The development of the cryptocurrency industry and IDO is progressing every year. Thanks to this, new ways of raising funds appear frequently. Initial Dex Offering is one such form. This is one of several ways to raise funds for crypto projects. It is worth noting that the first approach to raising funds for a project's token was the Initial Coin Offering (ICO), which in 2017 brought many advantages and negatives. At the same time, ICO has led to the fact that many investors have become millioners within a few days. How does ICO compare to IDO? Why can IDO be a more interesting concept for raising funds? We are writing about this in thie article below!

ICO and IDO

As we have written earlier, ICO is an unregulated approach to crowdsourcing funds from retail investors. In the crypto space, the main challenges of initial coin offering were related to lack of control and protection of investors' funds. Cryptocurrency projects access was based on complete trust. ICO creators were not due diligence tested. This has led to a time when almost every initial coin offering project could promise significant profits - but these promises have repeatedly proved to be empty.

Many ICO projects have simply proved to be a fraud. Decentralized finance (DeFi) can help with this, as they aim to address this problem through alternative fund-raising models. One such model is the decentralized Exchange (DEX) model. DEX offers cryptocurrency investors access to another, more egalitarian model of crowdfunding in the crypto market.

What is a DEX offer or IDO?

It is worth noting that the original concept of the initial offers of DEX has changed enormously over the years and in its current most popular form has little to do with what it planned to implement at the start of the initial IDO (Initial DEX Offering). In fact, the initial offer of DEX is the successor to initial coin offering and IEO, because its goal is to collect money and launch the project. However, unlike ICO and IEO, in which tokens are sold before being listed, in the case of initial dex offering, they are immediately listed on a decentralized exchanges. For this reason, the name DEX was created.

What is the Raven Protocol? The first ever Initial DEX Offerings took place in June 2019 – it was called the Raven Protocol. The protocol team selected the decentralized Binance DEX exchange. They place a new token at a specific price, and the traders could buy it until the hard cap has been reached on binance dex.

In theory, this particular way of fundraising had several powerful benefits, including:

Quick Trading
Immediate liquidity was achieved
An open and transparent means pf collecting money has been achieved

However, investors were not satisfied. The reason was that these symbolic sales would be sold out in a few seconds, leaving a small opportunity for the average investor to participate in the project. As a result of the immediate selling of the entire offer, there was speculation that it was done by bots. This is how the first initial dex offering start platforms, which are gaining popularity today, were formed.

What is a starting offer for DEX and IEO (Initial Exchange Offerings)

The first offer of DEX (IDO) is a way to raise funds that receives investment capital from retail investors. IDO was created to address the shortcomings of the 'traditional' model of cryptocurrency community funding, the initial coin offering. Given that IDO works with DEX, unlike centralized exchange, DEX can be regarded as a decentralized liquidity exchange. Decentralized liquidity exchange and initial dex offering is the latest model for funding cryptocurrency projects that want to raise funds from investors. However, let us remember that DEX is less scalable than ICO and IEO, and many trading processes are based on DeFi platforms

Token Generation EVENT and decentralized exchange

Today, in its most popular iteration and form, the initial offers of DEX are particularly similar to Initial Exchange offerings (IEO) with some key differences.

In the case of IEO, it was an echange which reviewed projects and conducted token sales. With initial dex offering, it is a third-party platform that checks the stock exchange, while token sales themselves take place in a slightly decentralized manner.
In theory, anyone can raise funds through IDO (initial dex offerings) using a third-party start platform because everything he or she would have to do is open the pool.
The way it works is quite simple. The project is sent to the starter, and if it meets the requirements, it is selected for the initial dex offering. The process itself may vary from one starter to another, but the concept is always the same.
There is a pool from which users can buy an "IOU" of the token that the project wants to run. The IOU is a confirmation of the debt. In other words, investors pay for their tokens in advance, but receive them at the Token Generation Event (TGE), which usually takes place very shortly after the IDO itself (usually within a few hours).
Once the IDO has been successfully concluded and TGE has started, the token is immediately traded on a decentralized exchange. In most cases, this is the case with Uniswap because the vast number of projects is still built on Ethereum and their tokens are based on the ERC20 protocol standard.

