Principles of Incentive Designing in Web3 That You Should Know
Introduction
"Never, ever, think about something else when you should think about the power of incentives."
Tokenomics is directly related to the psychological concept called incentives theory. Right from childhood, humans are wired in such a way that they will be rewarded for completing tasks. Hence, naturally, incentivization is within the thought of everyone, so ultimately, even a business must be operated in that way. You can even find the basics of this idea in your daily life. A kid, for instance, is being incentivized to help you with household chores such as making their bed or cleaning their room. They like to help, so they earn the incentive. In simple words, the theory claims that incentives or what we call "rewards" are likely to encourage specific activities.
In the blockchain world, incentives theory works in the same way. In a token economy, incentives encourage us to take useful action and are very important to a token's ecosystem.
In this blog, we will understand , What is incentive designing in tokenomics? Why it is important ? How to design an incentive system? and What if the system is not governed by incentives?. We will also look into the different incentive mechanisms across industries and how some projects are successful even without being heavily dependent on this mechanism.
What
is incentive designing in Tokenomics?
Incentives are everywhere in the blockchain platform, manifesting in a variety of ways such as miner rewards, transaction fee-setting mechanisms, token-curated registries,
and prediction markets.
From an economics perspective, it is the crux of the system. Incentive design is critical in the overall economic design of effective blockchain platforms. It builds on a platform's value proposition and structures the system for which the platform's Token will be designed. Incentives are what drive people to action within the given ecosystem. Properly designed mechanisms motivate users fairly and transparently.
As a human, your behavior depends on two main
factors:
1. The ability to receive rewards.
2. The desire to receive rewards.
Just like in your day-to-day basis life, the process of motivating crypto users in a token's ecosystem goes through these two actions. This means motivated users naturally will participate in critical network activities.
For example, let's say you are a user of a blockchain network. This blockchain rewards you each time you confirm transactions just because the confirmed transaction helps the blockchain to operate more securely.
If you confirm more transactions, you earn more rewards. This means better security for the network and an increased number of rewards for you. It's like a win-win situation for everyone. And this is exactly why incentives or rewards play an important role in blockchain networks.
Why
is incentive design important?
MIKE GOLDEN, a lead engineer at
consensus, has noted, "Blockchain gives programmable money; when you
program money, you can program incentives; when you program incentives, you can
program people." By using blockchain technology, we have the
capacity to build and implement large-scale structures for incentivizing human
behaviour at certain end.
Adam smith, a political economist and moral philosopher known for his foundational contribution to economics, discussed the importance of incentives in his magnum opus, "The Wealth of Nations."
"It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their interest."
How to create an incentive system that will align the entire circle of players in the ecosystem is the central issue?
Incentives could be used to encourage a variety of adaptive behaviors ranging from increased academic performance to a healthy lifestyle. The importance of a design of the incentive, what the reward is, and whether the incentive interacts with the intrinsic motivation. The prospect of obtaining a reward can motivate us to do a certain task or push ourselves to do better. Hence, it is very important to understand the network's incentive structures and design those aligned with overall desired outcomes. Incentive designing in Token economics is achieved through peer-to-peer exchange of values that incentivizes the actors to operate according to the overall effective outcomes.
Having understood the importance of incentive designing, let's see how to design an incentive system and what happens when a system is not governed by incentives.
How
to design an incentive system?
Economic
designs are a powerful tool for designing a decentralized economy, allowing the
participants to work together towards a common goal without the need for manual
supervision. In a system governed by incentives, the participants' behavior is
influenced by rewards and penalties.
According to a behavioral science theory called Incentive Theory in Motivation, people are more likely to act in desired ways if they are rewarded with an incentive. The reward could be a positive gift, praise, money, or a negative incentive like a penalty or participation restriction. In a system governed by incentives, the participants' behavior is influenced by rewards and penalties.
Are you looking at designing your incentive system? In the first case, you need to know what should be incentivized.
