NEAR Crypto-Economics: An Introduction in Context
Since the creation of Bitcoin in 2009, the past decade has witnessed the emergence of public computing platforms built around cryptocurrencies: From new currencies, to utility tokens, to security tokens, to non-fungible tokens the area of ‘Crypto-Economics’ has emerged alongside public permissionless blockchain ecosystems. This introduction explains the basics of the NEAR Protocol Crypto-Economic Model in context, and outlines future components of the model that will be discussed in subsequent posts of the series.
Section 1 provides a general introduction to crypto-economics: Why they matter, and their long-term significance for the health of any Blockchain Ecosystem. Section 2, introduces the general outline of the NEAR Crypto-Economic Model and the various incentives contained within it for different Network Stakeholders. To conclude, an outline for future articles in the series is put forward.
Section 1: Understanding Crypto-Economics
Crypto-Economic models are a natural result of public computing platforms and subsets of game theory dynamics such as mechanism design. In essence, they represent an economic system in which self-executing software and digital representations of quantifiable value are transacted between self-interested and uncooperative stakeholders.
All crypto-economic models are built upon certain core presuppositions, that increase the resilience and durability of the system in spite of unknown circumstances. These assumptions largely center upon incentives amongst the different stakeholders involved:
- Stakeholders such as network validators, users, and protocol developers are assumed to be non-cooperative and self-interested. This means that the design of any crypto-economic model must direct the self-interested incentives of all stakeholders towards the security and functionality of the network.
- No single entity can or should be able to leverage a disproportionate amount of control over consensus on the distributed network. This means that of all of the stakeholders involved, the flow of value must be such that no single actor can monopolize or jeopardize the overall network state.
- Rewards are allocated to network participants in proportion to the degree from which they support the security of the network. Penalties are enacted against network participants in proportion to the degree with which they jeopardize the security of the network. Because of this, there is a direct incentive to strengthen the network and avoid penalties, because each stakeholder involved is assumed to be fully self-interested.
- Value is created within the network, from the incentives and interests of the stakeholders transacting upon it. This value is imbued in the representation of a digital token or coin. Digital tokens or currencies are the language of value on a distributed network. This means that what makes a crypto-economic system valuable is the use that it provides to interested stakeholders: end-users sending or receiving money, companies storing data, or gamers purchasing items. In any and all of such examples, value is accrued to the overall network and distributed out to the self-interested stakeholders contributing to the networks’ security.
When taken together, these dynamics create the foundation for the Internet of Value: An global cloud environment, in which distributed computing provides the basis of valuable services to self-interested and uncooperative stakeholders, without any single entity or individual controlling the marketplace as a whole.
Crypto-Economic Design Over Time
There is one small caveat for launching crypto-economies of scale. Time. Transactions and commerce across a distributed network are the building blocks for network growth and user-interaction: As more value is transacted on a distributed network over time, the overall value of the network itself increases, just as the incentive to participate in securing the network increases. However, until a network has grown to such a point the underlying incentives for network stakeholders can often be misaligned.
As a result, crypto-economic ecosystems almost always require some type of governing body or distributed autonomous organization (DAO) to direct the network in its infancy and then slowly remove itself over time as the network scales, and more stakeholders and commerce accrues. The responsibilities of such groups include:
- Managing initial stakeholder relationships on the network to incentivize network participation.
- Designing and implementing the crypto-economic model of the Ecosystem itself according to the proposed function of the network. This specifically refers to how transaction fees are set and managed, whether the system is inflationary or deflationary in nature, and if special rewards are allocated to developers, early adopters, or entrepreneurs.
- Establishing a time frame for growing and scaling the network until such a point arrives that the network is self-sustaining without the guidance of the said organization.
Importantly, such organizations are not companies per se: They are often designed as Foundations, or Non-Profit Organizations who simply provide guidance, decision-making power, and structure to the distributed ecosystem.
Altogether, it would be fair to say the following about most Crypto-economic Ecosystems:
- They are designed around a distributed computing platform, where value is tied to a digital token or currency.
- They presuppose that all network actors are uncooperative and self-interested.
- The design is such that stakeholders are incentivized to enhance the network via a consensus structure, and penalized for harming the network.
- Until a given crypto-economic grounded ecosystem is self-sustaining a governance body of sorts, designs and directs the network’s development and the rules underlying its crypto-economic model.