However, other blockchains are also gaining popularity, including Solana, Polkadot and Binance Smart Chain (BSC). Therefore, some projects prefer to run their tokens on them to avoid high network charges in Ethereum. In this case, the token would be listed on a native stock exchange, such as the BSC’s PancakeSwap.

How do IDO cryptocurrencies work?

IDO (initial dex offering) works because DEX can provide instant liquidity for tokens based on smart contracts. That is why DEX tends to reward liquidity pool providers with attractive rewards. Liquidity pools allow DEX to operate without unexpected problems for their users. In order to help trade, most projects provide liquidity to DEX by allocating a part of the funds. This approach has become standard practice. Many projects are also supported by the “Proof of Stake (POS) mechanism. The POS consensus is designed to keep the network secure. But in this case, the mechanism mainly serves to discourage investors from selling tokens too fast. This ensures that investors hold their token capital in their portfolio. In return, they earn rewards for their "participation" in the network. Then, when the project is launched, investors can immediately start trading the token. Investors who have purchased tokens faster can sell them at a higher price when initial dex offerings begins to operate. When the public sale starts, the token value increases.

Fees and smart contracts

In the event of an ecchange, the fees for the performance of the new smart contract are negligible, as the trading pairs provide a high degree of liquidity. Smart contracts help manage the asset token and the liquidity pool. It should be stressed that unlike traditional fund-raising models, IDO can immediately create tokens. In addition, any meaningful IDO project can be qualified to raise funds from retail investors. The same can be said about avoiding the high costs of Initial Exchange Offerings (IEO). Investors do not have to wait long for the desired tokens to appear on the stock exchange. The list usually appears immediately after the initial dex offerings is complete. This time allows investors to make money on their investments much quicker compared to initial coin offering .

Pros and cons of IDO

Like any funding method, IDO has its advantages and disadvantages for project's token, which we have decided to present below:

Pros of IDO

Availability - IDO has no procedures that can be associated with IEO. As a result, many people can raise capital without unnecessary bureaucracy.
Speed - investors are quickly informed of the arrival of tokens on the stock exchanges and start trading because they have immediate access to trade. The listing occurs almost immediately after the IDO has ended. Its good for token projects.
Immediate liquidity - in connection with the promotion of PoS, significant capital is leftavailable on the stock exchange, thus improving its liquidity.
Transparency - anyone can review token contracts and projects beforehand.

Cons of IDO

Verification - the low level of verification leads to many rogue creators who attempt to defraud funds.
Competition - it is extremely difficult to participate in IDO because of a huge number of competitors who wish to purchase tokens.
Token sharing - most tokens in IDO generally reach the team and private investors first, and afterwards to the rest of the entities.
However, IDO still seems to be an attractive form of investment, with little bureaucracy and tempting, significant profits.

Crypto projects offered by IDO are lightning-fast. The initial waiting period for selling tokens at the exchange is short, which allows many people to profit quickly. Unfortunately, these offers are often attractive and, as a result, an average crypto trader may not be able to make the purchase in time, as you will see if do your own research into the matter. Moreover, IDO are not usually present on centralized exchanges, which means that they are also directed towards a smaller group of people. However, IDO is attractive due to the lack of bureaucracy, quick access to funds and the immediate provision of liquidity to the platform.

Applying Game Theory in Token Design

Kajetan Olas

16 Apr 2024

Blockchain technology allows for aligning incentives among network participants by rewarding desired behaviors with tokens.
But there is more to it than simply fostering cooperation. Game theory allows for designing incentive-machines that can't be turned-off and resemble artificial life.

Emergent Optimization

Game theory provides a robust framework for analyzing strategic interactions with mathematical models, which is particularly useful in blockchain environments where multiple stakeholders interact within a set of predefined rules. By applying this framework to token systems, developers can design systems that influence the emergent behaviors of network participants. This ensures the stability and effectiveness of the ecosystem.

Bonding Curves

Bonding curves are tool used in token design to manage the relationship between price and token supply predictably. Essentially, a bonding curve is a mathematical curve that defines the price of a token based on its supply. The more tokens that are bought, the higher the price climbs, and vice versa. This model incentivizes early adoption and can help stabilize a token’s economy over time.

