Written by: Web3 Xiaolu
Tokens are an incentive mechanism based on the new blockchain economy and are the core pillar of achieving decentralization. How to enable globally dispersed network participants to collaborate around a common goal in a decentralized network is the problem that token economics aims to solve.
Before token economics became popular, Web2 Internet companies needed a lot of manpower and financial resources to unilaterally capture users and create value for themselves. Today, Web3 applications can directly use tokens to incentivize users to improve network utility and create transferable value in the ecological network.
For example, the BTC network is designed to solve the problem of a peer-to-peer payment system and digital value storage, allowing network participants from all over the world to obtain value incentives by jointly maintaining nodes and supporting the network.
This is the best use case for Web3 projects: designing incentive mechanisms that coordinate the actions of decentralized parties to achieve a common goal.
With the development of the industry, the incentive model of the "single token model" of blockchain basic protocols such as BTC and ETH can no longer meet the needs of Web3 applications with multiple scenarios and diverse participants. As a result, Dr. Xiao Feng of HashKey Group delivered a closing speech on "Three Token Models for Web3 Applications" at the 2023 Hong Kong Web3 Carnival, pointing out that Web3 applications must have multiple needs, and the token model at the Web3 application level is different from the token model of the basic protocol. The basic protocol is a single token model, which should be unified globally, while the application level should be a three-token model, with different application scenarios.
The Three-Token Model for Web3 Applications nicely summarizes and improves the problems in the operation of the token economy in the past, providing a valuable path for the compliant development of the Web3 virtual asset industry, such as (1) the compliance issues of the three tokens; (2) the multi-party incentive issues of the three tokens; and the value capture issues of the three tokens.
This article first sorts out the concept of the three-token model of the Web3 new economy, then breaks down the value dimensions of the three tokens from the perspective of Web3 value capture, and finally explores a feasible path for the implementation of the three-token model in China through the implementation of blockchain game projects.
The Three-Token Model of the Web3 New Economy
Image source: Dr. Xiao Feng’s closing speech at the 2023 Hong Kong Web3 Carnival
Whether in the economic model of Web1 or Web2 (surveillance capitalism), the assets and data information of the digital world are enjoyed by the platform. After the platform monetizes them, it generates huge commercial value and gives birth to platform-level business giants such as Facebook and Googel, but this has nothing to do with ordinary user participants.
Web3, based on blockchain networks, is an economic model based on value networks (stakeholder capitalism), which emphasizes data credibility, data sovereignty, and value interconnection. Under the premise that all values can be tokenized, value includes not only ownership, but more importantly, the right to use.
Ownership is exclusive and difficult to divide. The organizational form under the ownership system (generally a company) aims to maximize shareholder interests and is a manifestation of shareholder capitalism. It is difficult for ordinary users to participate and share the value.
The right to use is non-exclusive and has multiple sharing characteristics. It can be authorized and licensed multiple times, and can even be open source and CC0 in an infinite cycle, which is conducive to ordinary users to participate and share value. The core of the right to use system is stakeholder capitalism. The original organizational form may not be suitable. The decentralized autonomous organization (DAO) based on open source organizations and non-profit organizations naturally fits stakeholder capitalism and has become the main organizational form of the new economic model of Web3.
Image source: Web3 New Economy and Tokenization
Under the right to use system, all participants in a decentralized organization collaborate on a large scale as stakeholders, make their own contributions, and share the value of the organization. In this context, the shareholder ownership represented by the shareholders of centralized projects is meaningless, and what is truly valuable is the right to use the project.
The right to use cannot be shared, but it can be tokenized. Combined with blockchain distributed ledger technology, the right to use can be standardized and shared in the form of tokens, which is related to the interests of participants in each project network. This token is called a utility token.
Image source: Web3 New Economy and Tokenization
For example, Worldcoin, a Web3 project planned by Sam Altman, the founder of OpengAI, is an open source protocol that aims to solve the problems of human identity proof (as distinct from AI) and fair distribution of wealth (redistribution of wealth created by AI) in the future world, build the world's largest and fair digital identity and digital currency system, and become the infrastructure for implementing Universal Basic Income (UBI), solving the problem of job losses that may be caused by the development of AI.
Since Worldcoin is designed to achieve global collaborative division of labor based on a decentralized blockchain network, the value of the participants' right to use in the Worldcoin network will be far greater than the ownership value of centralized projects (which does not exist in the Worldcoin project). The Worldcoin network belongs to all participants (right to use), and Worldcoin, as a functional token, extracts the value of the network and makes it standardized, shared, and financialized, so as to provide value incentives for participants.
