A Macroeconomics View of the Pocket Network

Ideas
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Authors:

The intention of this thread is to discuss a possible modeling of the Pocket Network’s economy in terms of the macroeconomic theory.
We encourage the community to read the full document, making emphasis on the sections 3 and 6. Below we will include some excerpts of the presented document that summarize the intentions and main conclusions.

Please note that the document was written on 2023-04-26, before the app burn rate was activated. Since that date some numbers changed, i.e. exchange rates, relay to token multiplier values and total relays, however the main contribution of the document remains valid.

Introduction

The Pocket Network strives to become the backbone of the Web3 ecosystem by providing unstoppable and high-quality access to any blockchain. As such, it must itself be a sovereign crypto network. A fundamental piece of a sovereign ecosystem is understanding the economic variables that influence it. While the crypto world is full of coins that have no intrinsic use apart from speculation or storing value (such as Bitcoin), the $POKT token, Pocket Network’s native cryptocurrency, represents a different kind of token.
Designed as a utility coin, the $POKT token grants its holder access to the Pocket Network, and consequently, unrestricted access to the blockchain data provided by it. It is not the only utility token out there. Ethereum can be seen as another, providing the holder access to operate smart contracts on its network. However, it’s essential not to conflate Ethereum and Pocket, given their differing use cases and economic processes, which we will elucidate in the document.
The purpose of the presented document is to outline the economic processes taking place within the Pocket Network. Drawing from the macroeconomic framework of a sovereign state, we describe how production, exchange rates, and interest within the Pocket Network economy are interconnected. The product of this analysis is an abstract economic model applicable to the current state of the network and adaptable to future changes.
We believe that establishing the macroeconomic foundations of the Pocket Network is crucial
to:

  • Standardize the language used in economic discussions, e.g., network profit, network cost, etc.
  • Establish a robust foundation for creating more detailed microeconomic models, such as those for service providers, validators, and portal ROI.
  • Define appropriate interaction and compensation mechanisms for new network actors, such as the “fishermen/watchers” in V1.
  • Create a practical, standard model to weigh and propose changes to economic variables, such as relay cost and network cost.
  • Introduce the concept of interest rate into the ecosystem.
  • Equip the Decentralized Autonomous Organization (DAO) with tools to observe and. manage the economy of the Pocket Network.

Conclusions

The document presents a plausible modeling of the Pocket Network economy, which surely is perfectible. It’s mainly intended to show how the Pocket Network’s tokenomics can be modeled by means of macroeconomic theory. It should not be regarded as a definitive model and the presented results are only rough approximations of the real mechanics that drive the Pocket Network ecosystem.
We believe that this modeling has the power to order how we approach the Pocket economy, simplify economic variable tracking, provide common ground to analyze economic proposals and use macroeconomic theory to support and propose new ideas. Nevertheless implementing such a model requires planning. We believe that it is important to:

  • Define a set of variables to be used in the model and track them over time. The model will need to feed from historical data to approximate its functions correctly.
  • Track the volumes across all known exchanges to have a better estimate of sell pressure. This will improve the balance of trade calculations which appears to be one of the most sensible points of the system.
  • Refine the proposed functions to match observed behavior. We only propose a simplified view of many functions (such as Consumption, Investment, etc.), these will probably won’t match observations and will be required to be re-engineered over time.
  • The economy is not a factual science, it changes with society, for this reason the model should be reviewed regularly and updated for changes in sentiment around the ecosystem.

Experiment Results

The document proposes a series of experiments that are simple illustrations of the model’s descriptive power. However if we accept the underlying modeling of all equations proposed in section 4, we can draw some conclusions.
It is also important to note that sociological effects are difficult to model, i.e. the exponential growth that can provide phenomena like “Fear Of Missing Out” (FOMO) or “Fear Uncertainty and Doubt” (FUD) will be difficult to take into account and play a central role in emerging ecosystems. So once more we remind that the model is accurate on variations near the observed equilibrium.

  • While the ABR does have a direct impact on the POKT price, its growth is not aligned with the network profit feature:
    This is concluded from our analysis of running the scenarios proposed in the PNF ABR activation document, where they use the network profit feature. This does not mean that ABR won’t affect the price. We expect that it would have a great impact on the price as the sentiment over the Pocket Networks future improves and Pocket starts to climb on the charts like the Web3Index and Token Terminal. However we must be aware that the network profit can be positive without necessarily meaning that the POKT price skyrocketed.

