The Case for Demurrage Tokens
As blockchain grows, we’re beginning to see financial instruments (used interchangeably with the word “tokens” in this text) being used in an ever-increasing number of ways. Individuals lend these tokens, provide liquidity in markets with them, invest into a variety of platforms to earn rewards, and much more. Because of these tokens’ transferability, liquidity, interoperability, and limitless programmability, these uses will only continue to increase.
Currently, these farming or staking systems are often incentivized by the token’s protocol through rewards to the user past what the productive use itself may pay. While this works well for many systems, it means rewards have to come from somewhere. This may mean rewards come out of revenue brought in by the system, come from a fixed supply of tokens that will deplete eventually, or are infinitely minted. Each strategy comes with its own problems.
The answer to encouraging this productivity may be demurrage instruments. Building upon Silvio Gesell’s concepts of currencies with a carrying cost, demurrage currencies, demurrage instruments are any type of financial instrument that has an artificial carrying cost.
For example, a protocol’s token (whether that functions as a financial instrument similar to a stock, currency, or anything else) may have a demurrage rate of 5% per year. This would mean that if you have a balance of 100 tokens and do nothing with them for a year, your balance at the end of the year will be 95 tokens.
In demurrage currencies (such as Freicoin), this is meant to encourage monetary circulation through the economy in similar ways that inflation does: if a currency is going to be less valuable in the future than it is now, it must be utilized quickly. Demurrage currencies, however, can often have their impact negated by simply exchanging capital into a non-demurrage currency.
With demurrage instruments, the token itself, rather than the current value behind it, should be what a user wishes to preserve to ensure it cannot be substituted by a non-demurrage instrument. Once you have a demurrage instrument that cannot be substituted, you can direct it to be employed in any manner preferred by removing the demurrage tax when used as desired. This strategy allows the same economic incentives as current systems without the need for rewards.
The key to taking advantage of a system using demurrage instruments is havens. Havens would be, in the context of blockchain, smart contracts in which the demurrage rate either lowers, is removed entirely, or is even negative (the rewards for a negative rate being gained through the demurrage tax on unproductive tokens in the system).
Let’s imagine a simple governance token that could use demurrage strategies to improve the system. The token is used to govern the protocol and, just as in many traditional systems, it will pay users with tokens for their participation in governance, but there are many more uses that should be encouraged.
The first haven from a demurrage tax would be the governance contract itself, ensuring tokens being used for governance do not get taxed.
This token may need to be traded, however, so an AMM (“Automated Market Maker,” such as Uniswap) can be made another haven where there is no tax. Now tokens are only able to be held without deteriorating if they are providing liquidity for the market or being actively used in governance.
If a useful lending platform appears that is beneficial to the system but not as necessary as other havens, it may be worth it to lower the tax — but not completely remove it — when tokens are staked there. This would make use of the lending platform viable while still encouraging other, more essential, uses of the token.
In the future, a different exchange may appear that is preferable to the first; the haven designation for the first AMM contract could subsequently be removed and switched to the new exchange.
The taxes on unproductive funds could then, of course, be used for anything desired. If the protocol benefits the most from a certain platform at any specific time, the controllers of the protocol can make the interest on that platform negative, meaning demurrage taxes would be given to tokens on that platform as extra rewards.
Using this technique, systems can discourage hoarding, direct users toward the most productive use of their capital, completely customize where capital should flow at any point in time, and not need to provide extra rewards, all while providing an extra stream of revenue from taxes. Demurrage strategies are not meant to remove all rewards from a system, but to increase productivity without an increase in distributed rewards.
Demurrage instruments could be incredibly useful in the current blockchain ecosystem. With the boom of numerous types of staking, farming, and lending, users must be encouraged to employ their capital productively, and a demurrage token would be able to encourage this in a more efficient manner than any current system.