For example, a bonding curve could be designed to slow down price increases after certain milestones are reached, thus preventing speculative bubbles and encouraging steadier, more organic growth.

The Case of Bitcoin

Bitcoin’s design incorporates game theory, most notably through its consensus mechanism of proof-of-work (PoW). Its reward function optimizes for security (hashrate) by optimizing for maximum electricity usage. Therefore, optimizing for its legitimate goal of being secure also inadvertently optimizes for corrupting natural environment. Another emergent outcome of PoW is the creation of mining pools, that increase centralization.

The Paperclip Maximizer and the dangers of blockchain economy

What’s the connection between AI from the story and decentralized economies? Blockchain-based incentive systems also can’t be turned off. This means that if we design an incentive system that optimizes towards a wrong objective, we might be unable to change it. Bitcoin critics argue that the PoW consensus mechanism optimizes toward destroying planet Earth.

Layer 2 Solutions

Layer 2 solutions are built on the understanding that the security provided by this core kernel of certainty can be used as an anchor. This anchor then supports additional economic mechanisms that operate off the blockchain, extending the utility of public blockchains like Ethereum. These mechanisms include state channels, sidechains, or plasma, each offering a way to conduct transactions off-chain while still being able to refer back to the anchored security of the main chain if necessary.

Conceptual Example of State Channels

State channels allow participants to perform numerous transactions off-chain, with the blockchain serving as a backstop in case of disputes or malfeasance.

Consider two players, Alice and Bob, who want to play a game of tic-tac-toe with stakes in Ethereum. The naive approach would be to interact directly with a smart contract for every move, which would be slow and costly. Instead, they can use a state channel for their game.

Opening the Channel: They start by deploying a "Judge" smart contract on Ethereum, which holds the 1 ETH wager. The contract knows the rules of the game and the identities of the players.
Playing the Game: Alice and Bob play the game off-chain by signing each move as transactions, which are exchanged directly between them but not broadcast to the blockchain. Each transaction includes a nonce to ensure moves are kept in order.
Closing the Channel: When the game ends, the final state (i.e., the sequence of moves) is sent to the Judge contract, which pays out the wager to the winner after confirming both parties agree on the outcome.

A threat stronger than the execution

If Bob tries to cheat by submitting an old state where he was winning, Alice can challenge this during a dispute period by submitting a newer signed state. The Judge contract can verify the authenticity and order of these states due to the nonces, ensuring the integrity of the game. Thus, the mere threat of execution (submitting the state to the blockchain and having the fraud exposed) secures the off-chain interactions.

Game Theory in Practice

Understanding the application of game theory within blockchain and token ecosystems requires a structured approach to analyzing how stakeholders interact, defining possible actions they can take, and understanding the causal relationships within the system. This structured analysis helps in creating effective strategies that ensure the system operates as intended.

Stakeholder Analysis

Identifying Stakeholders

The first step in applying game theory effectively is identifying all relevant stakeholders within the ecosystem. This includes direct participants such as users, miners, and developers but also external entities like regulators, potential attackers, and partner organizations. Understanding who the stakeholders are and what their interests and capabilities are is crucial for predicting how they might interact within the system.

_{Stakeholders in blockchain development for systems engineering}

Assessing Incentives and Capabilities

Each stakeholder has different motivations and resources at their disposal. For instance, miners are motivated by block rewards and transaction fees, while users seek fast, secure, and cheap transactions. Clearly defining these incentives helps in predicting how changes to the system’s rules and parameters might influence their behaviors.

Defining Action Space

Possible Actions

The action space encompasses all possible decisions or strategies stakeholders can employ in response to the ecosystem's dynamics. For example, a miner might choose to increase computational power, a user might decide to hold or sell tokens, and a developer might propose changes to the protocol.

Constraints and Opportunities

Understanding the constraints (such as economic costs, technological limitations, and regulatory frameworks) and opportunities (such as new technological advancements or changes in market demand) within which these actions take place is vital. This helps in modeling potential strategies stakeholders might adopt.

Causal Relationships Diagram

Mapping Interactions

Creating a diagram that represents the causal relationships between different actions and outcomes within the ecosystem can illuminate how complex interactions unfold. This diagram helps in identifying which variables influence others and how they do so, making it easier to predict the outcomes of certain actions.