Image source: worldcoin official website
The tokenization of usage rights is the key to understanding the development of blockchain infrastructure in the past 15 years. Because the basic blockchain protocol is globally unified and has a built-in value capture system, it only requires a "single token model", with BTC and ETH as typical representatives. In the next 15 years, the Web3 new economy will generate new currency markets, capital markets, and commodity markets. Web3 applications built on blockchain infrastructure will become the new focus of development. These Web3 applications need to use different types of tokens as value markers for economic activities.
Based on the Web3 value economic model, usage rights system, and stakeholder capitalism, the three-token model built around Web3 applications - utility tokens, security tokens, and non-fungible tokens (NFTs) - represent usage rights, ownership rights, and digital tokens, respectively, and will share value with all stakeholders participating in the network based on their own value forms.
Utility tokens represent the right to use and capture the value of the network scale effect of the Web3 network, system or application. The larger the volume of ecological applications and users, the higher the market demand for the token, and the price of the token depends on the market's value discovery. It is mainly used for Web3 applications or services, such as voting governance, in-app consumption, and paying gas fees.
Equity tokens are generally backed by certain assets, representing ownership and capturing the value of future cash flows of equity assets such as equity and debt. Therefore, in terms of their economic functions, these tokens are similar to stocks, bonds or derivatives.
NFT represents the value of goods, which include products and services, as well as various data, rights and interests, and certificates. It is a digital form of underlying assets and can be called a "digital token". The value captured by NFT is related to the value of the underlying assets it anchors, and the sources of value are diverse. In Web3 applications, NFT usually represents the user's identity proof, ability proof, behavior proof, workload proof, contribution proof, activity proof, and product and service proof.
Value capture of the three-token model
The three-token model proposed by Dr. Xiao Feng is not a new concept, but a summary of the existing market token economic activities. Since the three-token model (dual token + NFT) model was adopted by Axie Infinity, the leader of blockchain games in 2020, the three-token model has almost become the standard in the GameFi field. Especially in the recent case of the U.S. Securities and Exchange Commission (SEC) v. Coinbase, the SEC directly defined AXS (the governance token launched by Axie) as an equity token. Regardless of whether it is right or wrong, this makes the definition of the three-token model clearer.
The SEC believes that AXS constitutes an investment contract and is therefore identified as a "security." The logic is as follows: (1) Investment of money. Sky Mavis, the developer of Axie Infinity, sells AXS through private and public sales. (2) Common cause. Investment is made to jointly build Axie Infinity, which is still in the development stage. (3) Expected benefits. Through various public channels, investors are made to believe that AXS can be appreciated under the leadership of Sky Mavis. (4) The efforts of others. Sky Mavis has a full-time team of nearly 40 people and holds nearly 21% of AXS tokens. It is clearly responsible for the development and maintenance of Axie Infinity.
Understanding the classification of tokens from the perspective of Web3 investment value capture helps us understand the essence of the three-token model. Tokens are essentially carriers of value, and the most important thing for investing in Web3 projects is to determine where the value is realized.
When valuing equity projects, more attention is paid to the company's future cash flow capabilities, because shareholders have the legal right to the company's profit distribution. In the case of Axie Infinity, since the early project has not yet been completed, investors are looking forward to the value of the project after it is completed in the future, similar to early equity investment, so the public offering of AXS will be considered a "security."
When valuing token projects, the traditional cash flow valuation model may not be applicable. More attention should be paid to the network scale effect after the project is developed and decentralized, the demand between the network and the token, the actual performance of the token, and the liquidity of the token, etc. Therefore, compared with token financing projects, the token economy is crucial.
From the perspective of Web3 investment value capture, the following will extract the specific value of equity tokens and utility tokens to help better understand the essence of the three-token model. Since NFT is a digital mapping of the underlying asset, the value it captures depends on the value of the underlying asset it is anchored to. The source of value can be varied, which will not be discussed here.
The “Benefit” of Equity Tokens — Interest-Bearing Equity
Equity tokens include both "rights" and "benefits".
First of all, the “benefit” can be understood as the rights and interests of the future cash flow of Web3 applications, which represents the value of future cash flow. Since this “benefit” is basically the same as the “benefit” represented by interest-bearing stocks, bonds, real estate instruments and other securities, the public sale of such equity tokens (Security Token Offering, STO) will be strictly supervised by securities regulators.
On November 16, 2018, the U.S. SEC issued the "Statement on the Issuance and Trading of Digital Asset Securities", emphasizing the securities nature of some virtual assets and requiring issuers to "register securities issuance in accordance with the Securities Act unless exempted."
