Economics for web3 founders

# Intro to Economics for web3 founders This guide is a living document, developed to help web3 founders ground their initiative in first principles. The primary sources for this guide are battle-tested economic principles, and it is the authors hope that this document will help the reader navigate the "noise" of so-called "tokenomics." --- ## Platform Economies Platform economies refer to digital ecosystems where interactions between producers, consumers, and intermediaries are facilitated by technological platforms. These platforms act as marketplaces, connecting users and providers of goods, services, or information, leveraging network effects to enhance value with each additional participant. ### Core Characteristics - **Network Effects**: The value of the platform increases as more users join and interact, creating a self-reinforcing cycle of growth and engagement. - **Digital Infrastructure**: Platforms rely on digital technologies to operate, ranging from simple websites to complex blockchain systems. - **Multi-sided Markets**: Platform economies often serve multiple groups of users simultaneously, balancing the needs and contributions of each to maintain the ecosystem's health. - **The Role of Data**: In digital platform economies, data acts as both a tool and a product. It's used to improve user experiences, tailor services, and generate insights, while also being traded or shared as a valuable asset itself. - **Importance of Governance**: Effective governance mechanisms are crucial for managing the complex interactions within platform economies. This includes rules and policies that ensure fair play, equitable distribution of value, and adaptability to changing market dynamics. - **Blockchain as an Innovator**: Blockchain technology introduces new possibilities for transparency, security, and decentralization in platform economies. By leveraging smart contracts and distributed ledger technology, blockchain platforms can offer unique solutions to traditional challenges of trust and intermediary costs. - **Economic Impact**: Platform economies have transformed traditional business models, enabling new forms of value creation, employment, and entrepreneurship. They've also raised new regulatory and ethical considerations, as their influence on global commerce and society continues to grow. > **Further Reading**: [*Rochet, J.-C., & Tirole, J. (2003). Platform Competition in Two-Sided Markets. Journal of the European Economic Association.*](https://academic.oup.com/jeea/article/1/4/990/2280902). This reading provides foundational insights into the economic principles underlying platform economies. --- ## Stakeholders in Platform Economies Platform economies are complex ecosystems consisting of various stakeholders, each playing a distinct yet interconnected role in the value chain. The success of a platform economy hinges on the dynamic interplay between these roles: producers (or service providers), consumers, and the platform itself, which facilitates discovery, transactions, and interactions amongst all participants. Understanding these roles is crucial for anyone involved in designing, managing, or participating in a platform economy. #### **Producers/Service Providers** - **Role**: Producers or service providers are entities or individuals that offer goods, services, or content on the platform. Their offerings can range from physical products to digital services, including access to data or computational resources, like training data for machine learning applications. - **Contribution**: They are the source of the platform's value proposition, enriching the ecosystem with diverse offerings that attract consumers. - **Challenges**: Producers must navigate competitive marketplaces, maintain quality, and effectively meet consumer demands. They rely on the platform for visibility and access to a broader market. #### **Consumers/Users** - **Role**: Consumers or users are individuals or organizations that seek to consume, use, or purchase the goods, services, or content available on the platform. In the context of digital services, consumers could be developers, businesses, or researchers looking for data or computational tools. - **Contribution**: Their participation not only brings financial liquidity into the platform but also contributes to network effects, as increased usage can attract more producers and enhance the platform's overall value. - **Challenges**: Consumers face the task of navigating vast options, assessing quality, and making informed choices. They depend on the platform for efficient discovery mechanisms and trust assurance. #### **The Platform (Market Structure)** - **Role**: The platform acts as the mediator that connects producers and consumers. It provides the digital infrastructure necessary for hosting services, facilitating transactions, and enabling discovery through search and recommendation algorithms. - **Contribution**: Beyond mere facilitation, the platform often curates the market, implements governance and policy, and ensures a safe and trustworthy environment for transactions. It invests in technology and community building to scale the network effects. - **Challenges**: The platform must balance the interests of producers and consumers, manage governance, handle disputes, and continuously innovate to stay relevant. It also bears the responsibility of maintaining the infrastructure and adapting to regulatory changes. #### **Key Takeaway** The stakeholders in platform economies—producers, consumers, and the platform itself—are interdependent, with each playing a crucial role in the ecosystem's health and growth. The platform's challenge lies in orchestrating this interplay to create a balanced, vibrant, and sustainable economy. > **Further Reading**: [*Ostrom, E. (1990). Governing the Commons: The Evolution of Institutions for Collective Action.