game might reward users who play well or contribute interesting mods. A marketplace might reward early sellers who bring in new buyers. The best designs reward users not for paying fees or buying anything but for making constructive contributions to the network.
As the network grows, token rewards should taper off. More participants make a network more useful; once enough people are participating and network effects kick in, the need to offer incentives decreases. People who take a risk by contributing early, when a network’s success isn’t assured, gain the most.
This isn’t good just for users and contributors. It’s also good for the networks. A key challenge when building networks is overcoming the “bootstrap” or “cold start” problem: attracting users and contributors before enough of them are participating to make the network intrinsically useful. This is because network effects cut both ways: they can accelerate growth, but they can also handicap it. Scaled networks attract new users without much effort. Conversely, subscale networks struggle just to survive.
Token rewards can help overcome the bootstrap problem. DeFi networks like Compound pioneered4 this approach after recognizing that token incentives can recruit users during the bootstrap phase, when network effects are weak, as the chart below shows.
Corporate networks used similar techniques to overcome the bootstrap problem, although instead of token incentives they offered subsidies. As you’ll recall, when YouTube started out, it subsidized video hosting costs as an incentive for people to contribute videos to its network.
But subsidies go only so far. There are many networks that would be broadly useful and should exist yet do not because it is so hard to overcome the early hurdles to network effects. Token incentives offer a new technique for building networks in categories where previous attempts got stuck.
Take telecom, for instance. For decades, technologists have dreamed of building a grassroots internet access provider. Instead of a corporate network owner building out and owning the infrastructure, users would voluntarily install access points, like wireless routers, at their homes or offices. Another set of users would tap these access points (rather than, say, corporate cell towers) for network connectivity. The goal would be to displace incumbent telecom companies like AT&T and Verizon with community-owned alternatives.
Over the years, people have tried repeatedly to start a grassroots telecom service. Students at MIT (Roofnet), employees at a venture-funded startup (Fon), and neighbors in New York City (NYC Mesh) all took a crack at the challenge,5 and they all learned how hard it can be to install a sufficient number of access points for broad network coverage. Most projects stalled at the bootstrap phase.
That is, until one. An experimental blockchain project,6 Helium, got further than anyone else. The network encouraged people to install and run access points in exchange for token rewards, enabling it to reach nationwide coverage in a few years. The project still has lots of work to do to build out the demand side of the network. (The initial network was based on an esoteric networking standard, but it has since upgraded to 5G cellular, a much more popular option.) But Helium built the supply side of the network for a grassroots telecom service much more successfully than previous attempts—proof of token incentives’ potential.
Already, other projects are using similar methods7 to build out networks for electric car charging, computer storage, artificial intelligence training, and more. These are all networks that would be useful for the world but that have gotten tripped up by the bootstrap problem. Token incentives provide a powerful new tool for overcoming hurdles to building new networks. They can also help break the rich-get-richer tendency in corporate networks, where only the employees and investors, not the users, see upside when a network succeeds.
Tokens Are Self-Marketing
Achieving a word-of-mouth chain reaction is the dream of any marketer. One person tells the next two people, who tell the next four people, who tell the next eight people, and so on, exponentially. Such testimonial-driven marketing is the most effective and cost-efficient way to grow a product, a brand, a community, a network. The trick is to be contagious.
Ever since Hotmail added a default footer to emails8—PS: I love you. Get your free email at Hotmail—founders have obsessed over finding the right viral loop to make their services infectious. Facebook figured it out for socializing on college campuses. Snap got through to teenagers who were tired of having a permanent digital record. Uber found the secret in a magic button to make rides and food instantly appear.
But many users have settled into habits since these corporate networks first appeared. For evidence, look at the top apps in the Apple or Google mobile stores.9 Almost all the products that consistently stay in those top lists were founded more than a decade ago: Facebook (2004), YouTube (2005), Twitter (2006), WhatsApp (2009), Uber (2009), Instagram (2010), Snap (2011), and so on. Even the parent company of TikTok10 (2017) has been around for longer than you might expect: ByteDance (2012).
