Author: Eren, Four Pillars; Compiler: Tia, Techub News
Recently, projects that have received a lot of attention and a lot of investment, such as Berachain, Monad, Story Protocol, Initia, and Movement, have one thing in common: they are all Layer1. Instead of developing Layer2 on Ethereum, these projects have chosen to develop their own L1 solutions. Typically, they build their own ecosystems by leveraging their unique features and economic models. Each project also has its own mission, some focusing on high-performance EVM, and some focusing on optimizing the Rollup execution environment. In short, they are all committed to proposing new L1 solutions.
Which of these projects will become the next generation of L1 and achieve sustainable growth? Although the importance of technical strength and community participation cannot be ignored, token economics also plays a vital role in the development of L1. Therefore, this article will focus on evaluating the robustness of each L1 token economics.
Source: Foundation of Cryptoeconomic Systems
L1 operates in a very similar way to a country. L1 acts as a country, ecosystem protocols constitute local economies, and users or communities act as participating entities. In this framework, tokens organically link various economic units together. It is both an economic incentive and a reserve currency.
In this context, what role does the token economy play in the L1 "country"? The token economy is an economic system that incentivizes network participants to actively participate and ensures that the network is actively running. At the same time, it also needs to regulate the supply and demand of tokens to maintain a stable value.
Thus, the design of token economics reflects a country’s economic system. Just as countries design their economic systems taking into account geographic conditions, industrial structures, political systems, and culture, L1 token economics must reflect technical architecture, Dapp ecosystem, governance, and community characteristics.
However, many L1 blockchains that emerged during the ICO boom of 2017-2019 adopted a one-size-fits-all token economics that ignored the uniqueness of different networks. This led to the birth of “billion-dollar zombie blockchains” that maintained high valuations but achieved no real value.
Today, token economics has begun to become complex. It is necessary not only to monitor the supply and demand of tokens at the network level and introduce token economics optimized for technical architecture, but also to consider the distribution of benefits among different roles in the network, such as validators, protocols, and users. This article will use Berachain, Initia, and Injective as examples to introduce three dimensions that address the limitations of existing token economics and promote sustainable design.
The role of Layer1 tokens
"Why do we need tokens?" Although tokens are effective tools, this question is difficult to answer. However, for L1, issuing tokens is reasonable because tokens are needed to reward validators. L1 native tokens have three main functions:
Reserve currency: Users pay network fees in native tokens when using block space. When L2 uses the main chain as a DA (data availability) layer, native tokens can also be used as storage costs.
Incentive tool: Validators who honestly verify the legitimacy of transactions will receive native tokens as block rewards. In addition, L1, which has the "Unified Liquidity" feature, will provide native tokens as rewards to encourage liquidity provision.
Unit of Value: The native tokens issued by L1 directly or indirectly reflect the value created by L1. Market participants trade L1 tokens such as Ethereum based on their assessment of Ethereum's business performance and market position.
The Role of Layer1 Token Economics
While tokens have specific roles, the function of token economics that controls the flow of tokens is completely different. The term "token economics" is often narrowly defined as the destruction mechanism used to adjust the supply or token distribution method (maximum supply, distribution ratio, unlocking schedule, etc.). However, for the purpose of our discussion, token economics includes not only the destruction mechanism and distribution method, but also the incentive system that coordinates the interests of participants, token utility, and income distribution model-essentially the entire economic system based on tokens.
In this context, the fundamental role of token economics is to create a system that incentivizes the desired behavior of participants to ensure the smooth operation of the L1 network. Specifically, it designs reward structures to encourage behaviors that benefit the network, such as enhancing security or providing liquidity. In order for this reward system to be effective, the rewards must be of sufficient value to be meaningful to contributors. Therefore, token economics must also include mechanisms to regulate the supply and demand of tokens to maintain the value of rewards.
Source: X(@alive_eth)
Well-designed token economics has the potential to create a flywheel effect, with value circulating to promote the organic growth of the network. The model assumes that the interaction between validators (responsible for blockchain security), developers (creating applications), and users (forming communities) creates a circular growth structure. Through the "network effect", economies of scale are achieved and network growth is accelerated. Let’s trace the flywheel from the bottom up:
After the core team presents a new vision to the market, the initial capital completes the basic infrastructure of the L1 network and generates token value (in private or public markets).
As token value is generated, validators contribute to the supply side of bootstrapping the network in exchange for token rewards. For example, validators receive block rewards by validating transactions, providing security and functionality to the network.
Once the L1 network has established stable functionality and security, developers will join and build useful applications on the network.
These applications provide real value to end users, driving token demand. In the process, a community is formed around users and becomes supporters of the L1 network.
As the network becomes more active and the community grows larger, the demand for tokens increases, which is both a reserve currency for network fees and a unit of value that reflects the value of the network. Therefore, the market demand for tokens rises.
As the demand for tokens rises, validators have a stronger incentive to support the security and functionality of the network → This will improve network security and development environment, encourage developers to build more useful applications, and provide more value to users → Token demand rises → Incentives are strengthened → Network security and functionality are improved → Application development → Community becomes more active → Flywheel
Once this flywheel starts turning, the L1 network will gain the momentum for self-sustaining growth. The network no longer needs to be driven by the core team alone; instead, growth is automatically accelerated through token incentives. This flywheel maximizes the potential of token economics and is often seen as the ultimate goal that all token economics should ultimately strive for.