Section 2: NEAR Protocol Crypto-Economics – the Macro View
NEAR Protocol is a Thresholded Proof-of-Stake Blockchain, in which value is tied to the NEAR Token. Stakeholders on NEAR Protocol are incentivized to participate in validating ‘chunks’ or entire ‘shards’ of the blockchain, by setting up and operating a validator node on the network. To do this, a participant must either lock up NEAR tokens in a smart contract; or alternatively, delegate NEAR tokens via smart contract to an already existing validator on the network. In line with other game theory designs, if a validator succeeds in validating their chunk or shard, they are rewarded:
If validators fail or intentionally sabotage the network they fail, and a portion of their stake is slashed.
While Validators are responsible for validating transactions and maintaining security on the Network, NEAR’s crypto-economic model is also comprised of other key features that work to ultimately create a robust and enduring crypto-economy. For each feature discussed below, a specific blog post in the future will delve into the exact details of the system:
Token Supply, Inflation, and Deflation
Most crypto-economic models begin with a fixed number of tokens in circulation (circulating supply), with clear designs for how many tokens remain to be issued, or when certain tokens might be burned. NEAR’s monetary structure consists of both inflationary and deflationary dynamics, based upon a total supply of 1 billion NEAR tokens. The initial circulating supply is set at roughly 57,500,000.
Importantly, not all NEAR tokens are issued into circulation all at once: Instead, NEAR tokens are added progressively to the network over time in the form of base rewards for validator nodes, and other aspects of the ecosystem.
More specifically, each year there is a set inflation rate of 5% more tokens minted into circulating supply, with 90% of such tokens going to validators. The remaining 10% of the tokens are sent to the protocol treasury (0.5% of inflation each year).
As a counter-balance to these inflationary dynamics, NEAR’s design incorporates certain deflationary mechanisms as well. Rather than using transaction fees to reward validators (as done in many other networks), NEAR allocated 30% of each transaction fee back to the contracts that transaction has touched, after which the remaining 70% is burned. Developers of such contracts can then decide how such fees are to be used, while 70% of all transactions on the network are effectively burned. In this manner, a natural deflationary mechanism is built into the design of the network.
Overall, these crypto-economic features indicate that the NEAR Ecosystem will be inflationary in nature at the beginning as it scales and grows, with the opportunity to become primarily deflationary as network usage and transaction fees are burned from the network.
10% of all inflationary rewards are sent to the NEAR Protocol Treasury. In context, these rewards are used to ‘sponsor protocol and ecosystem development’. While the Protocol Treasury is initially managed by the NEAR Foundation, its design is such that over time it can be managed by a decentralized governance process.
While the full significance of this will be outlined in a future blog, the underlying value of the protocol treasury is that it provides a mechanism for sustainable ecosystem development into the future. As the ecosystem strengthens and becomes more used, support for projects from the treasury will naturally increase to equally strengthen future development on the network.
The Long Term View: dApps and other Tokens
While certain crypto-economic features provide a framework for growing and scaling NEAR Protocol, the prospect of open-source ecosystem development is perhaps the most important long-term indicator of the network’s success.
NEAR is designed such that future applications, solutions, and industry verticals built on top of the platform are directly correlated to the demand of NEAR tokens and the payment of transactions on the blockchain (and therefore, deflationary counterbalances). As such, when new dApps launch, new protocols are developed, and other decentralized marketplaces and platforms build on top of NEAR the entire Ecosystem as a whole grows.
In this manner NEAR is best understood as a modern hub for digital commerce amongst decentralized applications: As more solutions and dApps are built, more stakeholders are brought onto the network, more tokens are used, and more value is accumulated. In tandem, protocol treasury rewards strengthen over time, and more projects can be funded to bring in more stakeholders and so forth. A virtuous cycle of positive Ecosystem development is built into the very core of NEAR’s crypto-economic model.
Conclusion: 4NTS Crypto-Economic Series on NEAR
4NTS is a recently launched NEAR Guild created to help grow the Ecosystem by outreach, communication, analysis and education. In the up-and-coming NEAR Crypto-Economics blog series, we will be discussing the context, details, and Macro outlook for the following topics relating to the NEAR Crypto Economy:
- Token Functionality of the NEAR Token.
- Storage Fees and Rent.
- The NEAR Protocol Treasury.
- The Value of Inflation and Deflation.
- NEAR Gas Fees in Crypto-Economic Context.
- The NEAR Foundation.
- Ecosystem Development in Context.
- Staking Delegation on NEAR.
- Demand Pressures on NEAR.
… and much more!