Token due diligence and economy audit

Transcript

foreign [Music] well good morning everyone thank you for coming to this chat today and it's going to be quite a lot of impactful information being shared so be prepared to be mind blown by the information I'll share today so today we're going to talk about token audit and to get everyone started this is the general outline of what we're going to cover for 15 minutes we're going to show what are the types of due diligence and audit there are in the space you probably know two of them and the third one will be interesting the second is a web 3 economic growth Journey just like what we have in seed

stage series a series B what does that look like from an economics perspective economics considerations where we are designing web 3 ecosystems and then we talk about the three different economic pillars because that's how we're going to do audit that's how we're going to do due diligence then the lastly we're going to look at the different risk metrics and examples of risk metrics so with that we're going to get started with the different types of audit in place and different types of due diligence that people think about and the first two you probably heard a lot about it's Technical and financial with technical audit this is all your smart contract audits these are to check the code just check the bug you want to understand is there is there logic in the execution of the smart contract of the code and this is stuff that's really

very established and you have a lot of established projects out there and this usually happens after you finish coding and then at every different stage maybe every year or every quarter you do a different evaluation audit the second thing is financial audit and financial audit is nothing new we see Financial order in web 2 systems as well you have different KPMG you have the big four doing all these audits so the way we do Financial audit in web 3 is not that different the last one though is very new the last one is economic audit an economic audit is very new in the web 3 space because in web3 we we need to build our own economic models we build our own economic logic and what is this economic logic trying to do is to drive two things and two things only in your ecosystem use that question session and

user retention we change the economic logic when we're at different phases in different stages of the economic growth of all the platform growth that you have in your web series system so what does that look like from a growth trajectory I like to divide things into three components you have zero to one one to fifty and fifty to one hundred so zero to one is kind of like a seed stage in any of these traditional web 2 startups that you see and here you want to optimize for user acquisition the economic consideration over there what what do we have to consider when we're building the economy is a minimum viable economy so when people talk about launching a startup model launching a raise of hands if you have a token project

okay a lot of you guys have and when you're launching a token project usually people do a lot of simulation they do a lot of agent-based modeling they do a lot of cad-cat modeling which is fantastic by the way but these are all simulations these are all assumptions to figure out what is a minimum viable economy that works in a zero to one phase in a zero to one phase you want to go to product Market fit you want to get user you want to get Market validation and you want to acquire a good amount of users and using tokens as an incentive so the way we look at the complexity over here of doing economic audit is more minimal it's understanding if you're doing a lot of simulations in place or you have different kind of excel models you want to understand what is the logic behind what is the

assumptions in place are these Logics sound and how do they correlate to the different kind of economic policies you have in place or tokenomics that people call but tokenomics is not just the token value itself not just the inflation rate the interest rates but token is also about all the different incentives in place to drive user acquisition to drive user growth to try to drive interact between users between each other EOS operating users and smart contract so that's all in the phase one zero to one and now your projects out your project is launched and when your project is launched do you still want to do a lot of simulations you don't really need them or simulation because what you want to do over here is to understand how users are behaving in response to the economic incentives you have and so

from zero to one your goal there is to drive user retention and your your main consideration for economic growth is really to create a self-sustainable economy and you want to understand what is the intrinsic demand drivers the user behaviors that's correlated with your economic incentives in place so here the complexity is a little bit moderate because we need to understand given the live data that we have given that the projects are all live we want to correlate between or look at correlation or causation between the economic incentives we have driven by tokens and how users are behaving with respect to the incentives you have in place and lastly it's 50 to 100 this is where your project gets more mature and here we want to understand how do we drive

long-term value long-term value growth value capture in your system and it's all driven by the incentives of the tokens and here the the complexity can be a bit more challenging because yes we have done a lot of analysis on the 1 to 50 phase to understand how users behave how users behave with respect to the incentives you have in place and in the first place we have a lot of theories we have a lot of simulations now we need to combine both together to start growing and developing these very complex economy so if we take countries as an example con when countries are early stage it's it's a lot easier to develop the right kind of incentives in place as the countries get more mature you have different immigration policy you have different Market structure you have different people coming to the space you