Source: X(@alive_eth)
The flywheel model assumes certain facts when creating a cyclical growth structure. It assumes that as network activity increases, token demand will also increase, providing a basis for strengthening incentives for ecosystem contributors. It also assumes that enhanced incentives will prompt validators to contribute to the ecosystem in any way, thereby creating an environment for more useful applications. We need to question these seemingly obvious assumptions. Many existing L1 networks seem to have difficulty creating sustainable token economics, often missing key elements in three areas:
Are the incentives of all participants truly aligned?
L1 networks involve various types of participants with different interests in the ecosystem. If the structure that combines these complex interests with growth collapses, the flywheel will stop turning. In particular, we should question whether validators will necessarily contribute to the ecosystem in other ways when token demand increases and validators' interests are strengthened, as the flywheel model above suggests.
Validators' interests are not unrelated to the development of the ecosystem. Their block rewards are given in the form of L1's native token, so increases in token demand and value are in their favor. In addition, as the application ecosystem attracts users and generates more transactions, network congestion increases, which may strengthen validators' incentives. Most L1 networks (such as Ethereum's PoS network) use a gas fee mechanism, that is, the more severe the network congestion, the higher the transaction fee the validator receives.
However, at the network level, there is no direct mechanism to require validators to contribute to the ecosystem, which makes the relationship between validators and protocols or users weak. The lack of a direct link between strengthening validator incentives and ecosystem activation means that there is little incentive for ecosystem contribution. Conversely, without individual stakers being able to earn significant returns, there is no clear way or incentive for users or protocols to contribute to economic security. The low participation in governance in all L1 ecosystems suggests that individual users lack a clear motivation to contribute to network consensus. In other words, the interests of validators are not directly linked to the interests of other ecosystem participants.
Does increased network activity lead to increased token demand?
It is difficult to assert that as applications emerge and users join, network activity increases and token demand will inevitably increase. Network activity and token demand may not be consistent if there is no inherent structure or only a weak structure that links network activity to native token demand. As will be discussed in detail later, Ethereum is currently experiencing a situation where L2 activity is increasing, but the factors driving demand for ETH are very low. Like Ethereum, each blockchain network has its own unique technical architecture. Therefore, the token economics should reflect this architecture well.
How do tokens capture value?
Although similar to the previous question, we can ask it another way: How do tokens capture value? Let’s assume that the flywheel unfolds ideally and token demand increases as the network activates. Does this necessarily lead to an increase in token value? Obviously, an increase in token demand does not necessarily mean an increase in token value. Setting aside market speculation (independent of underlying ecosystem growth), simple calculations show that token demand must exceed newly created token supply for value to increase. Therefore, the mechanism for increasing token demand or decreasing supply upon network activation should be somewhere in between. This is sometimes overlooked or not worked effectively, failing to achieve the feedback loop of network activation → token demand → increased token value.
To summarize what we have learned so far, the L1 token acts as the network’s reserve currency, an incentive tool to encourage contribution, and a unit of value that reflects the value created by the network. L1 can construct token economics as an economic system to align the interests of ecosystem participants and ensure the active operation of the network through tokens and incentive mechanisms. Well-designed token economics has the potential to promote self-sustaining network growth by incentivizing the value created in the network through tokens.
However, the token flywheel we often idealize often differs from the phenomenon observed in actual L1 networks. This is because the positive feedback loop cannot work effectively in the process of inducing participant behavior or connecting value. Specifically, this is because it is not fully considered whether the incentives of all participants are truly aligned, whether network activities lead to increased demand for tokens, and whether value is accumulated in tokens.
These limitations often cause existing L1 networks to lose the sustainability of token economics in many cases. Therefore, in the process of determining the direction that the next generation of L1 token economics should take, we need to examine these previous limitations more carefully through concretization. To this end, let’s translate the questions raised about token flywheels into key points for L1 token economics design: I. Mechanism design, II. Alignment with architecture, III. Value capture. In the next section, we will continue the discussion, observing the limitations of existing token economics and their causes through case studies, while clarifying the above key points.
I. Are the incentives of all participants truly aligned? → Mechanism design
II. Does increased network activity lead to increased demand for tokens? → Alignment with architecture
III. How does the token capture value? →Value Capture
Given the complexity of token economics, judging token economics cases based on a single factor may lead to the error of a one-sided interpretation of the phenomenon. However, as one of the methods to find sustainable token economics, it may be a good approach to try to define the limitations encountered by existing cases and learn lessons. Let’s examine 1) the limitations faced by Bitcoin in mechanism design, 2) the coordination problems between architecture and token economics revealed by Ethereum, and 3) the structural limitations of Arbitrum tokens in not being able to capture value from the network to concretize the three pillars of token economics that support the flywheel.
Bitcoin is one of the most innovative inventions since the birth of blockchain and has now become an important asset in traditional financial markets. However, there is a significant gap between the intended function of Bitcoin at the beginning of its birth and its current role. As the role of Bitcoin assets evolves, the original incentive mechanism design no longer meets its current function, leading to concerns about the lack of incentives to maintain Bitcoin security in the future. This reality is reshaping Bitcoin's development roadmap. Let's take a closer look at the case of Bitcoin, focusing on mechanism design, which can be summarized as "how much rewards to provide, how to provide rewards, and what actions to induce participants to take."