I’m not saying new services will never hit it big. There will always be exceptions. Maybe AI apps like ChatGPT will have staying power and become the new top apps. But for the most part the game has changed. If you talk to consumer internet investors, they’ll tell you that users have filled up the home screens of their phones and it’s much harder for new apps to break out. People’s routines are set.
Big Tech companies are now the gatekeepers. For startups to reach people, they first need to go through these services. Corporate networks in the extract phase throttle how much free traffic startups receive and force most startups to advertise to continue growing, as discussed in “Take Rates.” To get noticed and stay relevant, many startups need to pay for promotion.
Startups justify the increased marketing expenses11 under the theory that if they retain enough customers, the long-term economics will work out. They convince themselves that they will, someday, become profitable. In practice, the marginal profitability of advertising declines12 as startups scale. Many later-stage startups—whether they’re selling mattresses, meal kits, movie streaming, or whatever else—have high user acquisition costs and negative margins. They devolve into bad business prospects, in other words.
Tokens provide a new way to skip advertising and acquire customers through peer-to-peer evangelism. Tokens empower individuals to become stakeholders in networks, not just participants. When users feel a sense of ownership, they are motivated to contribute even more and spread the word. These user-evangelists are more authentic and effective than corporate marketing programs run by hired teams. They win hearts and minds through blog posts, tweets, and code. They participate in forums. They sing praises and shout from the desktops. Thanks to their economic and other benefits, tokens don’t need marketing, per se; tokens are self-marketing.
Blockchain networks depend on community-led evangelism, not advertising. This allows them to grow without having to pay Big Tech gatekeepers. Bitcoin and Ethereum don’t have companies behind them, let alone marketing budgets, and yet tens of millions of people own their tokens. Evangelists use word of mouth. They organize meetups, chat online, trade memes, and write posts. The same happens with many other networks. Almost none of the top blockchain networks have spent materially on advertising. They don’t need to; they’re contagious. Users do the marketing.
Tokens are a powerful tool, but they need to be used responsibly. The networks they are part of should provide useful services. Marketing should be a means to building a network, not an end in itself. Otherwise, projects evaporate as empty marketing schemes. (This is also why thoughtful regulation is important, something I discuss in “Regulating Tokens.”)
Again, the city analogy is useful. Homeowners are incentivized to build and promote their cities. They develop real estate and start businesses, support local schools and sports teams, get involved in organizations and civic causes. They are true community members with financial upside and a say in governance.
Building true communities is the best way to go viral.
Making Users Owners
Perhaps the purest example of the self-marketing phenomenon13 in action is Dogecoin, a well-known “memecoin,” or joke token.
Like many memecoins, Dogecoin sprang from the open-source ethos of blockchains. Creating a blockchain network is easy because anyone can “fork,” or copy, another project’s code. Dogecoin is one such derivative. In fact, it’s a copy of a copy … of a copy. Dogecoin is a fork of another project, Luckycoin, which is a fork of Litecoin, which is a fork of Bitcoin. (That’s composability for you.)
The founders of Dogecoin intended the project to parody cryptocurrencies like Bitcoin. Yet, despite being a spoof with no practical applications, Dogecoin has maintained a market capitalization in the billions of dollars for years. Only a few places accept the coin as payment, but it has developed a passionate following anyway. More than two million users subscribe to the Dogecoin Reddit discussion forum,14 with Elon Musk as the project’s most famous supporter. After meeting at Dogecoin meetups, some people have even gotten married.15
Dogecoin’s creators are sour about what they built and periodically disparage crypto in an attempt to tamp down the mania over their invention. Despite the founders’ criticism, the coin has taken on a life of its own—like Frankenstein’s monster, only cuter.
Dogecoin’s tenacity proves how a grassroots community can propel a blockchain network long after the original team departs—or even turns hostile. To its users, Dogecoin may be a silly network, but at least it’s their silly network. Users own and control the network. If there were meaningful decisions to be made about the network’s development, the users would get to make them. If the network were to grow, Doge holders would see the upside, which is not the case in corporate networks. Dogecoin is the closest one can get to a clinical experiment demonstrating the power of tokens absent confounding factors.