Due to the complexity, high compliance costs and supervision of STO, it is not suitable for most mid- and early-stage projects. Therefore, many project parties separate the "benefit" of this cash flow from equity tokens and try to avoid directly designing equity tokens into interest-bearing and dividend-paying tokens to avoid falling into securities supervision.
This leads to the development of a variant of equity tokens, which obtains the "benefits" of cash flow through indirect means such as yield farming, staking, and veToken Model.
For example, in addition to receiving the established SNX tokens when staking, Synthetix users can also receive weekly rewards in the form of sUSD (Synthetix's native stablecoin); SushiSwap uses the cash flow generated by the protocol to repurchase its token Sui in the market to reward staking users; MakerDAO uses the cash flow income generated by the protocol to repurchase and burn its token MKR.
Although the above DeFi protocols all call their tokens functional governance tokens, in my opinion, due to the "expectation of profit", they may all be equity tokens. Although there is no regulatory enforcement of DeFi projects, there is still a risk of being identified as "securities" by the SEC. Of course, the specific identification also needs to consider factors such as the degree of decentralization.
Strictly speaking, to become an equity token, you must either comply with the strict securities STO procedures of the relevant jurisdiction (compliant listing), or be "fortunate" to be identified as a security by the SEC (fine + delisting + internal compliance control). Equity tokens cannot be simply understood as equity in the project company. At the same time, the complexity, high compliance costs and supervision of STO are not suitable for most mid- and early-stage projects.
Utility Tokens — Voting Governance + Actual Utility
In order to avoid regulatory compliance of equity tokens (interest-bearing equity), most projects will separate the "rights" in equity tokens - voting governance rights, and form tokens with voting governance functions. Most blockchain game projects on the market will refer to tokens with voting governance rights and other utility tokens as functional tokens, and design them into a dual-token model of parent and child tokens.
The primary factor of such a design is to avoid being included in the category of equity tokens. Secondly, it avoids, to a certain extent, the infinite dilution of governance rights (total supply is fixed) caused by continuous issuance due to functional utility demand (total supply is unlimited), which helps to form a relatively stable governance structure.
In addition to functional tokens for voting and governance, the utility of other functional tokens also includes: in-app asset upgrades, service purchases, consumption, etc. You can refer to StepN’s two tokens GST (functional token) and GMT (governance token).
Governance tokens have become the standard for DeFi protocols since Compound kicked off the DeFi Summer by distributing COMP tokens to users through a yield farming program in June 2020. For example, UniSwap’s UNI and Compound’s COMP do not capture any value from the commercial activities of the protocol (i.e., Uniswap’s trading and Compound’s lending), but users can use the tokens for governance and decide important matters related to the protocol.
Some would argue that such pure governance tokens have no value, but having an impact on the protocol itself is valuable. These tokens may eventually vote on the economic rights of the protocol in the future, such as whether to charge fees for business and how much profit to extract from liquidity providers.
From the perspective of value capture, functional tokens capture more of the network scale effect after the project is developed and decentralized, the demand between the network and the token, the actual performance of the token, and the liquidity of the token.
The compliance path of the three-token model in the country
Tokens are essentially carriers of value. After understanding the value nature of the token model, the project owner needs to cater to the compliance supervision of the corresponding jurisdiction based on the value attributes of the token itself. Only on the basis of meeting regulatory requirements can friends who participate in token economic activities participate in the distribution of this huge pie and promote the long-term development of the virtual asset market.
Compliance of Equity Tokens
In 2017, due to the lack of a regulatory framework around the world, the ICO boom led to numerous fraud scandals, causing regulators in many jurisdictions to crack down on ICOs. At the same time, some jurisdictions have also begun exploring compliance with asset tokenization under the existing securities regulatory framework. Basically, the current regulatory provisions for equity token offerings (STOs) in various jurisdictions are from 2018.
Recently, we have seen crypto mining companies list their equity tokens, HAG, on the US crypto securities market INXI through the STO process, which provides investors seeking to participate in Bitcoin mining with a more accessible, lower-risk and fully compliant investment option, the HAG token. The HAG token is an equity token that is permanently anchored to Bitcoin mining power, providing holders with the issuance of Wrapped Bitcoin (WBTC) as monthly Bitcoin dividends. For investors, holding HAG tokens means holding the corresponding Bitcoin mining power, and they can benefit from the growth of the Bitcoin mining industry without having to invest directly in mining equipment.
According to the SEC official website, HAG has obtained the SEC's exemption for securities issuance, which means that HAG can be publicly sold legally and compliantly under the premise of complying with the US Securities Act. For specific STO procedures and securities exemption procedures, please refer to the following guidelines given by the SEC.