*](https://www.jstor.org/stable/3146384) This work provides insights into managing common resources and can be applied to understanding governance in platform economies, emphasizing the importance of stakeholder roles and contributions. --- ## Operational Realism in Platforms Participants in platform economies exist within a context which is not limited to the platform economy itself. In this section examine some of the additional influences which impact decisions to participate in platform economies which are not under the control of the platform itself. #### **Service Providers** - What resources do I need in order to provide this service? - How is this service regulated within my local jurisdiction? - How is this service viewed in my local cultural context? - Are there other potentially better ways to offer this service? #### **Service Consumers** - Why am I seeking this service? - What am I actually willing to do (or spend) to access this service? - How is this service regulated within my local jurisdiction? - How is this service viewed in my local cultural context? - Are there other potentially better ways to access this type of service? #### **Platform Operators** - What are the real costs of providing platform operations? - What are the relevant regulations in my local jurisdiction on these activities? - How does the presence or absence of platform-native tokens affect my legal and financial risk? Depending on the answers to these questions, it may or may not be feasible to take a platform economy approach to a particular market. Even in cases where it is feasible, the level of difficulty may depend significantly on factors outside the control of the platform, and as such it is important to take a broad view of the institutional landscape, and work where possible to avoid conflicts with legal systems and cultural norms, and instead harnessing those regulatory modalities to achieve economic disruption of intermediaries via technological development. > **Further Reading**: [*Lessig, L. (1999). Code and Other Laws of Cyberspace.*](https://dl.acm.org/doi/10.5555/555000#:~:text=Lessig%20shows%20how%20code%E2%80%94the,damaging%20consequences%20for%20individual%20freedoms.) This work provides insights into the roles of markets, law, norms and architecture on patterns of human behavior. --- ## Institutional Economics **Institutions** are systems of established and prevalent social rules that structure social interactions. Broadly, they encompass firms, markets, and systems of governance, including the rules and norms governing common resources. ### Key Concepts - **Platform Economies as Institutions**: A platform economy itself can be seen as an institution—a structured system facilitating interactions between different actors: producers, consumers, and the platform operators. As institutions, platform economies are not spontaneously generated; they require deliberate investment of resources, both capital and labor, to develop and sustain. - **Founding, Investment and Risk**: The creation of a platform economy involves significant investment in technology, human capital, and marketing to attract users. There's inherent risk as success depends on the platform's ability to generate enough value for participants to sustain engagement over time. - **Path Dependence and Initial Conditions**: The trajectory of a platform economy is heavily influenced by its initial conditions, including its founding rules and economic policies. Path dependence implies that early decisions, especially those concerning governance and operational models, have long-lasting impacts on the institution's evolution and the distribution of its benefits. ### Role of Stakeholders in Shaping Platforms The development of a platform economy is a collective endeavor, involving input and participation from a diverse range of stakeholders: - **Producers**: Offer goods or services, contributing to the supply side of the platform. Ideally a diverse group. - **Consumers**: Demand goods or services, driving the platform's value on the demand side. Ideally a diverse group. - **Platform Operators**: Provide the technological infrastructure and governance framework, facilitating transactions and interactions between producers and consumers. - **Technical Dependency Providers**: Protocols and other low level infrastructures such as public networks, programming languages as open source software, affect what can be built. - **Regulators and Policymakers**: Shape the legal landscape within which the platform operates affecting incentives for all participants. ### Economic Policies and Participation The initial economic policies and governance structures of a platform play a critical role in determining who can participate and how benefits are distributed among participants. These policies influence: - Entry barriers for new users and service providers. - The fairness and transparency of transactions. - How value within the network is defined and measured? - How data and compensation are shared or distributed? - Mechanisms for resolving disputes and ensuring compliance with platform norms. Decisions regarding the above are necessarily constrained non-trivially by circumstances and limitations of the fledgeling platform as well as the expectations of the actors providing the upstart labor and capital. Therefore, holding space for effective governance is crucial for the sustainability of platform economies as institutions. It involves balancing the interests of various stakeholder groups, adapting to changes in the market or technology, and addressing challenges related to equity, access, and fair play. **Further Reading**: [*North, D. C. (2005). Understanding the Process of Economic Change.*](https://press.princeton.edu/books/paperback/9780691145952/understanding-the-process-of-economic-change) > This work provides insights into the dynamics of institutional change and development, offering valuable perspectives for those building new platform economies. > --- ## Platform Native Tokens Platform native tokens blend aspects of several different kinds of economic institutions. - **Import/Export:** At one extreme they can be seen as similar to **national economies**, in that their aggregate productivity is measurable via exogenous demand for their currency, as a result of net demand for services whose costs are demoninated in this currency, as balanced against that economies' need to import goods and services, whose costs are denominated in other currencies. Investors and early participants with primarily financial incentives are prone towards this view as it fits into a Return on Invesment (ROI) calculus. - **Source/Sink**: At the other extreme these economies are similar to **game economies** which are largely isolated, and currency value is endogenous -- characterized by the availability of the currency and what affordances can be accessed via the currency. In this case, the economic health is determined primarily by how well sources and and sinks of currency are tuned relative to user preferences and behavior. Builders and Activists are often better served by this model as it emphasizes what kinds of activities the platform engenders, and relates more directly to non-financial success metrics. Neither model is sufficient, but together they supply core concepts for reasoning about the relevant platform economic policies. #### **Token Purposes** Platform native tokens serve various functions beyond mere investment vehicles; they can mediate economic activities within the platform, such as facilitating transactions, incentivizing content creation, discovery