  • RTTM has no direct effect on the POKT price:
    The RTTM is the only parameter that we have been controlling so far, and that many proposals pretend to control. The reason for this is that we have not model (or observed) a direct relation between scarcity and price as we think that it is purely sociological or speculative, which are difficult to model without proper data. This could be a weakness of our modeling and we should discuss how and if such a mechanism can be included.

  • The most important feature that drives the price is the Network cost:
    This is not something ignored in the community, and almost all economic proposals have a common objective to drive the network cost down. However it is difficult to act on this variable because it is not something that we can control.

Observed Network State and Main Conclusions

The current state of the Pocket Network’s economy is dire, necessitating prompt action for short-to-mid-term remediation. The initiation of ABR is indeed a step in the right direction, but additional measures are essential. Our analysis identified the following major issues:

  1. The trade balance is entirely lopsided. Currently the imbalance is 998 K POKT (or 41.1 K USD) by day. This immense selling pressure must be counterbalanced by capital inflow into the system through the capital account. Assuming the estimates provided by PNF, this represents the first and most critical challenge for the network.
  2. The network’s costs currently surpass emissions, which presently approximate 523 K POKT. Despite operating at a loss, numerous Pocket Network operators continue to run, and there haven’t been significant departures from the network. Consequently, we question whether focusing solely on emissions will restore our economy’s equilibrium. Additional strategies are needed to address this issue, including greater R&D aimed at more streamlined and efficient clients, scaling the demand side, and increasing ABR to increase the price.
  3. Our calculations indicate that the revenue from running a node (avg. earn, trailing one year from 2023-04-26) is 26.8% and adjusted for POKT devaluation, the revenue is negative. This is even worst considering the risk of investing in the Pocket Network and the reality that investments typically yield a risk-free return of 5%. The initial fervor and attractive revenue of the Pocket Network have faded, and investors seem hesitant to enter the ecosystem. This reluctance is driving the price down as selling pressure from the operators persists.
  4. We require more tools to attract capital and stabilize the POKT exchange rate. This could be achieved by tapping into futures markets, expanding to larger exchanges, and supporting wrapped tokens. While establishing a robust futures market takes time, it could provide us with a proxy for the interest rate, thereby preventing capital from exiting the ecosystem.

Solving these problems is no simple task, and it is not our intention to provide immediate
solutions. Rather, we aim to guide efforts in the right direction. Transforming the current
economic climate will take time, and our approach should be two-pronged:

  1. A technical perspective to ensure each decision is informed by thorough fact-checking and rigor.
  2. A social perspective to guarantee the changes we make within the ecosystem reach both our community and the broader public. Economics is a social science, thus building confidence and a historical narrative is crucial for any plan’s success. Economic decisions shouldn’t be based solely on the current state of affairs but should take into account future expectations. In other words, managing market expectations is vital for a thriving economy.

Establishing a company with an innovative product is challenging in and of itself. However, creating a balanced economic ecosystem is an even more formidable task…

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Thanks for putting in the work on this, @RawthiL and company. It’s highly relevant in our current environment.

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Handling the macroeconomy of the Pocket Network is not a simple task, and it is harder to do if the community is not focussed on solving the problems that we need to solve.

Based on the document presented previously we created four actionable subjects. We believe that these subjects are the ones that the community needs to focus on:

Change Minting Mechanism

Current minting mechanism do not provide a mid-to-long term answer to the minting problem of the Pocket Network. We have created a proposal to address this problem:
Mint Incentivizing Network Transformation (MINT)

Create POKT retention mechanisms

The current price of the token and emission reduction proposals are pushing some token holders out of the Pocket ecosystem creating more pressure in the balance of payments. In order to diminish the effect of this and keep long term holders in the system while reducing the resulting minting, we propose to develop a mechanisms such as bond. Bond offers the assurance of regular interest payments and repayment of the principal amount at maturity, however the critical benefit it limits the mobility of POKT. These mechanisms were also proposed by some community members in the Telegrams chats, in the form of “locking up” capital until v1. You can read the whole subject in the following topic:
Pocket Network Bonds and Interest Rates

Show clarity on Pocket Network V1 economy

As chatGPT Peter Drucker said:

The best way to predict the future is to create it.