It should incentivize the good actors and disincentive the bad actors. It encourages the desired behavior and discourages the undesired behavior. The incentive could be a financial reward, access to resources or privileges, or recognition. Financial incentives are a strong motivation for people to join the network. It recognizes and encourages users to have a community around the ecosystem, participate, and stick with the network over time. Incentivizing is critical in attracting and retaining users and building a thriving and sustainable network.
Generally, the value of the Token is tied to the system's success. If the system does well, the community grows and becomes more valuable, increasing the Token's value and motivating the user to hold it. In addition, some tokens give the users voting rights, giving a sense of ownership and control over the system. Thus, thinking about the incentives of others is necessary to create a win-win relationship. Early investors, retail participants, and protocol users should push for strong and principled tokenomics.
The following approach is widely adopted to design incentives in tokenomics.
1. Identify the desired behavior
This is the first step in incentive designing to identify the behaviors that you want to incentivize. It could be holding the tokens for a certain period, participating in governance decisions, or contributing to the project development.
2. Incentivise desired behavior
Incentives can be designed to reward users who perform specific actions to encourage the desired behavior.
3. Disincentivise undesired behavior
Incentives can be designed to penalize users for engaging in undesired behavior.
4. Designing project tokenomics
Design the overall tokenomics, which includes demand, supply, and overall value of tokens.
5. Create network effects
Encourage users to participate in the ecosystem by designing incentives to create network effects. For example, it can be achieved by rewarding early adopters that increase the Token value.
What
happens if incentives do not govern a system?
Ignoring
incentives almost never works out well. Without incentives, there will not be
any motivation to work toward a common goal.
When incentives do not govern a system, the user will not have any motivation to participate, hold the Token and achieve network growth. There will be no reason to participate in the system as it would be difficult to retain users over time. As a result, user turnover will be high as they will not see any compelling reason to continue participation in the system.
The developers will not be motivated to build an ecosystem, without incentives, as they are drivers for any innovation and development. Hence there will not be scope for growth and evolution of the network.
The network's security could be compromised as miners do not have any incentive to validate the transaction, spending a lot of computational power and resources to maintain the network.
Lack of incentive may lead to centralization, as some participants are motivated only to contribute for incentives. This could lead to the concentration of power among those who do. Suppose the network has no or weak incentive system, in that case, miners may need more motivation to participate, reducing the network's hash rate and making it easier for a few miners to control it. This results in only a few actors having a large amount of control over it.
Prevailing incentive design mechanism across industries
Now let's look at a few design mechanisms across industries and understand how they incentivize the participants.
1. Learn to Earn
This is a prevalent method followed by centralized exchanges and crypto platforms. It helps the user to earn crypto by learning in an uncompetitive way.
Teaching is an essential component of an open financial system. Learn and earn incentivize the user for learning new concepts by rewarding in crypto. It is one of the effective ways to reach new users and educate them on their blockchain project or protocol. In this model, users will be eligible for crypto tokens until the predetermined amount is exhausted.
Coinbase has a very good learn and earn program that allows the reader to earn in crypto. It provides a simple and interesting module with a clear framework. In this, users are rewarded with crypto for watching the video or tutorial and taking the quiz that educates the users about the Token. This method incentivizes the user to learn about the project and provides knowledge to trade in any cryptocurrency. Furthermore, by introducing others to the learn and earn program, users will be rewarded with additional crypto as a part of a referral program. This model helps the user to learn about the Token instead of buying it by looking at the advertisement.
However, sometimes this program is available
only to those users who live in the listed geography or hold a minimum number
of tokens in the wallet to get qualified for the program. Users can exchange
the earned coin with other prominent tokens, hold or sell and realize it in
fiat currency.
2. Move to Earn
These are revolutions in the fitness industry and crypto market.
In a move-to-earn application, you
incentivize to move. The fitness application rewards users with gift cards,
merchandise, and vouchers in exchange for their efforts to reach fitness goals.