To be clear, I’m not a fan of Dogecoin, at least in its current state. I’m not a fan of most memecoins, for that matter. The majority exist solely for financial speculation, and at worst they can be Ponzi schemes that enrich their promoters. (The beauty of permissionless innovation is, of course, that if you disagree, you don’t have to get my blessing or anyone else’s.)
Despite its frivolity, the Dogecoin community has remained vibrant for more than a decade. Other memecoins have remained strong for similarly long periods. For thirty years users have been contributing to the growth of internet networks but have received little in return. Corporate networks forgot them. Dogecoin and other tokens actually include them, making them owners and granting them real control and upside for the first time. Clearly, ownership has a powerful and lasting effect.
Now imagine pairing that effect with a network that provides useful services. Uniswap combines a useful product16—a decentralized token exchange—with a dedicated community that benefits from the network’s success. More than $1 trillion in assets17 has flowed through the network since its debut in late 2018. In 2020, Uniswap distributed free tokens—15 percent of its total supply—as a reward to anyone who ever used the network. At the time, roughly 250,000 users received an “airdrop” worth thousands of dollars per user,18 plus network governance rights. Additionally, the network set aside another 45 percent of its tokens for community grant programs, thereby allocating in total 60 percent of the network’s tokens for its community.
Turning users into owners at this scale is unprecedented in the history of tech startups. Uniswap’s community received a majority of the network’s financial upside and governance power. Most corporate networks are much stingier when it comes to sharing anything of value with network participants, beyond a narrow set of employees. Facebook, TikTok, Twitter, and most other large corporate networks set aside no shares for the users who built, grew, and sustained these networks.
Throughout this book, I’ve discussed the drawbacks that arise from the corporate network model. Corporations have done a lot of good too, of course. As noted in “Take Rates,” the deflationary business models of companies like Amazon, Airbnb, and Google lowered the price of services for consumers while maintaining or improving product quality. Users voted with their feet, awarding money, attention, and data to companies whose offerings were better than what came before.
But we should expect more from the internet. Cost savings are nice, but wouldn’t it be nicer if companies let users, not just shareholders, participate in their financial success? The market cap of Big Tech companies totals in the trillions of dollars. Users, especially early ones, contribute much to this success. They sell products on Amazon, publish videos on YouTube, share content on Twitter, and so on. Users make early bets, just as founders and investors do. And yet in most corporate networks, users are treated as second-class citizens at best, or as a product to be served up to real customers, like advertisers, at worst.
There are glimmers of hope. Some companies have managed to set aside equity for users19 as part of their initial public offerings. Notably, Airbnb, Lyft, and Uber reserved portions of their initial public offerings for some homeowners and drivers and encouraged them to buy shares with onetime cash bonuses. These programs are a step in the right direction. But they account for only a fraction of these companies’ total ownership—in the low, single-digit percentages.
Blockchain networks are, meanwhile, much more generous. In most popular blockchain networks, the community receives more than 50 percent of the total tokens,20 which are distributed in various ways, including through airdrops, developer rewards, and early-adopter incentives. Instead of being concentrated in the hands of a small group of insiders, ownership is broadly distributed among users according to how much they contribute to the network.
This is how all networks should work. If corporate networks can figure out how to give their communities significant ownership, as many blockchain networks already do, that would be good for the world and a far better outcome for users. But corporate networks haven’t done this so far and don’t seem likely to. Besides, even if corporations do find some way to make it happen, they will still come up short in other areas, like making strong commitments to users, guaranteeing low take rates, and ensuring always-open, composable APIs.
Blockchain networks bake community ownership into their core design. It’s in their DNA. While memecoin mutations, like Dogecoin, may seem like a joke, they show how users are embracing all sorts of tokens—some silly, some serious—in search of community, to fill the void left by corporate networks. The internet was originally envisioned as a decentralized network owned and controlled by its participants. Tokens restore that vision.