Analyzing Impact

By examining the causal relationships, developers and system designers can identify critical leverage points where small changes could have significant impacts. This analysis is crucial for enhancing system stability and ensuring its efficiency.

Feedback Loops

Understanding feedback loops within a blockchain ecosystem is critical as they can significantly amplify or mitigate the effects of changes within the system. These loops can reinforce or counteract trends, leading to rapid growth or decline.

Reinforcing Loops

Reinforcing loops are feedback mechanisms that amplify the effects of a trend or action. For example, increased adoption of a blockchain platform can lead to more developers creating applications on it, which in turn leads to further adoption. This positive feedback loop can drive rapid growth and success.

Death Spiral

Conversely, a death spiral is a type of reinforcing loop that leads to negative outcomes. An example might be the increasing cost of transaction fees leading to decreased usage of the blockchain, which reduces the incentive for miners to secure the network, further decreasing system performance and user adoption. Identifying potential death spirals early is crucial for maintaining the ecosystem's health.

Conclusion

The fundamental advantage of token-based systems is being able to reward desired behavior. To capitalize on that possibility, token engineers put careful attention into optimization and designing incentives for long-term growth.

FAQ

What does game theory contribute to blockchain token design?
- Game theory optimizes blockchain ecosystems by structuring incentives that reward desired behavior.
How do bonding curves apply game theory to improve token economics?
- Bonding curves set token pricing that adjusts with supply changes, strategically incentivizing early purchases and penalizing speculation.
What benefits do Layer 2 solutions provide in the context of game theory?
- Layer 2 solutions leverage game theory, by creating systems where the threat of reporting fraudulent behavior ensures honest participation.

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Token Engineering Process

Kajetan Olas

13 Apr 2024

Token Engineering is an emerging field that addresses the systematic design and engineering of blockchain-based tokens. It applies rigorous mathematical methods from the Complex Systems Engineering discipline to tokenomics design.

In this article, we will walk through the Token Engineering Process and break it down into three key stages. Discovery Phase, Design Phase, and Deployment Phase.

Table of Contents

Discovery Phase of Token Engineering Process
Design Phase of Token Engineering Process
- Objective Function
Deployment Phase of Token Engineering Process
Time Duration
Required Skills for Token Engineering
Summary
FAQ

Discovery Phase of Token Engineering Process

The first stage of the token engineering process is the Discovery Phase. It focuses on constructing high-level business plans, defining objectives, and identifying problems to be solved. That phase is also the time when token engineers first define key stakeholders in the project.

Defining the Problem

This may seem counterintuitive. Why would we start with the problem when designing tokenomics? Shouldn’t we start with more down-to-earth matters like token supply? The answer is No. Tokens are a medium for creating and exchanging value within a project’s ecosystem. Since crypto projects draw their value from solving problems that can’t be solved through TradFi mechanisms, their tokenomics should reflect that.

The industry standard, developed by McKinsey & Co. and adapted to token engineering purposes by Outlier Ventures, is structuring the problem through a logic tree, following MECE.
MECE stands for Mutually Exclusive, Collectively Exhaustive. Mutually Exclusive means that problems in the tree should not overlap. Collectively Exhaustive means that the tree should cover all issues.

In practice, the “Problem” should be replaced by a whole problem statement worksheet. The same will hold for some of the boxes.
A commonly used tool for designing these kinds of diagrams is the Miro whiteboard.

Identifying Stakeholders and Value Flows in Token Engineering

This part is about identifying all relevant actors in the ecosystem and how value flows between them. To illustrate what we mean let’s consider an example of NFT marketplace. In its case, relevant actors might be sellers, buyers, NFT creators, and a marketplace owner. Possible value flow when conducting a transaction might be: buyer gets rid of his tokens, seller gets some of them, marketplace owner gets some of them as fees, and NFT creators get some of them as royalties.

Incentive Mechanisms Canvas

The last part of what we consider to be in the Discovery Phase is filling the Incentive Mechanisms Canvas. After successfully identifying value flows in the previous stage, token engineers search for frictions to desired behaviors and point out the undesired behaviors. For example, friction to activity on an NFT marketplace might be respecting royalty fees by marketplace owners since it reduces value flowing to the seller.