Bitcoin Token Economics: The Precondition of Halving
To summarize Bitcoin's mechanism, it combines network security with node incentives by rewarding mining nodes that generate valid blocks and abide by the rules of the PoW (Proof of Work) consensus algorithm. Nodes participating in the network compete to calculate hash values, consuming computing power to obtain block rewards to add valid blocks to the longest chain. For a malicious node to attack the network, it needs to control more than half of the computing power dedicated to PoW. This is difficult in practice, and even if it is achieved, the attacker will lose motivation because the attack will reduce the value of Bitcoin, causing them to suffer losses. Through this dynamic, Bitcoin implements Byzantine Fault Tolerance (BFT), operating as a decentralized monetary system through node consensus without the need for third-party trust.
Source: Bitcoin Wiki
Therefore, the block rewards obtained by mining nodes are crucial to maintaining the decentralization and security of Bitcoin, because it can incentivize nodes to act honestly and actively participate in the proof-of-work process. However, a closer look at Bitcoin's reward mechanism shows that in order to limit inflation, the block reward is halved approximately every four years and will eventually cease to be issued. As a result, miners will become increasingly reliant on transaction fees rather than inflationary block rewards.
This halving reward mechanism is designed based on the assumption that Bitcoin will eventually serve as a payment currency and transaction fees will completely replace mining rewards. Unlike what is currently considered a "store of value" (SoV), Bitcoin was created to replace centralized electronic payment systems. However, it is well known that Bitcoin faces scalability issues as a payment currency, and solutions such as USDC or USDT have been sufficient to replace payment currencies.
In response, some people have suggested that Bitcoin needs to revise its strategy, and the solutions to Bitcoin mining incentives can be summarized as follows. One scenario is that as the supply of Bitcoin becomes more and more limited, its scarcity will naturally increase, making it possible to solve this problem. Ultimately, as Bitcoin develops into a true store of value, its value may rise significantly, providing sufficient incentives for block generation even without mining rewards. Another solution is to develop Bitcoin as a programmable asset and network through initiatives such as BTCFi or Bitcoin L2. This approach aims to make Bitcoin a more productive asset rather than "lazy digital gold" and thereby increase the transaction fees generated within the Bitcoin network.
Bitcoin highlights the importance of mechanism design
While discussions on Bitcoin scalability continue, the potential lack of miner incentives in the future, contrary to the initial token economics design, raises critical questions about Bitcoin's sustainability. If mining rewards eventually stop, no one will spend computing power to earn block generation rights, which could lead to a situation where Bitcoin transactions are no longer recorded on the blockchain. Therefore, the market has set a new mission to gradually increase transaction fees to make Bitcoin a more productive asset to replace mining rewards. This has become an important task, driving the influx of developers and the expansion of the Bitcoin ecosystem.
The case of Bitcoin highlights the importance of mechanism design in token economics - "how much rewards to provide, how to provide rewards, and what behaviors to induce participants to take." Here, mechanism design refers to methods for setting up situations and incentives so that token economics participants take actions to maximize their own rewards. Mechanism design is also known as "inverse game theory." Game theory predicts how individuals will make strategic decisions to take actions that are in their best interests, while inverse game theory designs the best mechanism for individuals pursuing their own interests to achieve arbitrary goals together. In other words, it ensures that validators responsible for network security, protocols, and users pursue their best interests when participating in the ecosystem, achieving smooth operation and sustainable growth of the L1 network.
Architectural fit can be defined as whether the technical architecture of a blockchain and the economic model that supports it are compatible. L1 networks adopt different structures in their technical architecture, from consensus algorithms to transaction calculation structures and the existence of L2. For example, L1 networks with specific goals, such as the Monad blockchain that aims to achieve a high-performance EVM network through parallel transaction processing, or the Story network that focuses on IP tokenization, require unique technical architectures. But is it enough to just adjust the architecture? As the architecture changes, the types of participants in the network and their interests also change, so the economic model needs to be optimized to match the architecture. From this perspective, we can examine whether the architecture and token economics are consistent, and Ethereum's recent challenges with token economics sustainability provide a case study for considering this topic from multiple perspectives.
Ethereum has built the largest ecosystem of all blockchain networks with its rich liquidity and developer community. However, Ethereum has recently faced concerns about its economic model, in which the value of L2 does not belong to the Ethereum main chain and ETH. This issue stems from the fact that after the EIP-4844 update, the DA (data availability) fees paid by L2 when sorting transaction data to Ethereum were significantly reduced. This led to a corresponding decrease in the demand for ETH as a gas token. In other words, as L2 pays less fees to Ethereum, Ethereum's revenue decreases, and at the same time, the fundamental demand factor for ETH disappears, leading to the view that "L2 is economically parasitic on Ethereum."
To examine the context in more detail, Ethereum distinguishes between gas fees as a base fee, which is determined by network congestion, and a priority fee, which is arbitrarily set by users. Of these, the priority fee is provided as a reward to validators, while the base fee is destroyed. Therefore, when the total base fee generated in Ethereum exceeds the amount of newly issued block rewards, enough ETH is destroyed to keep the total ETH supply in a deflationary state. The fact that the absolute amount of ETH in circulation continues to decrease has been recognized by the market, supporting the fundamental demand for ETH as an asset.
