Despite the demise of $ring, node projects have been surging in defi in 2022. As an econ nerd, I’ve taken a deep dive into the tokenomics of node projects. Here’s what you need to know. I hope this information helps you evaluate good projects from bad. 🧵

1/ Emissions - i.e. the number of tokens given to node holders - should be viewed as a form of crowdfunding. Getting people to buy nodes is a way for protocols to raise funds. The question is what they do with those funds.

2/ There are a few problems to be aware of. First, is that most node protocols need to rely on ponzinomics to sustain a high emissions rate. This means that old node holders are paid out from investments from new node holders.

3/ This is no secret - e.g. $strong straight up mentions that 60% of revenue from new node purchases goes to paying out existing node holders (i.e. the rewards pool)

4/ Side note: ponzinomics ≠ a ponzi scheme. A ponzi scheme amounts to fraud. Most node protocols are clear about how emissions are paid out. This means they are not deceiving their users, and is therefore not a ponzi scheme.

5/ Second problem: Over time, as more nodes are created, and more tokens are emitted, the supply of native tokens is increased. When supply > demand, prices fall. Most protocols find it difficult to sustain the demand for their native tokens, which leads prices falling.

6/ In an attempt to address this price pressure, most node protocols have been fixating on the supply side. This involves strategies to: - decrease emissions (e.g. halvenings, reward decay models, node caps) - disincentivize selling (e.g. sales taxes, gas-free compounding)

7/ However, in order to truly sustain emissions, these node protocols need sustainable revenue and a way to increase token demand. Supply-side strategies are simply not enough.

8/ Most “node” protocols that were forks of $ring, were promised to be “DeFi as a Service” (DaaS). I.e. you would invest in a protocol, and the protocol would identify the best crypto investment opportunities, make a profit, and distribute those profits back to node holders.

9/ However, most node protocols have made underwhelming investments, if any. E.g. $HNR has made its first investment into: - the $FTM - $TOMB LP - $ETH - $FTM - $LUNA

10/ These are solid investments in blue chips, however they are also opportunities that are available to the average person. Most people in DeFi probably hold those same bags. Importantly, there’s simply no way revenue generated from these can sustain $HNR protocol’s emissions.

11/ The most impressive node protocols - e.g. $strong, $thor and $hive (to name a few) are the ones that treat capital from new node holders as the equivalent of startup funding.

12/ They attempt to take this capital and innovate. This is because node protocols as they currently are (i.e. dependent on ponzinomics and investments as the main source of revenue) are simply not sustainable.

13/ Therefore, we’re seeing $strong talking about creating its own blockchain, and $thor launching P2E gaming, NFT marketplaces, etc. These innovations will drive demand for native tokens, and generate significant revenue for protocols (much more than investing in blue chips).

14/ When used in combination with supply-side policies (e.g. node caps), this creates an environment for sustainability.

15/ The big problem though is around product-market fit (PMF). Product-market fit happens when you create a product that people want to continue purchasing. It’s notoriously difficult to find PMF.

16/ Most startups fail because they can’t find product-market fit before running out of cash - even though many of them have received $millions in investment from VCs. Successful node protocols have managed to create PMF for nodes - i.e. their initial product.

17/ However, when these node protocols are talking about new innovations that are in a completely different domain to their original product (e.g. P2E gaming), it means that they need to find PMF not once but twice (at least). This will be insanely difficult.

18/ The maing thing that these node projects have in their favour is their community. It’s significantly easier to find PMF if you already have a community ready to test out new products, and to eventually buy them.

19/ Moreover, node projects like $thor are hedging their bets by innovating in multiple spaces. In other words, they’re developing multiple projects to drive revenue and increase demand for their native tokens.

20/ The more products they develop, the more chances there are of finding PMF.

21/ The tl;dr: When evaluating a node project see if: (1) there are supply AND demand side policies in place to drive sustainability, (2) a protocol is treating initial capital from node creators as start up funding, (3) they are using this funding to innovate.

22/ If you liked this thread, I’d appreciate a retweet to help out with the twitter algo. Also make sure you follow @economiserly where I examine the economics side of defi.

23/ And here's a short follow up based on a few questions I'd been getting on $strong

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