_{source: https://www.canva.com/design/DAFDTNKsIJs/8Ky9EoJJI7p98qKLIu2XNw/view#7}

Design Phase of Token Engineering Process

The second stage of the Token Engineering Process is the Design Phase in which you make use of high-level descriptions from the previous step to come up with a specific design of the project. This will include everything that can be usually found in crypto whitepapers (e.g. governance mechanisms, incentive mechanisms, token supply, etc). After finishing the design, token engineers should represent the whole value flow and transactional logic on detailed visual diagrams. These diagrams will be a basis for creating mathematical models in the Deployment Phase.

Token Engineering Artonomous Design Diagram — _{Artonomous design diagram, source: Artonomous GitHub}

Objective Function

Every crypto project has some objective. The objective can consist of many goals, such as decentralization or token price. The objective function is a mathematical function assigning weights to different factors that influence the main objective in the order of their importance. This function will be a reference for machine learning algorithms in the next steps. They will try to find quantitative parameters (e.g. network fees) that maximize the output of this function.
Modified Metcalfe’s Law can serve as an inspiration during that step. It’s a framework for valuing crypto projects, but we believe that after adjustments it can also be used in this context.

Deployment Phase of Token Engineering Process

The Deployment Phase is final, but also the most demanding step in the process. It involves the implementation of machine learning algorithms that test our assumptions and optimize quantitative parameters. Token Engineering draws from Nassim Taleb’s concept of Antifragility and extensively uses feedback loops to make a system that gains from arising shocks.

Agent-based Modelling

In agent-based modeling, we describe a set of behaviors and goals displayed by each agent participating in the system (this is why previous steps focused so much on describing stakeholders). Each agent is controlled by an autonomous AI and continuously optimizes his strategy. He learns from his experience and can mimic the behavior of other agents if he finds it effective (Reinforced Learning). This approach allows for mimicking real users, who adapt their strategies with time. An example adaptive agent would be a cryptocurrency trader, who changes his trading strategy in response to experiencing a loss of money.

Monte Carlo Simulations

Token Engineers use the Monte Carlo method to simulate the consequences of various possible interactions while taking into account the probability of their occurrence. By running a large number of simulations it’s possible to stress-test the project in multiple scenarios and identify emergent risks.

Testnet Deployment

If possible, it's highly beneficial for projects to extend the testing phase even further by letting real users use the network. Idea is the same as in agent-based testing - continuous optimization based on provided metrics. Furthermore, in case the project considers airdropping its tokens, giving them to early users is a great strategy. Even though part of the activity will be disingenuine and airdrop-oriented, such strategy still works better than most.

Time Duration

Token engineering process may take from as little as 2 weeks to as much as 5 months. It depends on the project category (Layer 1 protocol will require more time, than a simple DApp), and security requirements. For example, a bank issuing its digital token will have a very low risk tolerance.

Required Skills for Token Engineering

Token engineering is a multidisciplinary field and requires a great amount of specialized knowledge. Key knowledge areas are:

Systems Engineering
Machine Learning
Market Research
Capital Markets
Current trends in Web3
Blockchain Engineering
Statistics

Summary

The token engineering process consists of 3 steps: Discovery Phase, Design Phase, and Deployment Phase. It’s utilized mostly by established blockchain projects, and financial institutions like the International Monetary Fund. Even though it’s a very resource-consuming process, we believe it’s worth it. Projects that went through scrupulous design and testing before launch are much more likely to receive VC funding and be in the 10% of crypto projects that survive the bear market. Going through that process also has a symbolic meaning - it shows that the project is long-term oriented.

If you're looking to create a robust tokenomics model and go through institutional-grade testing please reach out to contact@nextrope.com. Our team is ready to help you with the token engineering process and ensure your project’s resilience in the long term.

FAQ

What does token engineering process look like?

Token engineering process is conducted in a 3-step methodical fashion. This includes Discovery Phase, Design Phase, and Deployment Phase. Each of these stages should be tailored to the specific needs of a project.

Is token engineering meant only for big projects?

We recommend that even small projects go through a simplified design and optimization process. This increases community's trust and makes sure that the tokenomics doesn't have any obvious flaws.

How long does the token engineering process take?

It depends on the project and may range from 2 weeks to 5 months.