Reputation tokenomics

Reputation tokenomics is the economic analysis of the value of REP tokens in a DAO. This page assumes standard DGF mechanisms for REP minting and distribution using the Validation Pool and the Forum. REP tokenomics studies the economic consequences of these assumptions for reputation token design, as initiated in this paper.

The fundamental results of reputation tokenomics derive from analyzing the effects of parameter changes in the REP Token Minting Mechanism. Models for REP token evolution depend on the DAO's working parameters (such as the minting ratio $m$, the policing rate, and the lifetime of tokens) and on market factors (especially the interest rate and the amount of fees $f$ the DAO earns which determines the REP salary). The analysis follows by determining the income stream of a REP token due to this REP salary, which is equalized over time by calculating its present value.

The results of REP tokenomics help guide governance decisions. The formulas derived from tokenomics give us more precise intuition for how to manipulate the parameters to drive the system toward different goals. For instance, a DAO may choose to change the number of tokens minted when fees enter the system (a parameter denoted by $m$). The analysis shows how default inflationary minting of REP encourages decentralization, and to what degree parameter choices strengthen or weaken the effect. Such calculations precisely account for how different types of members (especially older or newer members) benefit from different DAO governance decisions, which clarifies the true moral principles the DAO embodies. This allows us to compare the functioning of a DAO against its marketing, in order to objectively evaluate the group’s values and integrity.

The formulas derived help us to rigorously program financial instruments, such as

• security tokens, e.g., BONDs
• insurance contracts
• equities, e.g., investor tokens
• ForEx instruments, e.g., stable coins
• tokenized commodities
• NFTs
• financial derivatives, e.g., calls and puts

Overview

Reputation tokenomics is a sub-discipline within general tokenomics, which is a sub-discipline of finance, which is a sub-discipline of economics. Tokenomics is the study of the value of digital tokens in online networks, originally blockchain based.

There are many valuable blockchains and DHT networks holding digital financial tokens that fall under the domain of interest for tokenomics. The digital tokens of greatest interest are Bitcoin, ETH, and the sub-tokens of Ethereum, typically fungible ERC-20 tokens representing ownership of DAOs and non-fungible ERC-721 tokens, called NFTs, representing ownership of individual properties.

These tokens fall under the financial instrument categories of equities, securities, commodities, utilities, and derivatives. However, most current tokens are combinations of these types. For example, the basic token of the Ethereum network, ETH, confers on its owner the power of using the network for information storage, processing, and transmission, because ETH is used to pay the network to run smart contracts. Therefore, the argument usually made to securities regulators is that ETH is a utility token. However, ETH has also been used in the past to make governance decisions. Therefore ETH also has some properties of an equity in the quasi-corporation that is the Ethereum network. ETH also has some aspects of a security, since the governance design has chosen to limit the quantity of ETH in the hopes that it will grow in value.

There is an active legal argument concerning what type of financial instruments these tokens represent for the purposes of national and international regulation. However, since Ethereum is not centrally incorporated, its governance is not structured like any traditional corporation. Therefore its regulation arguably falls outside the scope of the SEC in the US or the ESMA in Europe. (See Main article: Legal regulatory issues for DAOs.) The ownership of Ethereum is certainly international and arguably supranational.

REP tokens under DGF similarly overlap these financial categories. They are utilities in that they confer the power to obtain work through the availability smart contract. They may be equities if they are the type of REP that confers power over governance in the DAO. Our primary concern in reputation tokenomics is analyzing a REP token's value as a security. REP tokens have the quality of securities in the sense that they are a type of annuity, since they hold claim over any future fees the DAO earns through the REP salary. Though REP tokens are not a typical annuity, since they pay out at random, when the DAO attracts outside fees.

REP Valuation

Basic parameters

REP valuation models are based on the following parameters:

1. $R(t)=$ the total number of REP tokens in the DAO at time $t$.
2. The rate of total fees $f'={df \over dt}$ that the DAO earns. Therefore $f(t)$ denotes the total fees earned from the beginning of the DAO until time $t$.
3. $f_{0}^{1}(t)$ is the cumulative reputational salary collected for one REP token from start time $t_{0}=0$ when the token was minted until time $t$. This is our function of primary concern. After determining its formula, we are most interested in its present value .
4. $m$ is the minting ratio. This is the proportion of REP tokens that are minted relative to the fees the DAO collects. The default assumption is $m$.
5. $r$ is the discount rate. This will be the interest rate of the economy, or depending on context, the inflation rate of the stable coin in which the fees are paid, or the CPI. The default assumption is $r=4\%.$
6. $L$ is the lifetime after which a token expires. The default assumption is $L=\infty$. The token can be programmed to maintain full potency until it expires, or dwindle in power according to an attenuation function. In traditional finance, the lifetime is often referred to as its maturity, or expiration, meaning the initial length of a contract upon its inception. The tenor is the length of time remaining in the lifetime of a financial contract, $L-t$.