We need to create the conditions of a healthy economy in V1, and this means that we need to account for emissions and sinks of POKT from any network actors (Gateways, Apps, Fishermen/Watchers, Servicers, Validators, DAO). How we layout the token distributions (minting, burning and staking) is very important to provide macroeconomic perspective. We created a post to discuss this:
Pocket Network V1 Macroeconomic Needs

Create money inflow into the ecosystem

Arguably one of the main drivers of POKT high exchange rates during the late 2021 was the high demand for the token to stake nodes. This money inflow was larger than the enormous sell pressure (infrastructure costs) that the network had at that time. Today we have a much lower sell pressure, however the exchange rate is still depressed. We think that we need to address this by making the access to the POKT token easier and provide new tools for investments acquisition, specifically a futures market. See the discussion on this subject in the following thread:
Some speculation on the presence or absence of a risk-free rate

What now?

We invite the community to engage in the threads that we have proposed. To keep things orderly we request to keep the discussions of each subject in their respective threads. We will not answer about them here, we will re-direct your posts to the specific thread if you do.

If you wish to comment on the holistic view of the actionable list and/or the macroeconomic document that serves as base to our approach, please do so in this thread. We are open to discuss any inquiries that you have.

The Pocket Network is making great progress in reorganizing their structures and separating groups with different interests (i.e. PNI - PNF). Part of this reorganization must include an improvement in the approach to technical subjects.We believe that the DAO should focus on:

  • Data-centric decision making
  • Formal analysis of complex subjects
  • Proper publishing of results

Most of the work that we do is based on forum interactions, which are by far the most civilized channel that our community has. Providing feedback in forums help the community to build up a knowledge base. Fully developed ideas usually take lots of time to write and read but also have the larger impacts, wether they are forum posts, documents or blog posts.

If we succeed in these subjects, will all Pocket Network’s problems disappear?

No, we can successfully address all these points and fail.
As we said before, the economy is a social science, results are never guaranteed. What we believe is that by ignoring these subjects the economy will not recover. Miracles can happen tho, but that’s not an excuse for not doing nothing… As Machiavelli said:

I judge it to be true that fortune is the ruler of half of our actions, but also that she allows us to direct the other half, or perhaps a little less.

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Thanks for putting this together. I will review over the weekend together with the MINT pre-proposal

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Thanks, please try to keep topics separated in your response to avoid cross-talk as much as possible!

Its a fair note and I somewhat agree. The topics are rather heavy and the community bandwidth is limited. We don’t mind to discuss these topics over months (except MINT) and also we will use them as reference in any economical discussion that seems fit.

We decided to post this all at once for a few reasons:

  • All of these topics stem from a research that we did almost 2 months ago, at that time we decided to keep it in the back-channels to avoid noise, but we started to feel that it might get dated if we did not publish it. We wanted the community as a whole to know what we were thinking.
  • Most of the topics look to mid-long term, so it is not mandatory to read everything to participate in the discussions. The only topic that is an actual proposal is the MINT proposal. Other posts talk about things that are long term or that were already considered in other chats like Telegram, but never reached the “formality” of the forum.
  • We did not felt comfortable posting proposals (or economic topics) if we did not presented our view as a whole. We probably have a disruptive view of the POKT token economy (for us it is a currency not an asset or something else) . To support our thesis we need to write a lot.

Maybe it is not worth much, but we have almost emptied our research on the subject, so don’t expect other posts popping around (in economics at least)…

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To answer the broad question you make we created an specific document that discuss the POKT token and its relation to money. Yo can find the document here:

Some speculations about the POKT token

Before getting into the article and document analysis we will briefly address the question regarding the velocity of the money.
The Pocket Network abused the seigniorage mechanism (minting out of nothing), which lead to a loss of confidence in the token and the increase in the speed due to the excess of token offer. Due to this, it stopped working as a reserve of value.
If we don’t do anything, then it is true that POKT cannot be money because it is not a store of value. However, we can control this, we have the theory of money to do it and the tools to implement the solutions (as we describe in several threads). The first and most efficient, is to stop using seigniorage as a source of founding the ecosystem, which is already being done.
If we analyze this, its clear that the velocity problem will exist regardless the definition of the POKT token.

Now, back to the main article and the provided document. The cited article is based on the foundational principles behind capital. So we will start by making some comments on this foundational article.

Foundational Principles Behind Capital

In his 2019 article, Joel Monegro begins by stating that:

All forms of capital offer some kind of control over the distribution of economic resources across a group of people – in effect, governance over that pool of resources.

And he adds:

This insight, that capital is governance (and vice versa) leads to the source of its intrinsic value. Whoever has control over a pool of important resources also has the potential to direct some of those resources to their own benefit. So the value of a system’s capital is proportional to the value of the resources it governs.

