Assurance of Token Economies

Economics Design

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Why do blockchain projects feel responsible for getting smart contracts audited, but omit getting an independent view on their token economies design?

Introduction

This article aims to analyze the necessity of Audit and Assurance to obtain an independent view on token economy resilience and robustness, its inherent ability to accommodate and adapt to changing market conditions and events. Token based systems have evolved over the past reaching $2.8 trillion in market capitalization before Terra crash and attracting more than $25b in VC funding in 2021. Despite large funding involved when talking about blockchain projects and their resilience people mostly think about smart contracts and hack as the main and only risk. There is now the whole culture of responsible projects who are doing smart-contract audits.

But there is another elephant in the room - token economy, that is equally important to get an independent view on and understand the risk, but usual response in crypto space - DYOR. Token economics - designs the model used to influence the use of tokens in the decentralized ecosystem, through incentive mechanisms and a defined token environment.  That is not something that is possible to cover with a smart contract audit, that by substance is an analysis of areas that could be manipulated by hackers, or examining code that goes against common convention.

Recent collapse of UST/LUNA, can become something similar to once Enron’s collapse, and trigger the next step in crypto maturing and be a call for a more responsible attitude by projects’ teams towards their investors and community not only on the tech and cybersecurity side but also getting independent view on the loopholes in token economy design.

What is audit in essence - according to Flint the audit function has evolved in response to a perceived need of individuals or groups in society who seek information or reassurance about the conduct or performance of others in which they have an acknowledged and legitimate interest. Flint argues that audit exists because interested individuals or groups are unable for one or more reasons to obtain for themselves the information or reassurance they require.

This research is not aimed to blame or criticize Terraform Labs, UST, LUNA or any people associated with the project but rather seed to readers minds how UST/LUNA crash could have been prevented in the first instance if token economy assurance (similar to smart contract audits), blockchain projects would have the insights and flexibility to fix their tokens in the design of the economic system.

Assurance mandating parties and Intended users

Before doing an assurance project, it is worthwhile to clearly distinguish between customers and interested parties, where former are parties paying for assurance and latter are parties representing stakeholders or potential stakeholders of the reporting project.

Mandating parties of assurance assignments:

Interested parties:

• Protocol & Community:

  • Protocol governance

  • Governance token holders

  • Non-governance token holders

• Investors:

  • Institutional Protocol investors

  • Institutional & Private token investors

• Financial intermediaries:

  • Asset managers

  • Financial advisors

• Regulatory & Statutory stakeholders:

  • Prudential & Conduct Regulators

  • Marketplace supervisors

What Else Did You Miss?

• Basic concepts and assumptions

• Report standards

• Conclusions

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