However, Ethereum's long-term roadmap is centered on L2, which led to the EIP-4844 update to reduce sorting costs and improve L2 scalability. Since this update, the situation has changed. As can be seen from the significant increase in L2 transactions and unique active addresses, end users can now use L2 applications with lower network fees instead of Ethereum. On the other hand, Ethereum has gained a structural "disadvantage" position compared to L2. Despite the activation of L2, Ethereum’s average gas fee has dropped to 1 Gwei, resulting in an inflationary state of ETH supply. This is the reason why people criticize L2 as being economically parasitic on Ethereum.
Ethereum has continuously upgraded its architecture through L2 to make up for the lack of scalability of the main chain. This raises the question: given that Ethereum’s scalability has significantly improved and L2 activity has indeed increased, has Ethereum achieved its goals well? Ethereum has announced a rollup-centric roadmap that aims to achieve a highly scalable blockchain environment while maintaining sufficient decentralization. Therefore, the reduction in L2 operating costs and the improvement in end-user convenience since EIP-4844 may be consistent with Ethereum’s architectural upgrade goals.
However, the case of Ethereum shows that even if this is viewed as a transitional stage in the development of Ethereum’s L2-centric roadmap, problems arise when the technical architecture and economic model are inconsistent. While L1 has improved its architecture to fulfill its mission, and usability and activity have increased accordingly, the connection between the value generated from this activity and the economic model is broken. The connection between the scalability of L2 expansion and the economic benefits of Ethereum is missing. Proposals like EIP-7762 to increase the blob fees paid by L2 suggest that L2 scalability may regress, indicating that Ethereum has encountered a situation where the growth curves of the architecture and economic model are inconsistent.
This shows that token economics cannot be considered separately from the architecture built by Layer1. If Layer1 has a clear problem to solve and a mission to achieve, its technical architecture will be built as a methodology. Then, the token economics design optimized for that architecture should also follow. This problem is more likely to occur in modular blockchains, and there is a risk of economic fragmentation. In addition to Ethereum, the Cosmos IBC ecosystem has also spawned various application chains based on its unique technical architecture, but it maintains a fragmented ecosystem without a value chain that economically links the application chains into a single economic system. In other words, if ecosystem participants develop unique interests during the architecture development process, then an optimized economic model is also needed.
Value capture refers to the mechanism by which tokens capture value from the network. Even if the network becomes highly active, a mechanism that directly adjusts the supply and demand of tokens is needed to increase the fundamental demand for tokens. The lack of connection between Arbitrum and ARB, resulting in the inability of tokens to capture value, is a good example of the importance of value capture mechanisms.
Arbitrum Token Economics: L2 Tokens Are Meme Tokens
Arbitrum is currently the most active of all L2 networks, with approximately 700 protocols in its ecosystem and approximately 5 million transactions per week. However, compared to its high network activity, ARB has faced criticism that it is no different from a meme token and lacks utility beyond governance functions. It lacks fundamental demand factors recognized by the market. While various market variables complexly affect token prices, making price fluctuations difficult to simply explain, the token mechanism that creates the willingness to buy or hold tokens for the long term plays an important role in market participants' assessment of the value of tokens. In fact, the price of ARB has not escaped the downward trend, falling 66% year-to-date, and according to IntoTheBlock, 95% of existing ARB holders are losing money.
In response, Arbitrum DAO recently passed a proposal to introduce a staking function for ARB. The core of the proposal is to allow the delegation of governance rights through ARB token staking and strengthen the staking reward system. First, staking ARB will be able to earn interest from various sources of income, such as sorting fees, MEV fees, and validator fees. In addition, by introducing liquid staking, ARB depositors can interoperate stARB with other DeFi protocols while maintaining its staking status.
This token economics update will have various expected effects. Arbitrum DAO’s treasury has accumulated $45 million worth of ETH, but less than 10% of the circulating supply of ARB is used for governance. Therefore, strengthening the incentive for governance delegation through ARB staking provides an opportunity to improve governance security. Another important role is to make token holders willing to hold ARB for the long term.
The importance of value capture mechanisms emphasized by Arbitrum
Value capture involves accumulating network value in the form of tokens, either by distributing network-generated revenue to ecosystem contributors through tokens, or by adjusting token supply directly or indirectly. Value capture is important not only for L2 or DeFi protocols (as shown in the Arbitrum case), but also for L1 token economics. In particular, for L1 native tokens, which serve as incentives for ecosystem participants to act beneficially for the network, tokens must be seen as rewards with appropriate value to expect participants to contribute sufficiently.
The way tokens capture value is through a mechanism that combines network demand with token supply and demand dynamics. For example, if network revenue is used to buy tokens from the market and destroy them, the absolute number of tokens supplied to the market will decrease. Alternatively, there is a way to directly redistribute the revenue generated by the network to stakers. This value capture mechanism can create a basic demand factor for tokens or adjust the number of tokens circulating in the market, forming a virtuous cycle. This cycle can lead to L1 activation, which leads to an increase in token value, which in turn strengthens the incentive for contribution and further increases L1 activity.