These platforms incentivize people to stay fit who are not into daily exercise.
This concept dually incentivizes fitness enthusiasts. Firstly, to get them fit
by walking and participating in fitness challenges, and secondly, they can make
some income out of it. Walking is a routine part of everyday life; this concept
incentivizes people as extra revenue by doing everyday activities and staying
fit.
When it comes to move-to-earn games, STEPN is the most famous one in Web3 and the crypto world. It will reward you for completing the workouts. You will earn some GST (Green Satoshi Token) in the app for performing activities like walking, cycling, running, and many more. These tokens can be traded for other cryptocurrencies or invest in them. The more you move around, the more GST tokens you will earn. In addition, users are rewarded for referring friends and family members who are looking to stay active and healthy.
3. Play to Own
This is a recent concept in the gaming
industry, although the community continuously expands.
Play to own incentivize the players to
participate in the game. Players are incentivized to have a stake in the game's
success, to contribute to the platform for achieving specific tasks, or
reaching a milestone in a game. This motivates them to continue playing and
contributing to the game's success, which drives the ecosystem's and
community's growth.
An example of Play to own incentive model is Upland, where users can start playing with an "Upland Visa." Once the uplander acquires citizen status, players can acquire any digital item that has tangible value and can be liquidated in the secondary market. This increases customer lifetime value, engagement, and retention. These games provide ownership security and benefit from long value creation. Operators will get happier and more loyal customers.
4. Play to Earn
These are revolutions in the gaming industry.
In the Play to earn business model,
blockchain games offer tokenized incentives to players that enable a framework
for the player as an owner rather than a standard player as a consumer. In
traditional gaming, the users play to win, and developers control all in-game
economics. In contrast, in the P2E model, they play to earn where they have ownership
and control over their digital assets. It incentivizes players to play and
progress within the game by offering rewards that have measurable value outside
the game. The players are compensated for their efforts and time spent online
with digital assets that have value outside the game that may appreciate over
time. It allows players to create digital assets and trade them in the game.
You make in-game currency by completing missions, winning battles, or other
challenges. The money earned is in the form of crypto; you can trade it or HODL
it. There are great varieties of Play to games available.
An example of the Play-To-Earn incentive
model is Metacade, which has incentive structures for engaging with
its services. Content creators can earn the native Token for posting game
reviews, sharing alpha, and interacting with other users. Players can compete
with any other player worldwide or beat solo levels and grab crypto-earning
opportunities. With their governance tokens attached to gameplay, users can
vote to decide which new game proposals should go into development. The vote
winners will receive early-stage funding to help bring new blockchain gaming
experiences to life.
5. Rent to Earn
This is the blockchain version of Airbnb.
Rent to earn is the upgraded version of Play
to earn. This reduces dependency on centralized companies from the Web 2.0
world, and users earn tokens by renting their unused resources to other users.
This would create more efficient resource use and incentivize individuals to
participate in the network. In addition, this model allows the users to rent
their unutilized resources to the network, which ultimately benefits the entire
ecosystem. This would also help the individuals create more efficient resource
use and earn tokens in exchange.
An example of the rent to earn model is Filecoin, which allows users to rent out their unused storage space on their computer to other users. Miners are paid in File coin's native currency, "FIL," to store, distribute, and retrieve data from miners' storage. It leverages unused storage spaces of electronic devices such as personal computers. The economic incentive offered by the protocol encourages storage providers to play their role reliably over time.
6. Travel to Earn
This concept aims to shape the new ecosystem
that drives change across the aviation, travel, and tourism industries.
The users are incentivized in the form of
tokens for completing travel-related activities, such as booking a trip to an
unexplored area, sharing a review of their experience on the website, or even
booking a trip. It provides the customer with a simple and transparent way to
earn rewards, allows them to easily track their progress, and redeem tokens for
a range of products and services. In addition, it rewards travelers with
existing flights, accommodation, and other hospitality experiences.