Image source: SEC official website
In addition to the United States, Switzerland, Singapore, and Hong Kong are also at the forefront of STO compliance. We have seen recent news: Bank of China International (BOCI) announced that it has successfully issued RMB 200 million in tokenized notes on the Ethereum blockchain (without involving a central securities depository), becoming the first Chinese financial institution to issue tokenized securities in Hong Kong. This tokenized securities product was initiated by UBS and provided to its clients in the Asia-Pacific region. It is the first regulated STO product in the Asia-Pacific region issued under Hong Kong and Swiss laws.
Although I cannot find more information, my personal understanding is that UBS built the legal structure, asset packaging, and issuance on the blockchain under the Swiss legal framework, and then sold it to customers in the Asia-Pacific region through the Hong Kong securities regulatory system.
图源：Bank of China Embraces Digital Innovation: Issues $28 M in Ethereum-based Digital Structured Notes
Compliance of utility tokens
In addition to regulatory compliance for equity tokens, we see that many jurisdictions have begun or have already established regulatory frameworks for non-equity tokens, such as utility tokens, such as the EU's MiCA, Hong Kong's VASP system for virtual asset services providers, and Dubai, UAE's VARA virtual asset activity market regulations.
These regulatory frameworks are all aimed at regulating the virtual asset market, which is dominated by retail investors and where non-equity tokens are the main trading objects, and protecting the rights and interests of investors on the basis of KYC/AML/CTF.
The compliance status of the three-token model in China
The issuance and trading of tokens are regulated by law abroad, but not in China.
Whether it is the 2017 ICO era "Notice on Preventing the Risks of Token Issuance and Financing" ("94 Notice"), or the 2021 "Notice on Further Preventing and Dealing with the Risks of Virtual Currency Trading Speculation" ("924 Notice"), it is clear that virtual currency-related business activities are illegal financial activities. This basically puts an end to the tokenization of local assets (whether equity tokens or functional tokens). End of Story.
In addition, in China, virtual currencies similar to those used in games (similar to functional tokens) are still subject to the provisions of the now-expired "Interim Measures for the Administration of Online Games", which prohibit the exchange of virtual currencies for real currency or physical objects. At the same time, it should be ensured that the circulation and transactions of virtual currencies within the game comply with relevant regulations.
Therefore, the equity tokens and functional tokens in the three-token model have no basis in the legal framework of mainland China, so only NFT is left among the three tokens.
Domestic regulation of NFTs is still based on official documents from multiple ministries and commissions, such as the "Initiative on Preventing NFT-Related Financial Risks" issued by the Internet Finance Association of China, the China Banking Association, and the China Securities Association on April 13, 2022. The core of the document is: resolutely curb the tendency of NFT financialization and securitization, and strictly prevent the risks of illegal financial activities.
Exploration of the three-token model in domestic compliance applications
Through the above analysis, we can clearly see that NFT is the only token exploration path left in China. So how should project owners explore NFT applications within the domestic legal framework?
An article from W Labs titled "Is the blockchain game economic model without tokens feasible?" provides a substantial path for blockchain game compliance in China, which is worth learning from and referring to by all project parties.
Image source: https://www.treehouse.finance/treehouse-academy/the-role-of-defi-in-gamefi-tokenomics
Blockchain games can be said to be the application that relies most on the three-token model among Web3 projects. So is it feasible to directly cut out the most exciting and stimulating part of the token economic model right from the start?
Gua Ge, a willful and wild blockchain game industry researcher, first proposed to use NFT as a medium to link the inside and outside of the game, and add game coins as soft tokens in blockchain games, and directly or indirectly upgrade NFTs through game coins - NFT cultivation model, thereby realizing the appreciation and realization of NFT assets in disguise;
Secondly, the economic model should be designed to be Win to Earn as much as possible, and the traditional idea of using new funds for old players to Play to Earn should be avoided as much as possible;
Finally, we need to strengthen the serial value capture function of NFT, hoping that players can Play to Own, and by breaking through the islands between games/projects/platforms, NFT can be given greater power to link positive externalities. This idea has begun to be applied in the "platform + multiple chain games" model, and the "platform points" system can be added.
Yes, there is no need for tokens. A complete points system + NFT with serial value capture can meet the compliance requirements of most Web3 projects in China.
After summarizing and analyzing the three blockchain game cases of Big Time, Legend - Judgment of Flame Digital Collection Edition, and BitstarWar, Gua Ge felt that the token-free model is not an unpopular option in blockchain games. On the contrary, some game teams have voted with their feet and chosen the token-free model. All three cases use NFT as the main value carrier and provide a free trading channel for monetization. At the same time, the soft tokens in the game are used as auxiliary to lubricate the various economic activities in the game.
