Layer 2 Stage |Operating Advice: How to Evaluate Economic Risks for Protocols (for VCs and Founders)

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1. 0:00

   we have Lisa coming from Singapore to talk about evaluating economic risks for protocols and as always fun fact about Lisa she has actually lived in six different countries already I've only lived in America so Lisa welcome hi everyone good afternoon and good morning it's I really enjoyed sell's pitch because cell talked about how do you pitch and today I'm going to talk to you about how to build how to analyze how to build something robust so that you can pitch something relevant to your investors so show off hands who

2. 0:36

   here are founders good and who here are investors VC investors Angels okay that's also good the rest of you guys uh where are you guys from are you in marketing are you in in sales Business Development BD okay great marketing all right so this is also relevant to marketing to Founders and to VCS so today I want to talk a little bit more about how to analyze economic risks and something that I realized is this thing doesn't work again okay

3. 1:08

   great so I want to cover three couple of things today firstly is the risk types in web 3 in web 3 we talk a lot about economic we talk a lot about different kind of risks Financial risks and smart contract risks so I want to dive deep a little bit more into understanding what are the options of risks available in web 3 and how do we analyze them then I want to get started with with understanding economic risks something

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   that I want to focus on in this session why should we care about economic risks how do we look at designing and analyzing them and how do we design an an economy a robust economy so to begin there are three kind of risks in crypto in web 3 and people typically talk about the first two so the first one is Financial Risk and this is typical this is typical of web two you have Financial audit and you have

5. 1:55

   p&l kind of risk you have manager accounting to understand the Financial Risk company needs facing you have this for early stage startup for big Enterprises and this is nothing new we have that in crypto as well the assets might be a bit different instead of calculating things in US Dollars you have to calculate it in your own tokens perhaps but it doesn't stray away from the core fundamental of Finance as a risk the second thing we look at is

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   technological risk technical risks this is where smart contract Auditors come in and understand bugs understand kind different kind of exploits that's embeded within the code this is something new for technology firms you don't have that in FMB you don't have that so much in fmcg here is very specific to technology in web 3 is even more complex because we everything is open source and people can for the code very easily so techn technological risk

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   technical risks actually very important and we have dedicated smart contract companies doing that now the third risks that I want to introduce is economic risk and this is a risk that is quite new in these ecosystems that we're building because today we're building a brand new world a brand new country a brand new planet a brand new economy here it's not just about code and exploits and bug in the code it's not just about how people manage money but

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   here we're talking about how rules are being defined what can people do in the system what can people not do in the system how do people interact and in and and collaborate with each other in the ecosystem these are all the rules embeded within economics we talk about tokens as programmable money that programmability is the economic rules we embate within the system and this is a big big risk that's very new to a web 3 system it's not specific to web 3 it's

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   any economy that is being built any private or public goods economy where people get to come in and interact with each other you create a market in the market you have an economy and that is the economic risks we're talking about so today I want to focus very much on economic risk when we look at Financial Risk you can look at countless of books you can go to school for that there are a lot of ways to analyze Financial Risk when it comes to technological risks that's where a lot of smart contract

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    firms are doing audit firms are doing and you can read a lot of their reports and go to Twitter to understand them Financial risks on the other hand is something quite New Economic risk is something quite new it's quite specific to web three and this is the part that I want to dive into so before we get started I introduced this yesterday in my talk but just for everyone in the room how do we analyze and how do we build a robust

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    economic model the truth is that there is no one model that fits everything there is no one answer one model that fits the best economic model in the world if we have that we won't have different economic systems in Argentina in Brazil in Portugal in China in the US because every economic system is dependent and reflective of what kind of Market structures we are we have what kind of economic agents we have in the space so with that in mind I want to

12. 4:44

    introduce a framework instead and this framework is going to be very important because this framework is the framework of how we build systems and how we analyze economic risks this framework is something that I've worked on for seven years now and created a book all the clients that we work with around the world whether they're big Enterprises games or web 3 companies we all use this framework so this framework is very relevant and very useful in all kinds of