have different entrepreneur it could be very entrepreneurial entrepreneurial focused economy or it could be an economy that people like to join like social like the government or medicine or or the police where it changes the incentives of how people behave so with that in mind how do we evaluate the economic risks whether you're in Phase zero to one one to 50 or 50 to 100 we want to evaluate the economic risk from a macro to microstructure and the microstructure starts with the market design so the market design here is to understand the characteristics of the entire economy you want to understand the different factors that could influence how the protocol behaves and how the users behave within the protocol because we can't just assume that people behave rationally and people will will

keep depositing and their assets into your protocol to increase the tvl because you're just giving out tokens for free but there are other considerations that people take in mind and behave and act and move their tokens around the second thing is mechanism design mechanism design looks at the rules that need to be followed when we create an economy we create a system we Define what the market is so how do people behave within the market and then we need to create the rules of how people interact in the market what are the rules that people can do with each other over the smart contract and what they cannot do and this is part of analyzing the risks as well because the risks here are to analyze what are the rules of how people can follow and are these rules sound are these rules written properly

are these rules scalable or people follow these rules and lastly is the token itself with any economy with with any system when people are trading and interacting with each other they need to trade something they need to exchange something it's like Christmas day you need to exchange prices with each other but in the digital world it's not always tokens itself it's not always physical Goods it can be tokens it can be tradable tokens non-tradeable tokens non-fungible tokens fundable tokens could be currencies and all these assets need to have a rule that they are governed by a rule that that dictate what their behavior is the intrinsic behavior is so this is how we analyze things from a macro to micro perspective from Market design all the way down to token design so we want to if we want to analyze and

we want to do audit of how economies work we need to First understand how economies are being designed where we know how the bank design we know how they can work and then we can just almost like reverse engineer them to see how well they behave so in this is the framework that we've created looking at the three key pillars that we talked about just now again from macro to micro Market mechanism and token design again Market design is the structure of the market the constraints of the market what who comes into the who comes into your Market who comes into your uni swap to trade who comes into your ecosystem what kind of people what kind of economic agents and who gets to participate in these markets mechanism here will be the rules that people need to follow the rules that people need to

abide by when they're trading with each other over the smart contracts you have in place and lastly is the token the tokens are the assets that you're you're using to trade and translate with each other what are the rules the assets need to follow so to make it very simple the first part of Market design are the rules of the market the rules of the ecosystem the second is rules of how people people behave in the ecosystem and last one is the rules of the assets being transacted in the ecosystem so we look at economic risks we look at these three key pillars and then dive into them to understand from a macro to micro perspective we've done all the considerations of how economies are being structured economies are being designed and economies are being evaluated from a risk perspective so what we want to do at the end of the

day is to measure economic health is what is the risk exposure of this protocol considering that we are designing all these rules from scratch so when we're analyzing and reviewing the risks we are doing audit or due diligence to the economic health we want to understand what other potential risks in place [Music] so let's get started with the various kind of risk metrics and I'll give you specific examples so a risk from a market design perspective we looked at four different key categories that we showed just now in that chart on that diagram we have thickness congestion ease of use and safety so thickness is really how attractive your ecosystem is remember I told you from zero to one it's user acquisition so how do we drive user acquisition into space how do we

use tokens to do that how to use other incentives to do that how do we use whatever system that you have or whatever tools you have in your ecosystem to drive thickness to drive attractiveness of your ecosystem to attract people into the space with congestion we're looking at economic activities we want to understand this is if this is the space that that our users can interact with what are the economic activities in this that are being transacted and just analyze and Define the parameters almost like a demographic listing of what activities are who are driving these activities are there primarily Wells are there primarily governance gun holders are there primarily you know stable coin holders this gives us an understanding of who are the economic agents in the space and

