The Use of Utility Token Staking Rewards by Peter Zeitz & Will Warren (Devcon5)

okay so I'm going to be giving a little bit of an introduction for Peter who's gonna be talking about staking rewards to encourage user ownership within platforms I think this work is pretty broadly applicable to a bunch of different use cases and yeah you know if you're in systems of a theory and smart contracts on aetherium I'm just gonna quickly give a little bit of like motivation for what went in you know why we focused on this work and how it you know how we came to focus on it in the context of 0x specifically okay so 0x which is you know we're not really focused on 0x protocol as much as like the governance aspects of it in this presentation but a little bit of background so 0x protocol is basically a system of etherium smart contracts for peer-to-peer exchange of digital assets on the etherium blockchain and about three years ago when we were initially designing the smart contracts we realized that we were building on top of a rapidly evolving technology stack and that the smart contracts that we build you know built three years ago will probably need to be changing pretty frequently every six months or so and so if we were to have like a single monolithic smart contract that was not upgradable we run into these problems where every time we have to upgrade we have to ask our users to withdraw their assets from the first smart contract deposit them to the next and this leads to fragmentation ensuring you sirs so some people just like won't upgrade at all they'll just like stop using the system period and then we'll also run into the situation where some users will upgrade but others just won't and so specifically for exchange in marketplaces where liquidity network effects are so important it's really important that we allow everyone to upgrade in a seamless process without disrupting markets and so the 0x protocol architecture is designed in an upgradable way where we can basically plug in support for new types of token standards we can upgrade swap out pieces of this this kind of pipeline of smart contracts and we can kind of do it in a seamless way where users traders can just kind of gradually shift to the newest version and you can deprecated the older versions and retain these Network effects around liquidity and you know people ask like why do you need to have upgrades it introduces all this complexity I think like actually just recently there is a perfect example of why upgrade ability is important with the repricing of the S load op code in aetherium which is going to be going to the next hard work and will probably be breaking a lot of contracts that are currently live today and no one could foresee that happening so you have to have a way to upgrade and specifically in the case of 0 X you know 0 X protocol isn't supposed to be like a for-profit profit generator for like a private company it's supposed to be public infrastructure that anyone can plug into and when you have public infrastructure ok when you have public infrastructure it's really challenging to figure out how do we upgrade these systems of smart contracts because the stakes are high you know the you know today 0 X is moving approximately a million dollars every day and you know ideally well this number will increase many times over in the next years and so this public infrastructure is like pretty security critical many people are building businesses on top of it so how can we decide on upgrades so when we first released version 1 of 0 X 2 years ago you know we release 0 X with a governance token the zr x token and the idea is that instead of having like a single group or private entity decide on upgrades there would be a token that allows people to vote on these upgrades and we're you know make sure upgrades are representing the needs of the ecosystem and we pretty quickly realized after launching version 1 with the zr x token that the design was not working out as we intended it to so the system was designed such that these marketplaces built on 0x could receive fees in the form of ZRX tokens for people that are accessing their liquidity and what this would do in effect if you know ideally is it would push the token distribution into the hands of people that are actually using the protocol we want the protocol to be owned by its users but this was the early days there weren't many depths that existed back then and we learned very quickly that you know end-users don't want to fuss with tokens they just want to like do a trade and be done with it and these took you know having a usage token adds a lot of friction and so a couple years later we looked at the numbers and kind of compared you know are the addresses that own ZRX actually trading on the protocol and are the addresses that are trading on the protocol actually owning ZRX and the answer is that you know absolutely not like we saw that there is very little overlap between these groups and so at that point we brought on peter and to you know research this problem how can we increase this overlap and in what this overlap represents is incentive alignment between the protocols users and the people that are making governance decisions over the protocol and so Peters gonna be talking about how we can create incentives that maximize this overlap thank you will so you can see this Venn diagram here and this is gonna relate to kind of a Venn diagram and next slide describing the evolution of the Xerox token you know where we're trying to go in order to address this problem of getting our users a voice in the process of smart contract upgrades so so far we have this governance taupe token and which allows these Xerox holders to vote on whether we make upgrades go live in the blockchain so that's been achieved right but in order to have this process work as intended that people with voting power need to be the users of the software and not third parties who you know are purchasing a perspective motives or other reasons and so our plan to address this in version 3 the software which gonna go live in coming months is to introduce incentives that update our ZRX token mechanics and that provide a new reason for people to hold and use ERX and components of this will be the addition of user fees so that takers when they see a standing offer to buy and sell an asset and they want to take advantage of that currently they pay no fees whatsoever to the Xerox software there's no sort of revenue generation aspect with this modification they will need to pay a fee that's proportional to the gas price that they pay when they submit a trade to the blockchain so the CRX will collect some revenue and that it can use to to create incentives so these fees are there I'm gonna go into liquidity incentives that encourage people to create these standing offers to buy and sell assets so market makers who get their offers on 0 X 3 layers and get them taken for receiving a share of this income that's generated through user fees and there's also going to be staking rewards so that token holders holding the 0x token will be able to receive a share of the revenue generated through these fees and our philosophy here is related to the vendor I diagram you saw previously where we want governance our governance objectives to be achieved and to do this we've recognized we need to have incentives for people to hold the 0x token and