13. 5:07

    situations so let's take a quick two minutes to go through how this works you see that there are three pillars there you've got Market mechanism and token design if you think from a macro macro to micro perspective it's like a big funnel Market defines the macro structure the big economy what kind of Market are we talking about who is in the market who are the economic agents in the market what can people do in the market what kind of behaviors want want to incentivize you know the market is to

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    create the parameters of what is in this economy that we're talking about this is very relevant to your business model your your Revenue stream who are your competitors who are your stakeholders who is in the value chain dis still that all to part of your economic model second thing is mechanism design it's the micro part it's the moving towards the micro mechanism design talks about the incentives so what are the

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    rules that people need to follow to trade and interact the thing is at the end of the day economics are incentives and disincentives to drive people to behave in a certain way so we are creating the right kind of incentives to allow people to behave to allow people to participate yes we want voting we want governance we want people to vote on whatever decisions we want to make that is a good behavior and we're creating the the the incentives and

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    disincentives to allow them to participate to Signal their preference of voting to to signal and weed out bad behaviors and Bad actors in the system we talk about non-financial incentives and different kind of bargaining structure to allow people to coordinate and collaborate in the system so that's the middle part incentive design mechanism design and lastly we finally talk about tokens so realize that the first two pillars we didn't even talk about tokens do you need a token to create an ecosystem you don't need a

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    token you can have you can't have an ecosystem without tokens that being said an ecosystem a robust economy has to have a market if you have no Market if you have no one here there's nothing to design for you need to have incentives because people will always behave and interact in whatever way they deem fit and as an economist we're creating the barriers and rules and boundaries for them to interact and lastly tokens

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    tokens Can Be fungible non-fungible tradeable non-tradeable tokens Can represent reputation token can represents money token can represents Equity that increases in value it can be a store of value it can be a medium of exchange it does not matter because tokens over here are a means to an end the end is how people behave and interact in your system in any ecosystems that we're talking about the main thing we want to drive is user retention and user acquisition tokens

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    economy all these are driving forces to get people to interact more to increase user retention and user user acquisition and economy helps to build around that so with that in mind how do we understand the economic risks based on these three different pillars the first pillar when we talk about Market here we want to look at the market within our control and out of our control within our control out of control we look at

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    the legal and judicial risks what kind of countries do you operate op in is the foundation operating in Panama versus US versus Lisbon versus Singapore it really depends and understanding that gives us some understanding of to what degree and to what extent the external regulations the external rules will impact us we look at technological risks and we look at Community the things that we can control is the community who are the economic agents in the space initially you might have a lot of investors in

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    your in your community because you you have done fundraising but the main goal that we want to move towards are exra users if you are a game having a lot of investors as your economic agent in your game might not be the best mechanism right now we need to get the actual players coming in so how do we create the right incentives the right economic models to shift the economic Agents from primarily investors to actual Gamers how

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    do you work around that so that's very important to understand the market design in mechanism design we look at governance we look at the financials we look at economic transactions this is again it's not about tokens but how do people interact what is the user retention rate rate like how do people what's the 7 Days retention over here how do people interact with each other are they interacting with smart contracts are they interacting with each other are they interacting with the the

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    the virtual assets that you have in the game are are they interacting with the dexes are they interacting the staking protocol that it's a Insurance Pool for the ecosystem understanding how user behaves gives us a lot of insights to how robust this economy is how robust this ecosystem is because if if people are primarily not really interacting with each other they just holding tokens and there's a lot of wallets a lot of

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    people holding tokens but not doing anything with the tokens they're just holding it and hoping prices will rise that is not an economy that's not an economy where people are interacting and transacting with each other and when you do not have an economy where people are transacting and interacting there is no Market there is nothing to talk about everyone is transacting outside of your