So far, by studying existing token economics cases, we have been able to clearly identify three key points for creating a token flywheel. Of course, it will take a long time for Bitcoin's block rewards to disappear completely, so it is far from known at this point. Ethereum and Arbitrum are in intense discussions on solving current problems, leaving room for future improvements. Nevertheless, the problems encountered by existing token economics have also accumulated valuable lessons. Token economics is at risk of losing sustainability when there is a lack of incentives for ecosystem contributions, when the economic model is inconsistent with the technical architecture, or when network activity cannot be translated into token value growth.
However, meeting all of these criteria is not as easy as it sounds. The common solution proposed by Berachain, Initia, and Injective is to directly participate at the network level, align the interests of participants, or design token economics that fit the technical architecture. Alternatively, they try to adjust token supply and demand through unique mechanisms to overcome the limitations shown earlier. This strategy of deep participation in token economics at the network level has the potential to effectively supplement the flywheel gap missing from existing token economics. From here, let's take a look at how Berachain solves the problem through its complex PoL mechanism design, how Initia plans to economically connect the decentralized Rollup ecosystem through VIP, and why Injective has been able to maintain the deflationary state of its token in the long run.
Mechanism Design: Berachain, Proof of Liquidity
Mechanism design involves designing a system that enables L1 participants to ultimately contribute to the active operation and sustainable growth of L1 while pursuing their greatest interests. Berachain, which focuses on this area, has newly proposed PoL (Proof of Liquidity) as a consensus algorithm to solve the problem of interest misalignment by closely interweaving the interests and reward system of ecosystem participants.
Berachain Overview
Berachain is an EVM-compatible L1 built using BeaconKit, which is developed by modifying the Cosmos SDK. Similar to Ethereum's beacon chain structure, Berachain uses BeaconKit to separate the execution layer and the consensus layer, using ComtBFT as the consensus layer and EVM as the execution layer to ensure high compatibility with the EVM execution environment. With its solid technical strength, Berachain has been building its community and development environment for a long time, starting with the NFT project Bong Bears. Therefore, although it is still in the testnet stage, various protocols have joined and show high community participation.
Berachain Token Economics
Berachain is unique in PoL, which aligns the interests of participants at the network level. PoL is a consensus algorithm specifically designed to stably ensure liquidity and security and strengthen the role of validators in the ecosystem. It focuses on mechanism design in which each ecosystem participant prioritizes its own interests while promoting network growth under a mutually dependent relationship. Let's take a look at how Berachain aligns the individual interests of 1) users, 2) validators, and 3) protocols to a single growth intersection.
First, Berachain has three tokens: BERA, BGT, and HONEY. Each token plays a different role in the operation of PoL. BERA is used as a gas token for network fees, and BGT (Bera Governance Token) is used as a reward for providing liquidity and as a governance token to determine the reward ratio. HONEY is Berachain's native stablecoin, pegged 1:1 to USDC. While Berachain has this triple tokenomics, we will now focus on BERA and BGT to simplify our discussion of the PoL participant structure. To understand Berachain's mechanism design, we need to focus more on the special functions of BGT.
BGT is a token that can be used as a reward for providing liquidity to whitelisted liquidity pools (whitelisted reward treasury), as determined by governance. BGT is provided in an untradeable state tied to an account, and while BGT received as a reward can be redeemed 1:1 for BERA, the reverse redemption (BERA → BGT) is not possible. Therefore, providing liquidity is the only way to earn BGT.
The supply of BGT is determined by the validators voting to decide how much BGT issuance is allocated to which liquidity pool. Users who obtain BGT have two options: one is to redeem BGT for BERA for liquidation, and the other is to delegate it to the validator to obtain additional rewards. Here, additional rewards refer to bribes that flow from the protocol to the user through the validator, which we will introduce in detail later.
The reason why Berachain divides gas tokens and governance tokens into BERA and BGT is to ensure liquidity and security in the ecosystem. In an L1 network using a single token, staking tokens to increase PoS security limits the number of tokens that can be used as liquidity in the ecosystem. Therefore, by obtaining BGT for security only by providing liquidity, Berachain aims to solve the problem of inconsistent network liquidity and security. In addition, by allowing validators to distribute the issuance rate of BGT, it strengthens the structure of consistent interests of ecosystem participants by increasing the interdependence between validators and protocols and users.
Now that we understand the basic principles of PoL and the role of BERA and BGT, let’s look at how ecosystem participants interact under this mechanism design. Follow the flow of BGT, liquidity, and bribes from (1) to (6) to understand how ecosystem participants interact under certain interests.
User ↔ Protocol
(1) Liquidity: Users deposit liquidity into a whitelisted liquidity pool of their choice. The protocol uses the liquidity of this pool to provide a smooth trading environment for protocol users.
(2) BGT + LP Rewards: When users provide liquidity to the whitelisted pool, the protocol provides BGT rewards and liquidity rewards for the deposit pair. Here, the protocol needs to ensure as much BGT issuance rate as possible to make users choose their liquidity pool.
Protocol ↔ Validators
（3） Bribes: Validators have the governance power to determine the BGT issuance rate of the liquidity pool. Therefore, the protocol provides bribes to validators to vote for their liquidity pool.
(4) BGT issuance voting: Unlike other L1s, Berachain’s validators do not directly receive L1 tokens provided according to the inflation rate as network validation rewards. Instead, they receive incentives for network validation through bribes provided by the protocol (excluding priority fees that may occur from time to time). Therefore, in order to obtain enough bribes from the protocol, they need to obtain more BGT to gain stronger governance rights.
