Economics Paper V2 Draft

General
5

Hi @Patrick :slight_smile:

This is PM from MantaDAO, love to see Jackal coming up with an upgrade to his economic model, and thanks for the opportunity to provide feedback.

I have a contrarian take to the first two comments by @Cryptodegan and @Saul, which I will explain.

I believe (i) attaching real cash flows to the token (albeit indirectly by directing 60% of revenue to POL, which is an interesting design choice) and (ii) reducing inflation, tackles the two major issues of the original economic model.

My main concern is regarding inflation, I think the current proposal doesn’t do enough to cut it and this is likely to lead to a continuation of the structural downward price pressure for JKL (net of any interim upside volatility as we have been experiencing across the entire space recently). I’ll be sharing my thinking starting with some fundamental economic principles and going into the specifics for Jackal.

On Fundamental Value

  • The fundamental value of a business/protocol/DAO is driven by its capacity to generate future cash flows for its share/token holders, and the risk perceived by the market participants vs. their expectation of future cash flows.
  • Imagine Jackal generates $100 of annual cash flows from selling storage (let’s assume no growth to keep things simple) that are 100% distributed to token holders, and the market equilibrium for the perceived level of risk is at 10% APR (i.e. investors in JKL think they are paying a fair price for JKL when they get 10% APR in real yield in return).
  • Then the implied fundamental value of Jackal Protocol would be $100/10% = $1000.
  • Now, let say the total supply of JKL was fixed at 1000 tokens, then the implied fair price per token would be $1000/1000 = $1.

On Token Inflation

  • Inflation doesn’t create any value, it just increases the denominator in the previous example, meaning that everything else being equal (in term of revenue generated by the protocol), it leads to a reduction in price per token.
  • What inflation does is redistributing the ownership of the economic pie between the various groups of token holders. In the case of Jackal, this includes: the Stakers, the Storage Providers, the Development Team, and the non-staking token holders (including the liquidty providers).
  • A bit of inflation is not necessarily a bad thing, particularly in the early days of a protocol. It allows to incentivize and subsidize certain group of participants that might be critical to the long-term success of the protocol, but have short-term cash needs (e.g. to pay for infrastructure costs) or opportunity cost (e.g. to put their resources at work somewhere else where they will get a higher payout).
  • It’s important to keep in mind that this is just a mechanism transferring value from people on the receiving hand (e.g. the Stakers) by diluting people that don’t benefit of it, or not as much (e.g. the token holders that don’t stake and the liquidity providers).
  • The higher the inflation, the higher the require cash flow growth to compensate for dilution and maintain the price per token at current level.

On Token Liquidity

  • Building strong liquidity is fundamental to support token price stability, allowing existing token holders to sell with limited price impact, and potential new investors to enter with size.
  • This is particularly important for projects that decided to use inflation to subsidize certain participants. The underlying assumption is that real revenues in the early days is not enough to make it profitable for validators and storage providers to run the necessary infrastructure to guarantee the good functioning and security of the network.
  • The only way to turn this artificial revenue into real $ that can be used to fund operations is to sell those newly issued tokens into the secondary market. Deep liquidity is essential to mitigate this continuous downward price pressure this causes.
  • The only way for token price to remain stable or increase is that the demand for JKL from investors/speculators + real usage (e.g. to pay for gas and storage fees) + liquidity providers (i.e. market makers) ≥ sale pressure from validators + storage providers + Team + Insiders (private sell participants, advisors) + Mercenary LP farming liquidity incentives + Secondary investors/speculators exiting their positions.
  • Everything else being equal, the higher the inflation, the higher the sale pressure and negative price impact, the more tokens subsidized participants will have to sell to keep their $ income constant, which create a negative feedback loop.
  • Building Protocol-Owned Liquidity (POL) is a great way to mitigate the impact of some of this sell pressure as it sustainably deepens liquidity while also reduce/remove the needs to incentivize mercenary LPs that contribute to this sell pressure.
  • POL only works if JKL are paired with quality tokens that at least retain their value in dollar terms (i.e. stablecoins) or ideally increase in value compared to the dollar in the long-term. The best-case scenario is to pair with a token whose value is appreciating faster than JKL. The worst-case scenario is to pair with a token whose value is deprecating faster than JKL and the dollar.

Reviewing Jackal Economics V2 through that lens

  • JKL current supply stands at ~132.5m; based on the proposed revised inflation schedule, it will take roughly 3 years for the supply to increase by ~50%. This means, assuming JKL is currently fairly priced in relation to its revenue, revenue will need to growth by at least 50% in the next 3 years for JKL price to stay flat despite dilution from inflation, which seems reasonable.
  • However, in reality, current valuation is factoring in a lot of growth (which makes sense given the early stage of the project). Difficult to be accurate given the lack of transparency on revenue, but back of the envelope, based on total TB of storage space purchased from the network and assuming 100% of buyers will renew their subscription at perpetuity, Jackal is currently generating ~$43.5k of recurring annual revenue. At current JKL price ($0.15 as of 18-Nov-2023), Market cap is at ~$20m, trading at 456x revenue, which is a lot. Say differently, if 100% of the revenue was distributed to toke holders, this would amount to a real yield of 0.2% APR assuming no inflation, and less once adjusted for inflation.
  • So, revenue growth expectations from market participants are already high, therefore I don’t see the need to put Jackal under pressure to have to growth by another 50% within 3 years on top of what is already baked into current valuation, just to compensate inflation.
  • The rest of the proposal look good, I like the concept of using 60% of the protocol (real) revenue to build up POL, this is a viable alternative to direct revenue distribution to stakers (particularly if you don’t intend to entirely scrap inflation one day).
  • The concept of distributing 15% of the revenue in the form of referral commissions is also great, this paves the way for the development of a truly decentralized sales force. It might take some time to start bearing fruits, but it’s a very powerful concept and makes me excited for the direction the protocol is heading towards.

Recommendations

  1. Adjust the MintDecrease parameter so that inflation in year one is halved compared to what is currently proposed (from 16.36% down to 8.16% in year 1).
  • This is definitively more of an art than a science, but high single digit territory for the first year seems high enough to attract people that just look at the headline staking APR number and don’t understand the impact of inflation on price, while also mitigating the expected downward price pressure.
  • Limiting inflation will also limit the damage (dilution) to liquidity providers, which will include Jackal Protocol itself and any partners for building up POL. The lower the inflation, the more confident POL partners can be that they won’t suffer material IL on the position.
  1. Create of a dashboard tacking monthly revenue and key KPIs; this will be critical for governance participants to track the progress of the new economic model and make informed decisions.
  2. Explore partnerships to increase POL (ongoing proposal by Shade Protocol is a good one; MantaDAO will also come with a proposal after that one, the more the better).

Hope this is helpful. I am a big fan of the Jackal vision for decentralized storage and really want to see you succeed, this is really something we need <3

2 Likes