specifically we need to to encourage the people who we think have an interest in voting right we need to encourage this group who's actively using their protocol who has an economic interest or stake and the decisions we make we need to encourage them to be the people who holds your X tokens so that rather than say like okay we have these token holders they are a motivated they didn't interact much with the protocol how do we make them vote we think instead we have these users and they're very interested and they engage with us regularly how do we encourage that group to hold more tokens and buy them from this sort of this group of speculators that's the philosophy so why is this important to us right well it's this gets back to sort of our vision for the organization and so what we're trying to work together set out to achieve which is to create a token ice world where all value can flow freely right and we can sort of think of that as summarizing this concept of open access open and low-cost access to the ability to do online exchange of tokenized assets right and if cheevus mission so that everyone can sort of go online and use a Dex to trade into and out of whatever asset they want we want to measure the progress we're making in terms of the amount the volume of tokens that are exchanged in terms of the prices that are available to users right so that the more the larger quantity of specific assets available you know the better job we're doing the better price you can get when you're moving you know back and forth between tokens you know the bet more effectively we achieve our goal and the wider variety of assets that are available on our real ayres the better job we're doing and then in order to commit to this mission of just of ensuring that exchange is low-cost and open to everyone and there's no sort of rent extraction or you know profit taking that that is going to create barriers to to exchange happening we want to create a governance mechanism that commits us to our mission we want to use token voting mechanisms to ensure that the people who benefit from open access to online exchange are the same people who determine the choices we made we want them to to have accountability to the users that are benefiting from our software so that they will vote for for upgrades that are in their interest rather than the interest of some sort of speculator or investor who might might want to profit off of the exchange process okay so we can see though from the Venn diagram at the beginning right that we don't have a structure that really enables that accountability right now we have tokens very few of which are actually held by active users of the protocol who would then vote you know for things that that are in their interest for things that align with our organization's mission so we have to have some means of persuading these users of the protocol to become Xerox owners right and it's not just going to work through exhortation we could say in order to preserve the decentralized future you know do your duty and buy some Xerox tokens and vote you know participate in the voting process right but if a user is happy with the way the software works and he thinks that we're making good decisions so that other people are voting then he doesn't really have any incentive personally to sort of bear this cost and responsibility you can say well some other one else should vote for me I'm happy why should I you know bother it's too much trouble the next person will say the same thing because of this free writing problem and this is not going to happen you know without some intervention that motivates people to do this there has to be personally beneficial for individuals before we can expect that to happen so we see right now is that under our current system the incentive structure encourages tokens to be owned by speculators and does not really motivate users to buy the tokens a voting rights have not are not enough you know there's a free writing problem they're not going to cause a transition in the owners ownership distribution what we need is some way in which 0x users can realize a material benefit from holding the token so that they can get something as a user from owning the token that's not available to anyone else so Alice uses the protocol alter token and she can get a really nice benefit from that where's Bob you know holds the token and because he's not a user it's not beneficial to him it doesn't have the same economic benefit attached to it right so we need to create that dynamic so it's to encourage the Bob's of the world to sell their tokens to the Alice's who will be owner users okay and this is like I think this is a critical part of governance that is kind of under-recognized that is it's not just about the mechanisms we create that allow owners to influence or have voice in decisions it's also about the identity of owners the identity of owners matters quite a bit for what an organization will set out to achieve it will set out to sort of represent the interests of its owners so if we want to target a particular long term goal we need to pick people as owners or encourage people to be owners whose interests align with what we want to do all right we can't just sort of blindly assume that they will we need to sort of introduce incentives that encourage that so the first you know sort of part of this chain is token incentives and we want to introduce systems is that 0x ownership provide specific benefits that are available to 0x users but not to someone who's simply a speculator or a third party who doesn't engage with a software right and then we expect that to influence the ownership distribution so the non users sell tokens to users who can derive a greater benefit from them all right and then this feed to our voting process or as users come to hold a larger proportion of the the tokens that he will vote for decisions and policies that are in their interest and in particular if we think go back to this like the users will prefer systems that offer specific benefits for them rather than for other outside groups all right so this is self-sustaining like once once an organization sort of set on this path the people the incumbents who hold the tokens tend to vote you know for this for policies that sustain it because they benefit from them all right so in thinking about the long-term trajectory of the organization we want to sort of lay a foundation right now of owners whose interests align with our vision okay so that doesn't lead to the what do we mean by users right who is a user of the protocol do we want everyone who ever interacted with the 0x Mart contracts to own does that make sense or do we need to be more specific about you know what it's sort of a rational structure of ownership and voter participation so the zero x protocol has three main classes of users who might target you know police types of incentives the first are three layers which sort of host order book data they host these offers to buy and sell assets and the next is market maker so market makers create these standing offers to buy and sell tokens and then finally at the bottom of the period pyramid there are retail traders who sort of are the the final end and customers that the customers who take advantage of the offers of market makers and the sort of data availability platforms of real layers in looking at these three groups