Fundamental results

The basic results from which all other applications can be derived are summarized in the following theorems, which give the present value of a single REP token when it is minted.

Theorem 1.  (Infinite Life Tokens) 

$$R(t)=\int _{-\infty }^{t}m*f'(s)ds=R_{0}+\int _{0}^{t}m*f'(s)ds$$

where $R_{0}=R(0)$. The reputational salary of a single token is therefore given by the income stream

$$f_{0}^{1}(t)=\int _{0}^{t}{\frac {f'(s)}{R(s)}}ds.$$

The present value at time $t_{0}=0$ when a single token is minted in a DAO is

$$PVf_{0}^{1}=\int _{0}^{\infty }e^{-rt}{\frac {d}{dt}}f_{0}^{1}(t)dt=\int _{0}^{\infty }e^{-rt}{\frac {f'(t)}{R(t)}}dt.$$

Proof.

Theorem 2. (Constant fees)  

Assume the DAO is in the market position of earning fees with a constant rate $f_{0}'$ and the lifetime of a token is infinite, $L=\infty$.

Then the reputational salary of your single REP token is

$$f_{0}^{1}(t)={\frac {1}{m}}ln{\frac {R_{0}+mtf_{0}'}{R_{0}}}$$

and the present value is

$$PVf_{0}^{1}=\int _{0}^{\infty }{\frac {f_{0}'}{R_{0}+mtf_{0}'}}e^{-rt}dt={\frac {1}{m}}exp{\biggl (}{\frac {rR_{0}}{mf_{0}'}}{\biggr )}\int _{\frac {rR_{0}}{mf_{0}'}}^{\infty }{\frac {e^{-s}}{s}}ds$$

Proof.

Theorem 3.  (Finite Life Tokens)

Assume the REP tokens have finite lifetime $L<\infty$. Then the total number of active REP tokens at any time $t$ is

$$R(t)=\int _{t-L}^{t}m*f'(s)ds.$$

Then, assuming a single token was minted at time $t_{0}=0$  the fees it earns is given by

$$f_{0}^{1}(t)=\int _{0}^{min\{t,L\}}{\frac {f'(s)}{R(s)}}ds.$$

(Constant Fees)

Now assume the rate of fees $f_{0}'$ is constant. At any time $t$ after the DAO reaches token number equilibrium $t>L$, there will always be $R(t)=R_{\infty }=mf_{0}'L$ tokens in the system. The income stream of a single token is then

$$f_{0}^{1}(t)={\begin{cases}{\frac {t}{mL}}&{\text{if }}t<L\\{\frac {1}{m}}&{\text{if }}t\geq L\end{cases}}$$

and the present value of 1 token at time $t_{0}=0$ when it is minted is

$$PVf_{0}^{1}={\frac {1}{m}}{\frac {1-e^{-rL}}{rL}}.$$

(Exponential Fees)

Now assume a DAO has exponentially growing fees $f'(t)=f_{0}'e^{ct}$ and lifetime $L<\infty$. After the DAO has been running $L$ units of time, the number of active tokens will grow at a proportional exponential rate. The income stream of a single token is then

$$f_{0}^{1}(t)={\frac {c}{m(1-e^{-cL})}}min\{t,L\}$$

with present value

$$PVf_{0}^{1}={\frac {1}{m}}{\biggl (}{\frac {1-e^{-rL}}{rL}}{\biggr )}{\biggl (}{\frac {cL}{1-e^{-cL}}}{\biggr )}$$

Proof.

Consequences of REP valuation formulas

The formulas cannot directly valuate REP tokens, because a token's value is dependent on the rate of fees in the DAO in the future. However, the formulas allow us to quantitatively estimate the value of tokens by observing the past. And further, by making different assumptions about future DAO fee rates, expected present values can be predicted.

Old tokens with infinite lifetime are more valuable then new tokens

For infinite lifetime REP tokens, the present value of a REP token at minting will change depending on the rate of fees the DAO attracts. In this case, more REP accumulates as time goes on. Typically, a REP token minted earlier is more valuable than a REP token minted later, since a later token shares the REP salary with more owners of REP. One way to combat this inequity, if that is desired, is to limit the lifetime of a token.

