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title: beyond incentives

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**Introduction**

“Show me the incentive and I’ll show you the outcome”
Charlie Munger

web3's broken incentives hinder adoption. The root issue is that projects pay fixed percentages of the supply, but humans naturally value additional wealth less as they accumulate more. This creates incentives to start new projects but not to scale existing ones.

I propose a more aligned incentive system where insiders unlock their token allocations as token value increases rather than owning a fixed percentage of supply.

**web3’s incentives are broken**

Consider all the ways that crypto is better than TradFi: it’s global, instant, 24/7, cheap, automated, and censorship-resistant. Of course, it also has drawbacks - such as all your transactions being public - but most of us are here because we believe that the benefits outweigh the drawbacks and that crypto is the future.

So why has crypto had very little adoption to date? It’s not for lack of time: technology adoption cycles aren’t nearly as long as this. From what I’ve observed, crypto suffers from **broken incentives that cause projects to die early.**

**Typical project lifecycle**

Typically, crypto projects go through the following lifecycle:

* Raise money from angels.
* Build out team + product.
* Ship product, run some incentivized adoption system (points today, used to be LM). Your juiced metrics should cause the token to go up.
* Cash out $5M - $50M via token or secondary sales.
* Semi-retire: either become a VC, stay but reduce effort, or leave crypto.

Examples of this include Compound, Aave, Uniswap, Curve, dYdX, OpenSea, MoonPay, Balancer, and Gnosis.

**The zone of death**

This is a big reason why crypto is good at getting from 0 to 1 - from 0 users and $0 in TVL to 100,000 users and $1B in TVL - but bad at getting from 1 to n - from 100,000 users and $1B in TVL to 10M users and $100B in TVL. Projects start doing well, leading the insiders to semi-retire, which then lowers the probability of their continued success.

Because of this, there’s a “zone of death” of projects that have seen a little, but not a lot of, adoption. A cottage industry that serves the tiny segment of the global population that is crypto-natives.


**Root cause: diminishing marginal utility + a linear payout system**

“The additional benefit which a person derives from a given increase of his stock of a thing diminishes with every increase in the stock that he already has.”
Alfred Marshall, Principles of Economics
So why do insiders semi-retire once they’ve served crypto-natives instead of pushing for mainstream adoption? The answer lies in the diminishing marginal utility of wealth combined with crypto’s linear payout system.

In crypto, most teams receive a fixed % of the token supply. So if the token goes to a $1B market cap, team members are twice as rich as if the token goes to a $500M market cap.

![image3](https://hackmd.io/_uploads/rJsjVrFT0.png)

The problem with this as an incentive system is that humans are hard-wired to value incremental wealth less the more we have of it. 

![image1](https://hackmd.io/_uploads/SyoREStTR.png)

A founder’s life may materially improve as his project’s token goes from $0 to $1b. It’ll improve much less as the token goes from $1b to $2b.

![image2](https://hackmd.io/_uploads/SkjgHrFT0.png)

Because of this, it’s natural for teams to work hard to get their project from $0 to $100m - $1b, but less hard after this point. In other words, **the more successful a crypto project is, the weaker the incentive for insiders to make it even more successful.**

![image8](https://hackmd.io/_uploads/Bkv7HrtpR.png)

This explains why we have so many projects that make it from 0 to 1 and then slowly fade. It’s not that the insiders don’t want the project to succeed - they do - it’s just that they’ve already made it and so don’t want it as much.

**The solution: a convex payout system**

This is a bad state of affairs. So how do we fix it?

We can start by looking at a group that has been able to build massively successful technology businesses: Silicon Valley. Silicon Valley has a convex payout system: you either make it big or you don’t really make it at all.

I propose that we adopt the same by giving insiders a percentage of the token supply that grows as the total market capitalization grows.

**Silicon Valley and its convex payout system**

“First prize is a Cadillac El Dorado. 
Anybody wanna see the second prize? Second prize is a set of steak knives.
Third prize is you’re fired.”
*Alec Baldwin in Glengarry Glenn Ross*

If you’re starting a Silicon Valley start-up, there are really only 3 possible financial outcomes:
* Your company succeeds massively, its shares become listed in the public market, and you become a billionaire
* Your company has moderate success and you accept an acquisition offer; you become a multi-millionaire
* Your company doesn’t succeed and you go back to where you were before financially

It’s no wonder that Silicon Valley entrepreneurs are consistently driven and gritty, relentlessly focused on maximizing their company’s probability of success. They know that there is no golden parachute in the case of failure.

If we look at a founder’s payout curve, it looks something like this:

![image6](https://hackmd.io/_uploads/BJrCHBKaA.png)

Founders can make some money by creating moderate financial successes (acquisitions), but the bulk of the money is made by founders who create blowout returns for their investors (IPOs). In mathematical terminology, Silicon Valley founders have a **convex payout curve, which offsets the concave utility of wealth curve.**

![image4](https://hackmd.io/_uploads/BkEOFBY6C.png)


This means that founders are incentivized to keep growing the company even once it’s started seeing success.

![image7](https://hackmd.io/_uploads/rkN_LHKaR.png)

**A simple convex payout system for web3**

Silicon Valley has a convex payout system by virtue of how traditional capital markets work. Because there’s no public market for start-up equity, insiders are sitting on ‘paper gains’ until IPO or acquisition.

web3 is different. We can and should add long-term vesting / lockups for insiders, but this doesn’t prevent insiders from selling after those lockups expire even if the business wouldn’t have been considered IPO-able. dYdX is an example of this: it’s been around for 7 years and still hasn’t made a dent in the global derivatives market, yet it trades at a $2B FDV which has allowed insiders to pull out tens (hundreds?) of millions in liquidity. It would be absurd to have a 7-year lockup, so we need something different.

The simplest mechanism I can think of is price-based unlocks for insiders. For example, you could do something like “the founder gets 1% of the token supply for every $1B of market cap, up to a maximum of 10%.” Then, at $1B, the founder would only have $10M of the token 

compared to the $1B they would have at $10B. This convexifies the payout curve so that founders are incentivized to create tokenholder value even after the project has experienced success.

![image9](https://hackmd.io/_uploads/BJjYFBKa0.png)

Concretely, how this would work is you would give the full allocation to either a smart contract or a trusted multisig. That smart contract or multisig would watch the simple moving average of the token price and pay out tokens when it’s higher than the threshold.

**Conclusion**

web3’s incentives don’t work and need to be fixed. The root issue is the linear incentive scheme of a fixed percentage of supply, which can be corrected with price-based unlocks.