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    market and that's not a robust economy and lastly we move to tokens again in tokens we look at the kind of tokens in the ecosystem what is the economic value that they are generating when people think of economic value they you always think of what is the token prices like if I want to do due diligence and figure out economic risk of my protocol I need to figure out our prices appreciating that I get it that's that's one perspective to look at things the other alternative to look at is that tokens

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    represent intrinsic value a value for you to stay within this ecosystem otherwise you can just exit change this to US Dollars and go and participate in another ecosystem so there is intrinsic value being generated by holding your tokens and participating in this ecosystem of course it depends between a DEX a lending protocol a game or an Enterprise project the intrinsic value of tokens can change drastically that being said it's important to understand

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    the first principles the fundamentals of why tokens exist in the first place what intrinsic value it generates and gives to the Token holders and from there understand what kind of risks are involved with this intrinsic value can they be exploited can this intrinsic value adversely select for the wrong kind of economic agents so for example if you there is a protocol once there was once a protocol and what they do

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    promotion they they help to bootstrap other people's ecosystem by giving out tokens as rewards they give out the partners tokens and their own tokens the problem with this it all sounds very good you know we're all co- sharing communities we're all growing things together and there is an intrinsic value there is to participate in another ecosystem the economic risk over there is that it adversely selects for the wrong kind of economic agents if you're giving Financial incentive as a reason

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    for people to come into your system people are only there for for the financial incentive once you start giving out free money once you start giving out free tokens they are going to leave because the reason for them coming into your protocol in the first place is that they're there for the value for the monetary or financial value the token value that's given to them so that is a risk to consider now one thing that's important which I want to challenge you

30. 11:48

    guys is who should care about economic risks we all talk about decentralization the world should care about this the world economic Forum should participate in this the bis and World Bank and and monetary policy all the all from the protocol creators to the all the token holders in communities everyone should care about economic risks sure in the perfect world I agree with you but this is the real world in the real world people are lazy in the real world people

31. 12:11

    don't really care so much about so many things right so to what it's not about one or zero it's not about complete decentralization or centralization who should care and who should not care but it's a degree of who should care and to what extent they need to understand the details maybe not everyone needs to know the exact p&l of what's going on in the ecosystem but at least there's there must be some level of information that shared with the community so the least

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    involved is actually the active Community yes we would like to switch this around where active communities are most involved but voters apathy is a real thing and that is that's why we put active Community above and then VCS investors and finally protocol creators and decision makers as a protocol decision maker as a protocol Creator what you are most you have the most vested interest to make sure that the

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    protocol is going well why because V and active communities they're all short-term and Midterm focused as a protocol Creator you are long-term focus when you're thinking long-term you're focusing longterm you're creating the right kind of policies to generate value in the long run it's not about creating pumping the tokens up people extracting value in leaving the system that is not what we're building here in crypto we're building here we're building something

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    that stays and to build something that stays we need to build we need to think long-term we need to build long-term plans long-term value creation that acres to the Token holders that Cruise back to the economy and that is what we want to do and that's why we care about economic risks not because it's something that impacts my p&l in the mid and short turn but how do I create value in the long run that generates value for everyone coming into the

35. 13:45

    ecosystem so what are the risks looking like just like in traditional Finance we have educ syncretic risks and systemic risk systemic risk is Market risk risks we cannot control and edos syncretic risk are risks within the protocol that we can control control and so I've divided this into eight components divided into systematic and idiosyncratic for us to understand we can we have all these risk we classify them and understand what we can control and what we cannot control in systemic

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    risk things we cannot control will be the market the users the technology we get to choose what users we want to select for what technologies we want to use what market and jurisdictions we want to be in but there are a lot of things that's out of our control what we can control are the idiosyncratic risks this will be protocol risk economic parameters governance Financial Risk and liquidity risks these are things that we can control and these are things that as economists as as people doing due due

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    diligence these are things that we can control and when things go south in the protocol that is something that we can tweak we can manage we can adjust from that so with that I I want to conclude the presentation you can scan the QR code to download the the presentation and get a free consultation from us and with that thank you I'll be at the back answering questions