Validators ↔ Users
（5） Bribes: The way for validators to obtain stronger governance rights is to obtain BGT delegations obtained by users through liquidity provision. To do this, they need to return the bribes received from the protocol to the users, or provide separate incentives to increase the number of BGTs delegated.
(6) Delegated BGT: Users delegate BGT to validators in exchange for bribes received from validators.
The direction of token economy proposed by Berachain's mechanism design
In summary, Berachain aims to ensure the liquidity and security of the ecosystem through PoL and solves the problem of fragmented interests of validators. Berachain goes beyond the existing approach of a single token as a base currency serving all roles, distinguishes between BERA for liquidity and BGT for governance, and solves the trade-off between liquidity and security. By constructing validators to receive rewards through bribes and giving them the power to determine the issuance of BGT, it strengthens the interdependence between validators, protocols, and users.
Of course, as the complexity of the mechanism increases, the learning difficulty of end users will also increase, so it remains to be seen whether the PoL-centered interaction can proceed smoothly after the mainnet is launched. However, Berachain's token economics is quite mature in mechanism design, which solves the problem of discontinuity of flywheel caused by the imbalance of the incentive mechanism of participants and points out an important direction for L1 token economics.
Fit with architecture: INITIA, VIP
Initia is expected to make up for the inconsistency between architecture and economic model when the architecture needs to be consistent with the network. Initia focuses on the fragmentation problem faced by the existing Rollup ecosystem. According to its mission of "Interwoven Rollup", it aims to build an ecosystem in which L2 Minitias are distributed around Initia while being closely connected in terms of economy and security. As part of this work, it attempts to connect the decentralized Rollup ecosystem economy through its unique token economics VIP.
Initia Overview
Initia is a Layer1 based on Cosmos, powered by MoveVM, and is the settlement layer of the Layer 2 Rollup called Minitia. Initia (L1) and Minitia (L2) are interconnected in terms of economy and security to form a comprehensive ecosystem called Omnitia. Therefore, various functions of Initia are created to strengthen the connection with Minitia L2. For example, in terms of security, if fraud occurs within Minitia, Initia's validator nodes will intervene with Celestia to resolve the dispute, thereby reconstructing the last valid state. In terms of liquidity, it operates a liquidity center called Enshrined Liquidity at the L1 network level, which Minitia can use to achieve smooth flow and exchange of assets between Minitia for users through Enshrined Liquidity's router function.
Initia Token Economics
Initia is designed with a focus on interconnection with Minitia L2, so it designs a mechanism called VIP (Vested Interest Program) for economic connection with Minitia. VIP aims to make INIT, the base currency of the Initia ecosystem, an important part of all L2s. By using INIT to connect Initia and Minitia, and continuously create use cases for INIT. The VIP process can be roughly divided into three parts: 1) allocation, 2) distribution, and 3) unlocking.
1) Allocation
First, 10% of the INIT founding supply is allocated as VIP funds. These funds are distributed every two weeks to Minitias and users who are eligible for VIP rewards. Here, VIP rewards are distributed in a split state according to two pools: balance pool and weight pool. Balance pool rewards are distributed to Minitias in proportion to the number of INITs held by them. Weight pool rewards, on the other hand, are distributed to Minitias according to the weights set through measured voting in L1 governance. In other words, L1 stakers determine how much rewards to allocate to each Minitia through measured voting. Therefore, the balance pool encourages Minitias to hold more INITs and create use cases for INITs in their applications, while the weight pool creates use cases for INIT tokens through measured voting and encourages validators, users, or bribery protocols such as Votium or Hidden Hand to actively participate in L1 governance.
2) Distribution
The rewards allocated to Minitias are provided in the form of esINIT (custodial INIT), which is non-transferable in the initial state. The recipients of esINIT allocated to Minitias are divided into operators and users. Operators here refer to the project team that operates Minitias. Project teams that receive operator rewards can use esINIT in various ways. They can use it as a development fund to replenish Minitia, redistribute it to active users in Minitia, or stake it in Initia L1 for self-voting in future epoch votes.
On the other hand, esINIT distributed as user rewards is given directly to users based on their VIP score. The VIP score is a number calculated based on various KPIs set by Minitia, which is designed to encourage users to interact in Minitia. For example, by setting criteria for VIP scores (such as the number of transactions, trading volume, or loan size generated by users through Minitia in a specific period), Minitia can incentivize users to perform specific actions.
3) Unlock
As mentioned above, when rewards are distributed to users based on VIP scores, esINIT will be provided as a non-transferable escrow token. Therefore, users need to go through the unlocking process to liquidate the esINIT received as rewards. At this point, users can choose one of two actions to maximize their benefits. One is to maintain their VIP score over multiple epochs to unlock esINIT as liquid INIT. During this time of maintaining the VIP score, users can accumulate additional points in Minitia, which has the advantage of inducing user retention from Minitia's perspective. Another way to utilize esINIT is to deposit it in Enshrined Liquidity as a liquidity pair to receive deposit rewards.
In summary, VIP is the token economics of Initia, which aims to economically connect L1 and L2 and create continuous demand for INIT. In the 1) distribution process, it aims to increase the use cases of INIT and activate the ecosystem by providing devices such as balance pools and weight pools with different distribution methods to encourage governance participation. In the 2) distribution process, it allows Minitia to induce specific user behaviors through VIP scores, thereby aligning the interests of Minitia and users. 3) The unlocking process is a device that induces users to retain or directly contribute to the Initia ecosystem by providing liquidity.