how do they behave with respect to what are their preferences and interests and when it comes to ease of use and safety ease of use is how easy it is to use the system and then we also want to think about ecosystem ecosystem stickiness as well as user retention so user retention is what we look at primarily in the in the 1 to 50 phase because in the first phase you give out a lot of tokens token farming or yield farming and any kind of systems and incentives out there to drive a lot of users into the space but that is not enough you have a lot of people coming into your ecosystem but if no one is using the ecosystem no one is staying there no one is repeating the interaction in your ecosystem then your ecosystem is going to die after you finish your token subsidies so how do we

drive the ease of use how do we drive user retention how do we drive stickiness this is all part of the designing of the entire macro system macro Market of the market of the protocol and lastly safety things to consider will be things like your extraction the value extraction rate because when we talk about economics we talk about two key ways of value we have a short-term value and long-term value in the short term value creation people are also extracting value in the system whereas in the long run we want people to invest in the system in the long run we want people to stick longer we want people to have skin in the game in the future growth of the protocol so when we look at safety we don't just look at safety in terms of smart contract risks but help people how safe people feel in

investing their tokens in the future investing not into in terms of expecting expecting huge financial returns but really investing in the growth and the community strength of the ecosystem it's all about economic growth we're talking about here so there's everything Market that's the big macro picture now we go to mechanism design a mechanism design these are the rules of how people interact and trade with each other and here we look at governance non-financial incentives and structure and you realize I haven't even touched about tokens yet so governance when we talk about governance everyone's talking about creating a dow creating using gnosis to to create your doubt structure and having on-chain different verification and multi-second things like that that is very great the other thing about governance is also how do

you punish bad behaviors Governors provides the structure of how people interact and the rules they need to follow how decisions are being made but we also need to start punishing bad behaviors because economics everything we're talking about is what are the incentives to drive people's behavior or what are the disincentives to impact people's behaviors and governance is where these incentives can come in because you need to punish the people who are not acting in good faith in your ecosystem for example people who are constantly extracting value in the midterm they come in they extract value and they get the token they dump the token out there this is not the kind of the right kind of of activities that we want and you can analyze a lot of these from economic risk perspective it gives you the lens to start thinking about all the different potential risks that you

see the midterm and the long term with no Financial incentives we have things like a lot of other monitoring activities related to we can look at so-bound tokens we can look at nfts we can look at things that are not financially driven to help and to look at how people behave how what the people what how are people reacting to these different non-financial incentives in place and structure here we're talking about what is the for example bargaining structure how do people agree with each other to trade and interact with the the any execute any trade so it could be auction Theory and auction theory yes there are some tokens being considered but how robust is this auction is this auction something that people can cheat is this auction a first price auction

second price auction English auction Dash auction these different auctions can have different implications not just primary implications but secondary and tertiary implications of events that could happen because you have these incentives in place and lastly we have tokens tokens we look at token policy Financial incentives and architecture we talk about token policy it's kind of like monetary policy but not all tokens are money so taking the monetary economics Concepts in place how do we evaluate the policies the rules that tokens abide by and tokens live by and tokens have to follow and evaluate that risks from there with financial incentives that's probably quite a no-brainer when with tokens you have different kind of financial incentives in place and how do you evaluate them the most important thing that we're

looking at over here as well is not just the primary impact of the the behaviors when you have these incentives in place but the secondary and tertiary events that could happen because of the token incentives that you have the primary impact could be very useful could be to drive retention could be to drive user acquisition but the secondary impact is that you're driving the wrong kind of user retention or the the wrong kind of user acquisition so for example you can have an incentive a financial incentive that drives user growth and they help to create a referral program because it's a marketing kind of yeah but because of the incentives in place you realize that you're attracting the wrong kind of people you're attracting the people who are extracting value in the long run and they're not really contributing they're not really contributing they're not adding value in

the long run and that's a big potential risk in the secondary and tertiary Behavior events kind of outcome so with that in place I want to show you some examples some bit more realistic examples of what that could look like if you're trying to measure risks from the market mechanism and token design perspective so a very simple easy metric that we can look at from a market perspective again the market is the macro picture understanding the market structure the economic agents what they can do and listing down what they can do they cannot do what Their behaviors are what are the behaviors we want to incentivize what are the behaviors we want to distance their device so here we can look at the user retention rate the user churn rate and the user acquisition this helps us to analyze the market thickness of this of this system