We seriously believe that it is a major mistake to confuse the rights held by the owner of
capital with the governance of capital.

We believe that whoever owned the rights to the capital decided how to use it may have been
true in the mid-nineteenth century, when the owner of the factory was the one who ran the
factory (the one who made the decisions). With the emergence of super-specialized management, the managers of the companies (the ones making decisions) rarely know the owners of these. This means, that whoever owns the capital hardly governs an organization, and whoever governs it is rare to be the owner of the capital. Some people study for many years to get to run an organization, although they may never be owners of that organization.

Let’s be extremely severe, let’s say that a person owns a hospital. Does anyone imagine that the owner of that hospital would think of making any governance decision about the hospital? Or does anyone think that the owner of the hospital is not a capital holder because he does not decide how to manage the organization he owns?

In another section of the text Monegro points out that:

Certain proof-of-stake systems are good examples of this idea. Here, miners are required to lock a certain amount of tokens in order to be allowed the right to work for the network. The value which flows from users to the supply side is then distributed to miners proportionally to their stake. This way, tokens that can be staked are a form of capital in that they represent the power to organize some of the economic resources of the network, such as production capacity and distribution of income. And ultimately this is a form of governance, in the sense that staking is a mechanism for deciding how income should be allocated across miners. And so, as the value of that income grows with user demand, so does the value of stakeable tokens.

We do not agree that the power to organize some economic resources is synonymous with
value, rather we believe that the value is in the efficiency of an organization.

It is obvious to us that it is important to establish what portion of the cake will be given to each
member of the organization.
If the cake is small, even if we keep seven portions out of eight, we will go hungry. On the other hand, if the cake is huge, with a a small part of it we will surely be satisfied.
We insist that the value of a capital is not in the ability to distribute the resources at will, but in the efficiency with which those resources are applied, beyond how they were managed and distributed.

These objections to the foundational article in which Chris Burniske from (placeholder.vc) bases his article are crucial, as any conclusion based on a false premise is not valid, even when such conclusion might appear to be correct.

Value Capture and Quantification: Cryptocapital vs Cryptocommodities

The article makes a distinction between two broad categories of cryptoassets, namely those that may resemble capital and those that may resemble commodities, while we find the distinction interesting, we believe that for the case of POKT the relevant question is whether a given token can be thought of as money or not, and we do not believe that this depends on whether it is a capital asset or a commodity, it depends on a much deeper concept which is,
what is money?.

To go deeper into this subject we suggest to refer to the linked document at the beginning of this post.

The article states:

The TLDR is that cryptocapital will take inspiration from its capital asset peers, and as a productive asset its value will be calculated as the net present value (NPV) of annual value flows to supply-siders. …

We do not believe that NPV is a good model for valuing assets per se beyond whether those assets are digital or not. What we do believe is that NPV can be a good idea for valuing investment projects, to some the difference may seem subtle, but to us it seems foundational.
Different investment projects, based on the same cryptoasset can generate different present values of expected future cash flows, and the value of the cryptoasset will not be determined by the NPV of one project or another, but will be determined by the laws of supply and demand of the market.

We can agree that those projects related to cryptoassets that are not called money and that
have an expected future cash flow, can be valued quite accurately by the present value of the
expected future cash flow, and perhaps this will help us to value cryptoassets with which it is
possible to assign only one investment project. However POKT its a token associated with a number of possible investments:

  • Servicing relays (node-runnning)
  • Securing the network (Validators)
  • Selling relays (Gateways)
  • Monitoring the network QoS (Watchers/ a.k.a Fishermen)
    This rises the question, which is the investment that we will use to evaluate the POKT token?

Besides the particularity of POKT, the criticisms to this are the usual: how to know what probability of occurrence to attribute to each cash flow? What cost of capital will each company have? Because if two organizations have different costs of capital, even for the same project, and discount the expected cash flows at different rates, it is clear that they will have different present values.

But still, we believe that under certain circumstances, and for cryptoasset-based projects that are not called money, and have expected future cash flows, the expected NPV model can be a good idea for valuing those projects.

The article continues:

… Meanwhile, the equation of exchange (MV = PQ) remains our best bet at pricing non-productive cryptocommodities, where PQ = annual transaction volumes using the native asset. Note that “annual value flows to supply-siders” and “transaction volumes” are separate metrics, and serve as the respective linchpin metrics for cryptocapital and cryptocommodities.

We humbly believe that the article makes the mistake of confusing the general price level with the price of money (the price of POKT, or the token we are talking about) thinking that the quantitative equation of money describes its price.