Through this process, Initia aims to prevent the economic fragmentation of the Minitia ecosystem while creating multifaceted use cases for INIT and correspondingly generating basic token demand factors. As modular blockchain-centric infrastructure becomes more and more common, the economic fragmentation of the ecosystem is considered a long-standing problem that must be weighed against the benefits of a modular-based development environment. In this regard, VIP proposed by Initia provides a meaningful direction for the design of token economics in future modular ecosystems.
Unlike Berachain and Initia, which have not yet launched their mainnet, Injective has been well known in the market since 2018. However, until recently, it has continued to improve its token economics through updates such as INJ 3.0 and Altaris, and has built a unique deflationary token economics through its destruction mechanism. Therefore, I think this is a noteworthy use case when discussing L1 token economics from a value capture perspective and want to introduce it in this section.
Injective Overview
Injective is an L1 built on the Cosmos SDK and a custom consensus mechanism based on TendermintBFT, optimized for finance from spot trading to perpetual futures trading or RWA. As an L1 built for finance, it provides a high-performance blockchain environment with more than 25,000 TPS to handle high-frequency trading, and utilizes on-chain order matching models such as FBA (Frequent Batch Auction) to prevent MEVs from achieving capital-efficient transactions. In addition, Injective also provides plug-and-play modules as part of its development resources. In particular, with the exchange module, processes such as order book operations, trade execution, and order matching can be easily handled, and the shared liquidity built into Injective can be used to build a financial services environment without the effort of attracting separate liquidity.
Injective-style token economics
IInjective is known for its token economics, which achieves deflation through destruction auctions, aiming to reduce the circulating supply of INJ in the market. The process of the destruction auction is as follows: When assets generate income from the Injective application and flow into the auction fund, these assets will be auctioned and people can bid with INJ. After the auction is completed, the winning bidder will exchange the INJ used for bidding for tokens in the auction fund, and the INJ used for bidding will be destroyed, thereby removing that amount of INJ from the total token supply. Injective conducts such auctions once a week, and as of October 2024, 6,231,217 INJ (about $142,000,000) of the total token supply has been auctioned off.
Diving deeper into the destruction auction process, it is conducted through the auction module, which handles the bidding, winner determination, and INJ destruction processes, as well as the exchange module. First, the auction fund assets are collected through three channels. One is that part of the revenue of applications using the exchange module is transferred to the auction fund. Another is that applications that do not use the exchange module can transfer a nominal amount or a certain percentage of the fees to the auction fund. Finally, individual users can independently contribute to the auction fund.
The assets accumulated in this auction fund are mainly accumulated in the form of USDT, USDC, or INJ, and anyone can participate in the auction of this fund using INJ. Auction participants have the opportunity to obtain the fund's assets at a slightly discounted price, such as winning $100 worth of auction funds for $95 worth of INJ, which naturally generates bidding competition. Finally, the winning bidder exchanges his INJ used for bidding for tokens in the auction fund, and the INJ used for bidding will be destroyed.
The direction of token economics proposed by Injective's destruction auction
Injective's destruction auction accumulates the bidding fees generated by the exchange module, creating a structure in which the amount of INJ destroyed increases as the exchange module's trading volume increases. Therefore, as Injective's trading activity increases, the supply of tokens circulating in the market decreases, allowing the token to extract value from the network. Therefore, Injective combines ecosystem growth with token value enhancement through its destruction mechanism and seems to continue to strengthen its growth-driven token destruction mechanism in the future.
While most blockchains have mechanisms to burn a percentage of network fees, few L1 networks adjust token supply as intuitively as Injective. In particular, since most blockchains other than Bitcoin and Ethereum (mainnet) were developed with low gas fees in mind, network fee-based token burn mechanisms are limited in how much they can burn. Injective is also committed to achieving near-zero transaction fees, with an average fee of $0.0003 per transaction. In this context, a burn auction that can burn a large amount while keeping gas fees low is consistent with the user environment that future L1 networks are designed to develop, and Injective is the most noteworthy in this regard.
So far, we have examined the limitations of existing token economics and the case for improving token economics, identifying potential directions for the next generation of token economics. It is worth noting that Berachain, Initia, and Injective show a common trend: they are enhancing their token economics through unique mechanisms implemented at the network level. Each project is building token economics to leverage its strengths in mechanism design, alignment with architecture, and value capture.
So, we conclude, what constitutes the ideal token economics for L1? Is there an absolute token economics framework to drive the token flywheel? To answer this question, we view token economics as a comprehensive system that includes not only token-related discussions, but also the mission that L1 aims to solve, its technical architecture, and the behavioral patterns of ecosystem participants. The key insight from this process is that token economics itself is just an idea. The value of token economics is reflected in the actual interactions between the various elements that make up the L1 network and its participants.
Therefore, we need to shift our perspective from "What is the ideal token economics" to "What is the ideal L1 and what role does token economics play in it?" From this perspective, I believe that an L1 with great potential is an ecosystem in which the mission, architecture, protocol, and token economics are organically linked together with a consistent logic and produce synergy.
