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Incentives and Digital Assets – Part 1

I’ve been thinking for a while about how much Bitcoin changed the world by introducing a whole new type of incentive – the cryptocurrency.

Obviously for so long we used actual fiat currency as an incentive for work, goods, services, chores, studying, sex, eating right, charity, and so many other experiences. In our work as financial advisors, we have seen fiat currency used to help keep key employees with their companies, to create buy-out opportunities, to push employees to work harder, or save more.

We see fiat used as the incentive to try to get people to open checking accounts, as circular as that logic is – let us hold on to your money and we’ll give you a little more money that we can then hold on to, which was ours just before you walked in the door. Fiat is used to make people talk more about things they shouldn’t, and to make people stop talking about things they should.

We have since added other incentives that are not exactly fiat, but some representation of it. Loyalty points have been a huge hit. Airline miles, hotel points, Subway stamps. People vastly overestimate how much these rewards are worth. The average frequent flyer mile is worth 1.3 cents, but I usually have to spend a dollar to get it. If, for some reason, I carry a credit card balance, and have to any interest on that dollar, it could cost me nearly 10 times the value.

Even knowing that, I am still more likely to use the United Card than a cash back card, because I foresee a time that I can take a vacation with my family “for free.”

So how did Bitcoin change the incentives?

With Bitcoin, and the proof-of-work mechanism that rewards the miners for processing the Bitcoin transactions with more Bitcoin (more circular logic), a next iteration of the loyalty point was borne.

There had to be a mechanism to give people the incentive to devote processing power and electricity that they pay for to process the blocks. Those miners received Bitcoin as payment for their service. The creators of Bitcoin didn’t want banks or other financial companies to process the transactions. They also didn’t want to pay the miners in fiat currency, as that would still make them subject to the very centralized financial system they were trying to break free from.

The miners had to believe in Bitcoin, and have faith that it would eventually have some value. I doubt they were thinking it would have the value it does today, that it would become its own asset class, that it would have an entire financial ecosystem built around it. However, they had to at least believe that they could exchange their earned Bitcoin for something in the future, even if it was just with the other miners.

We all know what has happened since to the value of Bitcoin, and the growth of the asset class…and we’re really just getting started. To that point, there wasn’t another algorithmically derived, or technology-based currency that had taken off.

By being the first cryptocurrency, and with its proof-of-work model, Bitcoin gave us all a new incentive structure. After that experiment went so well, new projects, organizations, companies could launch, and use a currency that wasn’t tied to banks or governments as incentive, and adopters and investors would have some faith that the currency would have some value.

To be fair, many people took advantage of this new faith, and new desire to get rich quick by changing fiat into crypto. However, the ICO experiment really proved the demand for many all over the world to try to invest in new and growing companies, and to find an alternative to their home currencies.

Now that people could have some faith and idea that a crypto currency would have value, organizations could build something new, and attract people to their project with the promise of their own crypto currency. New blockchains were built using proof-of-work, proof-of-stake, and other consensus algorithms, with the idea that I would participate because I would receive their crypto currency in return for my time, energy or money.

The markets and exchanges that have been built for cryptocurrency trading have accentuated the values and the abilities to provide crypto as incentive. I can now create a project and launch a crypto currency that I might give to my early adopters. My goal is to “seed” my own economy, and get people to use my token. As more and more people use my token within my project, the value of the token grows, and those that were in early see a profit.

This is what Synthetix has been able to do in building a synthetic asset ecosystem. Their goal is to be the synthetic asset platform of choice as the decentralized finance stack is built. They had to get users to adopt, and build a base for their synthetic exchange, so they have a structure where I can stake my SNX tokens and receive more tokens based on the transaction fees incurred within the exchange.

There are more tokens offered to stakers in the first year, in the hopes that we will not only lock up our SNX tokens, but then use the Synthetic USD tokens to trade on the exchange, driving more liquidity, and therefore more adoption.

It remains to be seen if that adoption will really happen, or if it is just those of us trying to grow our SNX base, and value. However, Synthetix is one of the fastest growing DeFi protocols, and looks to continue its growth.

Another great example of the new incentive structure is Helium. Helium has created a system for Internet of Things (IoT) devices to interact with each other over a Long Fi network.

They chose to not use Wi-Fi or traditional Internet because of the costs involved for the users. For example, if I have a trucking company, and I want to track my trucks, I can do so using GPS trackers, satellite, and Internet. However, I pay a hefty fee for all those interactions.

I can use a GPS device that utilizes the Helium network, and track my trucks for a small fraction of the cost.

Helium has chosen to build out their network by asking people to purchase their hotspots and connect them to their own Wi-Fi networks in their homes or businesses. The Helium hotspots then find each other, and process blocks. Since I have several Helium hotspots, I receive Helium Network Tokens (HNT) as a reward. I can sell those HNT’s to Helium, which they then burn to provide data credits, which their users pay to utilize the network.

In this way, Helium is getting the purchasers of their hotspots to fund the buildout of the network. This is genius!! But why would I do that? Because I might get much more than the price of the hotspot back in HNT tokens I earn.

It is still important to point out how different this is from frequent flyer miles or other loyalty points. I am receiving something that might have some value in the future, based on the success of the project, the value placed on it by the community, and the ability to liquidate that asset. I’m essentially being asked to make an investment, but without the typical investment friction.

Of course, with the incentives come the disincentives as well. We’ll leave those for another post.

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