whether there are a lot of is there is it growing in Market size are people using using the system a lot more are people finding it safe is there stickiness is there retention is there is there longevity in someone coming and joining the system because if people if there is a high user acquisition rate with a low user retention rate then that's not a very meaningful ecosystem to want to be participating in a lot because people are just coming in to get value and then they're leaving so user retention becomes a very important metric to look at as well from a macro Market perspective the other one will be the second phase will be the mechanism design remember mechanism design are the rules that we have in place for people to interact with each other and things would be like

a decentralization index so GD coefficient to understand the distribution power and influence within the economy and this helps us to understand and evaluate whether yes this economy is good they have high retention rate they have high user user acquisition everything is all good but it turns out the decentralization index is not very high so there's a huge inequality that we look at with people making the decisions and people using the product so maybe in the short well short run that's good because we have the financial incentives to allow the the you know smaller fish to interact with each other but in the long run because the decisions are made by the people who are holding who have a larger stakeholder interest in a very different kind of growth of how the ecosystem will grow and how the ecosystem will change and how decisions are made and how

Governors will be shaping the future of the protocol that could be a potential risk that you you can look at from a protocol perspective then we also have allergenic coefficient and things like a player to protocol transaction rate so we're on from a player to protocol transaction rate we want to understand the structure of the economy the structure of the market the structure of how people behave and interact in the ecosystem whether it's EOS like to each other or to contract addresses so here we want to measure the percentage of economic activity attributed to users interacting with the smart contract or the platform as opposed to with each other and this will this could make sense for for example if you're a game if you're a game and your game is about going to battle and people are interacting with each other then you want to understand the growth of that

that percentage that number as opposed to Smart contract where they are minting and breeding different kind of nfts or they're selling and going to secondary Market to make that kind of exchange or if you are a landing protocol then you want more people to be interacting with the smart contract to see that growth to see that retention to see more activate real value generated in the system we can start measuring and analyzing these things from a lending borrowing perspective if a lot of people are just trading with each other because you can measure that based on whether their wallet has the Ave token for example and they're primarily trading with each other that defeats the purpose of Ave for example because it becomes a peer-to-peer ecosystem instead of facilitating through smart contracts and lastly it's token design so token

design is uh it's a little bit more Finance related and the metrics that we look at is probably metrics that a lot of Traders are looking at as well whatever I told whatever we've been talking about so far is how operators are behaving how operators are changing the economic system to make it easier to drive user acquisition or user retention growth so here the token design metrics are probably things that you've heard about the amount of token and circulation the net value to transaction ratio token velocity inflation rate utility utility ratio and the the thing with these numbers when we're analyzing risk it's not just figuring out what the numbers mean but what is the context behind the number so it's not just token circulation hi good but what is the the context behind that is there a reason what's the what's the qualitative

explanation or policies that we have in place the incentives that we have in place to drive that high token circulation and is there any implications from a risk perspective are there any secondary tertiary implications that could happen if there's a huge token circulation so maybe token circulation could be high because there are more people coming in and when more people come into the system we're just maintaining kind of minting tokens which increases the token circulation Supply but if we correlate it back to our Market design and we look at retention rate the seven days retention rate is actually very low people just stay for two days and they leave and there seems to be a trend in this specific protocol and that's not that's a very risky metric of that's a very risky ecosystem to look at when we are correlating the different kind of

metrics in place so these are things to consider and it's not just you don't consider these metrics in isolation how do you compare them across the entire Spectrum to look at from a macro to micro perspective what are the risks in place how how does the the micro risk metric impact the macro structure that we have created and design how does it impact the users interacting in this ecosystem so that gives you a better understanding and better idea of of how you do economic risk and Analysis and before I and do we still have time for questions no okay I guess I will not conclude then

but the last page if you want to have we do we run a consulting firm and if you want a 15-minute consultation you can click that link and if you want to share you a meeting with me you can click on the other QR code thank you [Music] foreign [Music]