Clear mission
The technical architecture faithfully reflects the mission
An ecosystem full of protocols and applications optimized for network development environment or architecture can be called "only possible on xxx Chain"
Therefore, provide differentiated value to users
Token economics is not mentioned in this list, but this does not mean that token economics exists independently. Token economics should serve as a lubricant to keep the gears of architecture and protocol running smoothly. Using this framework to diagnose the L1 networks we examined today, we can draw the following conclusions:
Berachain designed a unique consensus algorithm called PoL to create an EVM-compatible L1 network, convert liquidity into security, and developed its own framework compatible with the EVM, such as Polaris. In addition to this, there are projects emerging, such as Infrared, which liquidates non-tradable assets BGT, Smilee Finance, which hedges impermanent loss to offset the risk of PoL, which must focus on liquidity provision, and Yeet Bonds, which allows protocols to autonomously ensure liquidity (liquidity owned by the protocol) through bond product sales, minimize resources spent on liquidity bootstrapping (liquidity mining, bribes), and implement self-voting to autonomously ensure the emission of BGT. When these components are combined with PoL (which is both the purpose and the means of Berachain) and the triple token economics of BERA, BGT, and HONEY, we can look forward to building a unique ecosystem where validators, protocols, and users can create synergies and grow together.
Initia is an L1 network built for "Interwoven Rollup" that aims to solve the fragmentation problem of modular blockchains. To this end, it has built various architectures to strengthen the connection between Initia and Minitia, from the Minitia framework Opinit Stack for building Rollup based on Initia, to Enshrined Liquidity for protecting Minitia liquidity, and OSS (Omnitia Shared Security), a shared security framework for Minitia fraud proofs. Based on Initia's architecture, Minitia dedicated to modular infrastructure are emerging, including Tucana (an intent-based DEX that integrates liquidity from the modular network) and Milkyway (which aims to provide re-staking services based on Initia). Here, VIP token economics has the potential to create a virtuous cycle economy in which Minitia accumulates the value created in Initia, and Initia in turn increases the activity of Minitia.
Injective has a technical architecture optimized for financial application development, faithfully embodying its goal of "blockchain built for finance". It is based on a high-performance blockchain environment that handles high-frequency transactions and supports plug-and-play modules that can be used for financial application development, from exchange modules that provide shared order books and shared liquidity to auctions, oracles, insurance, and RWA modules. Injective has a variety of financial applications and products developed using these different modules. I think the cases of Helix, an on-chain order book exchange that uses the exchange module to provide a trading environment comparable to CEX, and the launch of a tokenized index for BlackRock's BUIDL fund using Injective's built-in RWA oracle are good examples of things that are "only possible on Injective". Here, Injective's token economics, namely the burn auction, plays a role in coordinating ecosystem growth with the increase in token economics value, promoting the launch of more killer applications.
It can be seen that these projects have the conditions for the L1 network and the various components of the token economics to produce synergies and grow together. Of course, since Berachain and Initia have not yet been officially launched, it is necessary to closely observe the interactions that will occur in the ecosystem for a long time. In particular, both chains are preparing quite complex token economics. Therefore, careful consideration from all angles is needed to effectively reduce the high learning curve that users will face and ensure that the token economics can perform as expected during the actual implementation.
At the same time, Injective's token economics in particular requires the activation of the application ecosystem as the most critical prerequisite. At present, Injective has an average of 2-3 million transactions per day and a cumulative trading volume of 39.2 billion US dollars, which shows a high level of activity and maintains a stable INJ consumption rate. Looking ahead, the activation of financial products and applications that actively utilize the unique features of financial professional chains (such as the BUIDL index or the 2024ELECTION perpetual market) will continue to play a key role in maintaining the unique deflationary model inherent in Injective's token economics.
Is the crypto industry still a "narrative game" without substance? Looking at the recent crypto industry, the atmosphere seems to be very different. With the RWA market size, which has reached $12 billion, led by large institutions such as BlackRock and Franklin Templeton, the influx of traditional institutions is accelerating, and market participants are not only concerned about short-term narratives, but also about the actual cash profitability and profit distribution mechanism of protocols such as Uniswap or Aave. Given this status quo, fundamentals are becoming an increasingly important topic in the crypto industry.
When fundamentals become increasingly important, token economics is undoubtedly the core criterion for evaluating the fundamentals of L1 networks. Based on our discussion in this article, we can diagnose the fundamentals of token economics by checking whether the network activity is sufficient to trigger token demand, whether ecosystem participants actively interact around tokens to obtain their own interests, and whether these interactions converge into network growth. In addition, whether this token economics not only exists as an idea, but also plays a synergistic role with the various components of the network may become an increasingly important framework for judging the fundamental value of L1 in the future.
Against this backdrop, the reason why Berachain, Initia, and Injective, introduced today, deserve attention is that they attempt to overcome the limitations of existing models by conducting token economics directly at the network level. Injective maintains a unique token economics in terms of boosting token value through its deflation mechanism, while Berachain's PoL and Initia's VIP provide a blueprint for L1 token economics in an unprecedented way. Considering the reality that many L1 projects in the past have remained "zombie chains," I think the token flywheel has barely moved. On the other hand, whether these new approaches truly build a sustainable ecosystem and achieve the ultimate goal of the flywheel will be an important point in determining the next stage of L1 token economics.
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