Text: Lukas Philipp, Forgd
Compiled by: Leia, TEDAO
Why should token economies be audited?
Decentralized applications (DApps) are a core component of Web3, providing an interface for about 99% of users in the Web3 ecosystem to conduct transactions, investments, and various other activities. These platforms are driven by smart contracts on the blockchain and are able to provide permissionless and intermediary-free automated processes 24/7.
Smart contracts are the foundation of DApps, so their security and reliability are of utmost importance. To ensure that they can effectively resist malicious attacks that may cause loss of user funds, smart contracts are usually audited, sometimes even multiple times - as the saying goes, "cause caution can catch a thousand cicadas, and caution can make a boat last for ten thousand years."
However, just as auditing smart contracts has become standard practice, auditing the token economy is equally important to the long-term success of the corresponding project. Almost every blockchain project, not just DApps, includes its native token, often as a core element of the project's business model or ecosystem. In this article, I will explain why token economy audits are so important and why you should consider taking an extra step to keep a good check on your token economy.
Smart Contract Audit
Smart contracts are the core backbone of DApps, enabling platform functionality to run seamlessly without intermediaries. The immutability and continuous availability of these contracts on the blockchain ensures uninterrupted, permissionless, and trustless transaction execution 24/7.
The importance of auditing is that smart contracts, especially in decentralized finance (DeFi) protocols such as lending platforms, hold users’ deposits. Take Aave and Compound as examples, billions of dollars are stored in the smart contracts of these platforms. Therefore, the robustness of these contracts must be foolproof to protect the safety of user funds.
Audited smart contracts bring several significant advantages. First, it can greatly enhance the confidence and trust of users and investors in the platform. Accreditation by an audit agency usually means that the protocol meets a certain quality standard, which of course depends on the credibility of the audit agency. Additionally, committing to an audit demonstrates that the project team is committed to safety and willing to invest in strengthening its infrastructure.
Token Economic Audit
Image source: fortune.com
After understanding the importance of smart contract audits, we can clearly see that token economy audits are equally important for DApps that adopt token economy. If you choose to integrate a Web3-based token economy into your business model, its success depends not only on reliable smart contracts, but also on the effectiveness of the token economy and its fit with the strategic goals of the project's business model.
Most importantly, realize that not every Web3 project needs its own token, especially in some mature business models. For example, consider whether your token is primarily a medium of exchange within the platform. Think about whether this truly enhances your business model or if it instead creates barriers for your current and potential users. Tokens that are primarily a medium of exchange can easily be replaced by more suitable alternatives, such as reputable stablecoins like USDC or BUSD.
A token should always provide value to its users and not hinder the scalability of your project. To assess its value proposition, first ask why someone should buy the token and, more importantly, why they should hold it. If you can answer the first question but struggle with the second, your token may be acting as a mere transaction facilitator — a medium of exchange without substance. The answer to the latter question will reveal the specific value drivers that benefit token holders throughout the holding period. Note that I am not referring to speculation here.
Beyond that, a well-functioning token economy should include key factors from the quantitative side of token economics, such as a reasonable token distribution to avoid centralization, a carefully planned issuance schedule to prevent excessive inflation, and reasonable valuations when planning token sales.
To address these issues, a token economics audit involves an expert scrutinizing both qualitative and quantitative aspects of the token economics, examining whether the project’s goals are aligned with the token economics. An important aspect of this assessment involves applying game theory to understand how users will interact with the token and the project, exploring potential unintended consequences and feedback loops that could quickly turn into a vicious cycle.
By analyzing and optimizing these economic mechanisms, projects can strengthen their value proposition and build trust among users and investors, thereby solidifying their position in the evolving blockchain technology landscape.
Advantages of Token Economic Audits
Just as smart contract audits increase user confidence and trust in a project, token economic audits ensure that your token economic strategy is viable within your business model. These audits assure users and investors that the tokens add value and have been thoughtfully designed, further increasing confidence in the project.
Furthermore, a well-executed token economics audit not only verifies the basic functionality of a token; it also dives deep into the alignment of the token’s utility with the overall project goals. By examining the role of the token in incentivizing network participants, facilitating user engagement, and driving long-term growth, an audit helps optimize the token economics for continued success.
Additionally, token economic audits are a critical risk management tool. By identifying potential flaws or vulnerabilities in token design early on, projects can proactively address and mitigate risks before they impact the platform or its users. This proactive approach not only protects the project’s reputation, but also reduces the likelihood of unforeseen challenges in the future.
Finally, the results of a comprehensive token economics audit can serve as a valuable communication tool. Transparently sharing audit results with the community demonstrates a commitment to openness and accountability, which can lead to stronger community support and engagement.
in conclusion
Now that you understand why auditing smart contracts is important, you also know why you should audit your token economy. Smart contract audits are fundamental to ensuring the security and reliability of DApps, while token economy audits play a vital role in validating the viability and value of the token economy within a business model. An audited token economy can increase user confidence, attract investors, and establish a project as a trustworthy player in the blockchain space.