Such an economic system eliminates the complex elements of staking and token market making that are common in Web3 applications. It is a relief for both players and project owners. It uses a simpler and more direct approach that is closer to the essence of "this is a game, let's play it first", and conveys the truest soul of the game to players.
Image source: https://odyssey.starbucks.com/
In addition, we also see that many Web2 consumer brands are beginning to explore the path of Web3. Considering the compliance issues of equity tokens and functional tokens at home and abroad, NFT seems to have become a must for these Web2 consumer brands. In particular, the combination of NFT + Loyalty (brand loyalty) projects may bring a new wave of growth flywheels for Web2 consumer brands.
The NFT + Loyalty (brand loyalty) model of the Starbucks Odyssey project deeply explores the value of NFT and provides a new business paradigm for Web2 brands to enter NFT.
The Odyssey project first enhances the sense of participation and emotional connection of its members through gamification. Through the Odyssey Journeys journey game (similar to the coffee version of Pokémon GO), it integrates the online and offline NFT stamp (Journey Stamps) collection, allowing users to have fun while also strengthening the connection with the Starbucks brand. This step transforms the traditional Shop to Earn model into a Participate to Earn model.
Secondly, using NFT as a carrier (the carrier of value and the circulation of value), Participate to Earn is further upgraded to Collect to Earn, that is, collecting generates both fun and income, thereby increasing user stickiness and repeat purchases.
Finally, the Airdrop to Earn model that connects NFT member data to the business world after it is uploaded to the chain, such as Pizza Hut's precise airdrop of pizza coupons to Starbucks NFT holders, empowers NFTs and drives NFT member stickiness and repeat purchases, thereby realizing a multi-layered growth flywheel for the brand's commercialization.
Image source: Twitter @starzq.eth
Since Dr. Xiao Feng "officially" defined the "Three-Token Model of Web3 Applications" in his closing speech at the 2023 Hong Kong Web3 Carnival, the most critical issue at present is whether the existing supervision (mainland and Hong Kong) has given the three tokens a clear legal status and cooperated with the legal regulatory framework of virtual assets to avoid the emergence or induction of various market fraud problems.
We have seen that Hong Kong has officially implemented a new VASP system since June 1, 2023, providing a compliant legal regulatory framework for the three tokens. We believe that more specific rules will be issued in the near future to inject a "boost" into Web3 applications, or the entire virtual asset market. On the mainland, further guiding virtual assets from virtual to real and further empowering entities is also an internal circulation economic idea under the existing institutional background.
Tokens are essentially carriers of value. Only after a deep understanding of the value essence of tokens can we design the optimal economic model for Web3 applications, realize a multi-layered growth flywheel, and achieve incentives for all participants.
References:
[1] HashKey Group, Web3 New Economy and Tokenization White Paper https://www.hashkey.com/cn/insights/web3-new-economy-and-tokenization-whitepaper
[2] Wanxiang Blockchain Xiao Feng: The Three Token Model and Value of Web3 Applications (full text) https://mp.weixin.qq.com/s/un9FaVkiYP3Lbw1gztsW2Q
[3] SEC Charges Coinbase for Operating as an Unregistered Securities Exchange, Broker, and Clearing Agencyhttps://www.sec.gov/news/press-release/2023-102
[4] Buidler DAO, Four-quadrant Token Economic Model (I): Dual FT Model https://mp.weixin.qq.com/s/u373Zi9qCtCmjDzfpfqKjA
[5] Buidler DAO: Analysis and summary of the initial issuance method of tokens https://mp.weixin.qq.com/s/dHttI8UiqabuS7XE0ItHig
[6] Bankless, What's the Best Token Model?https://www.bankless.com/what-is-defi-tokens-best-invest-price
[7] Understanding SAFT and Web3 token investment and financing from the three-token model https://mp.weixin.qq.com/s/YJb0ZNi4-r3YR8rwCTFAhQ
[8] Anna Liu, Legal Director of HashKey Group: The Future of Tokenization https://www.defidaonews.com/article/6814228
[9] The first SEC-registered Bitcoin computing power STO, mining company HAG tokens listed on the US crypto securities market INXIhttps://mp.weixin.qq.com/s/wV3NONdpLhGtSdQslbDgaw
[10] GuaTian Lab, Is the blockchain game economic model without tokens feasible? https://mp.weixin.qq.com/s/SMWO0o2cAN68UzkjFSVbYA
[11] Starbucks’ 3 profound impacts on the business world https://Twitter.com/starzqeth/status/1612253577111810053