For those that are not familiar, the quantitative equation of money is the following:

M. V = p Q

The equation describes the preference for liquidity, and not the price of a currency. The equilibrium conditions of an economy, such as those governing the POKT ecosystem, will occur when production, exports and the quantity of money are in equilibrium.

The other discrepancy we have with the previous work is that we are looking at the functions of the cryptoasset, in our case POKT. If the cryptoasset fulfills the functions of money, it should be called money, and should be treated as such. This means, seeking the macroeconomic equilibrium of the ecosystem where the cryptoasset functions, and this goes beyond the nature of the cryptoasset, whether it is a utility token, a commodity, a governance token, or a store of value. Again, if the token fulfills the functions of money, it should be considered money and studied as such.

To go deeper into these concepts, we suggest to refer to the other work that studies how to develop POKT considering it as money (linked article).

Regardless of whether a cryptoasset is more similar to a commodity, a consumable/transformable, a capital asset or a simple store of value, the ability to become money will be determined by how many the members of the community believe that this asset will continue to be money.

As stated in the article:

Converging on consensus models to value cryptoassets is essential to improving the efficiency and thereby stabilizing the volatility of the crypto markets.

We agree on the fact that converging on consensus models to value cryptoassets is essential to improve efficiency and thus stabilize the volatility of cryptocurrency markets. But we want to make it clear that the price volatility of non-cash cryptoassets, well developed (i.e. with a dynamic and frictionless options market) is going to be better modeled by the developments of
Black, Scholes and Merton (Robert C. Merton 1973) and their successors. Also, for cryptoassets that can be called money, the volatility of the exchange rate is going to be fundamentally governed by the expectations that this currency generates.

Regarding the superclasses of digital assets, it is certain that it seems to us a very interesting classification, but we want to make it clear that we are focused on studying whether or not POKT is a cryptoasset that can be called money or not.

The article poses then:

Most physical commodities have marginal costs of production that fall as the system scales in its ability to extract it, because as more capital is invested in the process of production, economies of scale are achieved and incrementally more units are produced. Bitcoin and its proof-of-work peers have marginal costs of production that rise as more people work to “mine it,” because while more resources are contributed to mining, the rate of supply production of new BTC stays fixed.

It is strange to raise the issue of diminishing marginal costs, because since Adam Smith’s time (16th century) it is considered that the existence of diminishing returns may seem logical if we think about it from the following point of view: just because there are more workers in a construction site, the work is not necessarily done faster and more efficiently.

There may come a point in which so many people working in the same space may get in the way of each other due to lack of space and not perform their tasks correctly. A greater number of workers will cause the level of production to decrease for each unit of worker employed. In this case the marginal increase in production is negative.

The same thing happens by increasing the capital factor. For example, imagine the reader that only one person works in an orchard. The work he has to do to produce is enormous. If he buys a tractor he will be able to perform his tasks much better. But if he buys another tractor it will be of no use to him since he cannot drive both at the same time. Just as the first tractor caused production to increase, the second tractor did not, i.e. the marginal yield was zero when the second tractor was added. Let’s imagine that he is given 10 more tractors. Because he will have to use part of his orchard to park them, production will be reduced, with the marginal yield decreasing for each tractor added.

It is also important to add to this point that Pocket Network and Bitcoin are two completely different animals. Bitcoin does not need increasing hashrate to grow (as the farmer did not need so many tractors) it only needs to make sure that a given hashrate relates to effort (and resources) in the real world. Bitcoins marginal production cost rise with added “miners” is a design choice, used to keep block rate constant in time. The difficulty of Bitcoin is modulated by the hash-mining power of the network, but it does not care on the absolute value of its hashrate.
On the other hand, Pocket Network does need to increase its relay-rate to grow. More relays means more network usage and that translates to token usability (and healthy economy).
Thinking that Pocket needs to follow Bitcoin’s path and create a diminishing gain for node runners (or increasing the marginal cost) as the relay-rate grows is to join two completely different concepts. Bitcoin and other Proof of Work network relies on hash-mining which is a different (and maybe opposite concept) to relay-mining. Hence thinking of POKT as a simple cryptocomodity (like Bitcoin) is not accurate.

In general it seems to us that with respect to cryptoassets that are store of value, the article poses is very focused on stocks. We believe that while stocks are a fundamental part of the valuation of an entire cryptoasset, we believe that in the case of those that can be called money, it is necessary to look at a few more things…

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