Convergence to fair value for finite lifetime tokens

Theorem 3 shows that for finite lifetime REP tokens, the number of tokens that exist in the DAO is not important if the rate of fees stabilizes. Assuming the DAO is healthy, in the sense that it attracts a regular rate of fees, that grow with inflation $r=c$, then the present value of a token minted at equilibrium is $PVf_{0}^{1}=1/m$ which is the same amount of the fees that were brought given to the DAO in order to earn the REP token. Therefore, an expert who earned a REP token does not immediately receive the cash for their work, but they do ultimately receive more than the amount of cash they brought in. The present value of REP tokens (on average) are exactly the same as the amount of fees they attracted with their work. However, the reputation accounted for is also a signal that the owners of REP tokens have done useful work in the past, and their tokens can be slashed at any point up to time $L$.

Perfect markets

DAOs in Web3 offer more efficient and competitive environments for business and economics. The platforms being built with P2P technology and DAO architecture are designed in line with ideal economic properties for optimizing the effectiveness of markets.

DGF allows us to create theoretically more perfect markets than traditional approaches. The following conditions are primary characteristics of an ideal perfect market. As we explain each quality, we comment on how primary DAOs designed under default DGF assumptions naturally satisfy or fail to satisfy each property.

Conditions of perfect competition

• The market is deep – This means there are a large number of buyers and sellers. Primary DAOs are open, meaning anyone on the planet may participate if they follow the transparent protocols using freely available open source technology.
• Zero transaction costs – This means buyers and sellers do not incur costs in making an exchange of goods. In theory smart contracts can minimize costs to neglible amounts due to contemporary computing power. However, in practice, most platforms, such as Ethereum, have charged expensive fees for transactions. This is due to bad incentive design for the maintenance of previous platforms, and not an inherent property of P2P technology (e.g., Skype started as a free P2P video conferencing app that took advantage of the low cost of contemporary computing power in 2003 – today it is much cheaper). We use DGF to create block producer DAOs designed with balanced incentives for minimizing transaction costs to further the community's goals of profiting from authentic economic activity. Free transactions for the public can be motivated, for example, by paying nodes in REP tokens for other DAO activities which require distributed computing to achieve decentralized business.
• No barriers to entry or exit – Primary DAOs are open, which means both entry and exit are free of sunk costs. Graceful Exit BOND markets support barrier free exits which allow members to immediately cash out with zero threat to the governmental stability of the DAO they are leaving.
• Perfect information – This means all consumers and producers know all prices of products and utilities they would get from owning each product. This prevents subDAO firms from obtaining any asymmetric information which would give them a competitive edge. The transparency associated with DAOs leads to extremely symmetric information.
• Well defined property rights – These determine what may be sold, as well as what rights are conferred on the buyer. In the context of a primary DAO, property rights are nearly perfectly defined by code. The major caveat is that judicial governance makes review possible.
• Rational buyers – This means buyers make all trades that increase their economic utility and make no trades that do not. In order to be decentralized and open, DAOs are required to have maximal bureaucratic transparency concerning all interactions inside and outside the group. This transparency allows more accurate audits of every business transaction, allowing free and open access to information about the market a DAO creates, so that public buyers can have maximal knowledge and understanding of market information, which encourages rational buyer behavior.
• Profit maximization of sellers – Firms sell where the most profit is generated, where marginal costs meet marginal revenue.
• Every participant is a price taker – Decentralization implies no participant has market power to set prices. Each DAO must negotiate with other DAOs for all business.
• Homogeneous products – This means all products are perfect substitutes for each other (i.e., the qualities and characteristics of a market good or service do not vary between different suppliers). In DGF DAOs are designed to police each work contract to guarantee that it is in line with their standards using the Validation Pool.
• Anti-competitive regulation – DAOs under default DGF protocols inhibit anti-competitive activity by governance which encourages equal access to work through openness and by using availability smart contracts which choose random members for work.
• Perfect factor mobility: In the long run factors of production are perfectly mobile, allowing free long-term adjustments to changing market conditions. This allows workers to freely move between firms. Under DGF, DAOs are required to renegotiate adjustments through governance processes which provides the opportunity to adjust to market conditions, but is an obstacle to immediate adaptation to the market. However, since the regulatory process in DGF is complete, any possible regulatory scheme is expressible with smart contracts. So while factor mobility in a DAO is far stronger than a managed economy, it is not perfect.

??The following qualities still need comparison from DAOs to traditional markets:

• No externalities – This means costs or benefits of an activity do not affect third parties. This criterion also excludes any government intervention. While this is largely true of
• Non-increasing returns to scale and no network effects: The lack of economies of scale or network effects ensures that there will always be a sufficient number of firms in the industry.

Applications

• Treasuries
• BOND tokens
  • iBONDs
  • fciBONDs
  • fREP
• BOND Markets
  • Graceful Exit
  • Underwriting
  • generalized chit fund banking
• Stable coins
• PoR block production consensus