and curation of content, or staking for service provision. They are also commonly used for determining who can participate in governance, as well as to assign voting weights. This multifunctionality imbues tokens with characteristics akin to both currency, capital and political voice within the platform’s economy. #### **Initial Distribution of Tokens** The allocation of platform-native tokens among founders, investors, and early participants is a fundamental decision that influences the platform's economic structure and stakeholder dynamics. Unlike traditional equity, tokens can be more liquid and are often integral to the platform's operational and governance mechanisms. In addition to intial allocation of platform-native tokens it is prudent to consider the natural circulations of tokens amongst the stakeholder that are engendered by the economic policies. While an initial gradient of tokens to stakeholders is common for bootstrapping, healthy circulations are required for long term sustainability. Minting and burning are powerful economic tools available to influence endogenous and exogenous economic activity. #### **Key Takeaways** - **Path Dependence** Early decisions regarding token distribution, liquidity, and utility directly impact the platform's governance, the balance of power among stakeholders, and the long-term sustainability of the platform economy. - **Token Distribution as a Governance Tool**: The initial distribution of tokens can set the stage for equitable or skewed participation in the platform's economy. A well-thought-out distribution strategy can ensure a fair and inclusive ecosystem, promoting long-term engagement and growth. - **Liquidity and Economic Dynamics**: The liquidity of tokens influences the platform's economic dynamics, affecting transaction ease, stakeholder incentives, and the platform's ability to attract and retain users. - **Balancing Token Sources and Sinks**: Managing the flow of tokens—ensuring there are enough incentives for participation without causing inflationary pressures—mirrors the challenges of balancing sources and sinks in video game economies or managing currency supply in national economies. > **Further Reading**: [*Voshmgir and Zargham (2020) Foundations of Cryptoeconomic Systems*](https://assets.pubpub.org/sy02t720/31581340240758.pdf). This work bridges the gap between traditional economic principles and the emerging field of cryptoeconomics. --- ## Managing Complexity As platform economies grow and evolve, they encounter increasing levels of complexity. This complexity arises from the dynamic interactions among stakeholders, the changing external environment, and the need to adapt economic policies over time while preserving stakeholder trust and engagement. Successfully navigating this complexity is crucial for sustaining the platform's growth and ensuring its long-term viability. #### **Separation of Operations and Governance** To manage complexity effectively, it's essential to distinguish between platform operations and platform governance. This separation allows the platform to adapt and evolve without compromising the foundational principles that stakeholders rely on. - **Platform Operations**: Day-to-day activities and interactions within the platform, including service provision, consumption, and the dynamics of entry and exit by participants. Operations are dynamic, reflecting the ongoing changes in stakeholder behavior, market demand, and the broader economic environment. - **Platform Governance**: The set of mechanisms and policies that determine the platform's structure, capabilities, and economic policies. Governance decisions impact the platform's strategic direction, the distribution of power among stakeholders, and the overall balance of economic flows within the ecosystem. Governance mechanisms are necessarily slow moving as too much structural change destabilizes day-to-day operations, which rely on structure to set ground rules and manage interactions. #### **The Governance Surface** The **governance surface** refers to the mechanisms through which stakeholders engage in making structural changes to the platform economy. This may include changes to the platform's technological capabilities, economic policies, or governance rules. The governance surface enables the platform to evolve in response to internal challenges and external pressures, ensuring its continued relevance and effectiveness. - **Mechanisms of Governance**: Governance in platform economies can take various forms, from centralized decision-making by platform operators or designated foundations (e.g. the Ethereum Foundation) to decentralized approaches like DAOs (Decentralized Autonomous Organizations) and community-driven processes for code and policy updates (eg the EIP process). - **Separation of Time-Scales**: Governance mechanisms require time and effort to utilize to weed out unnecessary activity, and provide predictability for all involved. Blockchain-based platform economies can codify *rules about changing the rules* directly into their platforms (e.g. via methods for updating economic parameters which go into effect after a period of time). - **Importance of Clear Goals and Metrics**: To guide governance decisions and ensure they contribute positively to the platform's long-term health, it's essential to establish clear goals and metrics. These should be based on values important to the platform, such as market efficiency, diversity of offerings, accessibility for new entrants, and participant retention. By measuring these metrics using data from platform operations, stakeholders can assess the impact of governance decisions and adjust their strategies accordingly. #### **Key Takeaways** - **Adaptive Governance is Key**: As platform economies are not static, their governance structures must be adaptable, allowing for the evolution of policies and mechanisms in response to changing needs and challenges. Adaptation is nonetheless constrained by the governance surface. - **Stakeholder Involvement is Crucial**: Effective governance relies on active participation from all stakeholder groups, ensuring that decisions reflect the diverse interests and perspectives within the platform economy. - **Metrics-Driven Decision Making**: The use of clear metrics and data-driven analysis supports informed governance decisions, aligning changes with the platform's long-term goals and values. > **Further Reading**: [*Zargham, M., & Nabben, K. (2023). Aligning Decentralized Autonomous Organization with Precedents in Cybernetics*](https://law.mit.edu/pub/dao-precedents-cybernetics/release/1). This work unifies existing theories of organizational management and adaption with the affordances of blockchains and smart contracts.