they're not all necessarily equally sensible as people who might own and participate in voting we need someone who a group that has a strong enough interest a strong enough economic interest in the protocol that decision-making is decisive for them that the decision can influence you know their welfare that they they feel powerfully impacted upon it enough with sufficient motivation to become well-informed and then go through the hurdles of the voting process we also need besides that a group whose interests align with the organization's mission organization's mission to sort of enable online exchange in the public interest rather the interests of sort of maximizing private benefit and so looking through these groups you know real ayres you know they have this they're building businesses in the protocol um but there's a little bit of ambiguity in in their their incentives or goals because these are mostly you know for-profit businesses and they might prefer that the protocol be run in a manner that maximizes their business income rather than provides this public good of free and open access to online exchange at the bottom we have retail traders there are certainly beneficiaries of free and open access to exchange but at the same time you know they're not likely to be motivated to sort of become informed or participate in governance because there's so large a number and because they can't sort of reap a personal benefit and in the middle we have market makers and this is the group that we sort of identified as the most logical candidate owners so why do we think you know that among our users we should target market makers with incentives to own the token and vote with the token as opposed to anyone else well we believe that market makers because of their line of business you know they benefit from free and open access to venues to do business right they're their business is to buy and sell token inventories and charges small margins that when they sell they sell us like premium when they buy they buy to slight discount and the more volume they can do the more easily they can you know connect an offer make these offers they're the more money they can earn so from this perspective market makers you know share our goal of ensuring that there's no sort of rent seeking intermediaries who extract fees in the exchange process right so that they can have say peer-to-peer connections make an offer to an end user directly rather than have to go through a platform which will levy a large fee on the exchange so this market maker ownership addresses a problem that the market structure of exchanges and exchanges have significant networked economies that lead that mean that when as an exchange grows it does host more and more liquidity as it does more and more volume the prices that exchange is able to offer to people fall right the market becomes more efficient the more co-located liquidity you have in one place and that gives this exchanges bargaining power right if they're big enough they can offer these much better prices than anyone else and they can begin to charge fees they can begin to a levy substantial fees in every single trade such that even though they're extracting this cut users are still better off going to the largest exchange rather than going to a much smaller one that doesn't demand any fees at all so there's this sort of tendency towards monopoly or oligopoly market structure and ownership matters a great deal here so third party owners who have created the exchange for profit maximization without a direct participation they prefer to set high fees that will maximize fee revenue that will maximize the income for the sort of exchange owner market maker owners in the other hand they're running a business on top of the process where the the income they generate from this business is proportional to the amount of trade volume the more trade volume is done the more they can earn through this activity that's enabled by the exchange so this group has an interest in much lower fees that maximize the revenue they get or the profit from this kind of business that's built on the platform right and that aligns with our goal of keeping fees low keeping access to the exchange process free and open and this is you know this is a powerful motivator this isn't just you know one of the things that is very important to me in in deciding upon this system as opposed to alternatives is that there's a large you know a very impressive historical precedent for this ownership form so for the past hundred years you know most equity chain exchanges for most of the people most of the this time ensayo saw and Japan or in New York or in London most major equity exchanges have been organized as nonprofits owned owned by market makers a sort of mutual organization so they don't sort of the market makers vote on rules for trading and the exchange itself does not distribute profit to market makers but instead just supports their business activity and another thing that's really important is is okay so it's thinking about whether market makers have a stake in this process right with it whether they it's important enough that for them to have a voice that they would be motivated to purchase your X tokens and you know go through the house and our experience in market-makers interact with us extensively giving advice or recommending changes or making demands for how they want the software to operate to make it easier to do their business now these market makers are making a bet on the protocols long term success and there in order to learn how to market make on index they're paying a substantial upfront cost and so they have a strong interest in ensuring this bet pays off by participating working with us to build this kind of decentralized future okay so I'm going to then that sort of wraps up this discussion of what is our motivation what is it our vision for governance of the protocol and I want to talk about sort of the mechanics very briefly of staking and market maker incentives so first we have like a maker he had creates an order and then takers whenever they take and orders that is listed on a real layer they're gonna have to submit a fee in aetherium which is proportional or equal to the gas fee they're paying to the miner so if you pay 15 cents to the miner when you submit a transaction you'll now be paying an additional 15 cents of aetherium as a protocol fee which is accumulated here and ultimately these fees are going to be distributed back to market makers and then in once we've collected all this revenue right we have to distribute it somehow and this is where the staking process comes in here we have a market maker who's gonna receive a portion of the collected revenue and the amount that he received is going to be influenced by two things one is the amount of trades that he does so the more fees he's he collects by posting liquidity on order books the more revenue he'll get and the other is steak the more steak that he owns or rents from 0 X 0 X token holder the more money he will collect right so he has this incentive then to either buy Z or X himself or rent it from a third party in order to maximize his rebate income and then finally this this motivation of market makers to acquire stake that they don't own is going to mean they'll have to pay an income stream to to 0x holders okay so I time so I should stop there you