An example of the travel to earn model is Platform, it provides customers with a level of connection and engagement that was not possible earlier. It replaces traditional loyalty points or miles with crypto tokens. By tokenizing rewards, customers enjoy a more personalized and tailored travel experience. It allows the customers to earn tokens based on a percentage of the value of their purchases within their network. These tokens are transferred directly from the partner's wallet to the customer's wallet, and the transactions are recorded in the blockchain.
7. Share to Earn
This incentive model is being used by any
project who wants to attract new users to the project.
Users are incentivized in the form of rewards
for sharing information about that project or product with others. Interested
users can sign up with the platform and receive a unique referral link or code
that can be shared with their wide circle of friends and acquaintances. In
addition, the referrer will be eligible for rewards in the form of crypto when
the link is being used for signing up.
An example of the share to earn model is
being used in Crypto.com. It offers referral and affiliate programs for
users who can potentially invite more users to the platform. When an invitee
joins and trades on the exchange, both you and the invitee are eligible for a
reward. On top of this, the referrer will get a commission on trading fees
charged to the invitee.
8. Wellness to Earn
This concept is shaping up the fitness and
health industry.
It rewards the user for investing and
improving their well-being, particularly in mental health. This is a version of
Move-to-earn.
Users have to do light activities such as
Meditation and mindfulness, mental health support, and quality sleep. These
apps track the participant's progress through a smartphone, fitness tracker, or
smartwatch. They incentivize the users to continue using the app and engage in
mindfulness practices. It rewards the users with platform tokens and other
perks, such as discounts at wellness stores. They also penalize the users for
engaging in unhealthy behaviors such as smoking or for consuming too much
alcohol. Users are eligible for discounts if they hold a certain number of
tokens. Donations can be accepted through crypto, that attracts the young and
tech-savvy donor base and allows for transparent donation tracking.
An example of wellness to earn is Metatate,
which promotes mental health awareness by incentivizing daily Meditation. This
encourages the users to uplift their minds, body, and spirit each day. Users
are incentivized with the app's native Token, which can be exchanged for
rewards redeemed with merchandise partners, Meditation and wellness items,
technology items, and exclusive experiences.
Pokemon has announced the release of Pokemon sleep in the Summer of 2023. This game rewards players with a token to get a good night's sleep. To play, users need to place smartphones by their pillows, which enables the app to analyze data about the quality of their sleep time routine. The player's sleep style will be classified into snoozing, dozing, and slumbering. The longer a player sleeps, the higher their score will be, and more Pokemon will appear.
Projects without incentive design but still successful
Though
incentives are an important factor for the success of a crypto project, there
are few successful projects in the crypto space, including the below-mentioned
projects, that did not rely heavily on incentive design.
1. Stellar (XLM)
Stellar is designed to facilitate cross-border payments and other financial transactions. There are no special incentives for using or holding Stellar except for a small transaction fee for network usage. However, the project has gained traction due to its financial inclusion and partnership with World Bank and IBM.
2. Cardano (ADA)
Cardano is the first blockchain platform that
was built, focusing on research and development, academic peer review, and
layer architecture. The platform's success is mainly because of the
research-first approach, where new features and updates are thoroughly
researched and peer-reviewed before implementing in the platform. This
witnessed a well-designed and stable platform focussed on solving real-world
problems.
Key Takeaway
Undoubtedly,
blockchain has experienced significant expansion and appeal in recent years. As
a novice investor, having understood that incentives are powerful tools in a
decentralized economy, instead of asking about a token, you can critically
evaluate the real incentive behind the existence of a token. The project has to
encourage the desired behavior of stakeholders such as investors, users, and
miners by incentive design resulting in success and growth. However, it is
equally essential to be aware that creating an effective incentive system
depends on the community of individuals whose behavior needs to be
oriented.
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