A General Theory; with Special Reference to ValuesDAO
Values DAO is organization to realize and implement a very significant shift in the application of economic theory. This shift can be expressed in the following way: in digital economy, the economic forces of demand versus supply are generalized into forces of internal coordination versus price coordination. Supply and demand pertain only to price coordination, while entrepreneurship/self-organization (which falls outside neo-classical price theory) pertain to internal coordination. The framework of internal coordination theory is able to explain economic productivity and intrinsic value within digital economy, as distinguished from the more specific materials economy.Internal coordination is still underappreciated as a form of economic productivity, with particular relevance to digital economy. Internal coordination is separate from the forces of supply and demand, and is what equilibrates or regulates supply and demand. Thus, it is what motivates natural self-correction and self-governance by market participants themselves from within the market. The market requires a human being, an entrepreneur, to recognize and solve existing coordination problems, outside of the price mechanism. This happens through the negotiation of social norms. The market is only self-regulating and self-correcting to the extent that common sense norms are negotiated and shared by everyday participants, through internal coordination.The dynamics of internal coordination versus price coordination were first articulated in transaction cost economics, by Ronald Coase in his essay The Nature of the Firm (1937), and later by Douglass North in Transaction Costs, Institutions, and Economic Performance (1992). Transaction costs are essentially extra-monetary communication costs of operating in a market. They include costs of planning, deciding, and deliberation. Essentially, transaction costs reflect the normative rules that internally self-govern and self-regulate market activity.
What is produced in the materials economy are tangible, discrete, finite supply goods. For example, plates, screws, toaster ovens, shirts. The price mechanism can determine the optimal distribution of material goods, because these goods are adequately measured by the criterion of price-quantities. What is produced in digital economy are ideas, incentives, and infrastructures. Price is not an adequate criterion to measure these goods, because such goods are not purely tangible, discrete, or finite and thus cannot be measured purely quantitatively. Price is only one among many competing forms of coordination that are produced by a digital economy, and by no means the most determinate. The economic goods produced by a materials economy are material goods, while the economic goods produced by digital economy are focal point goods. Focal points are the more and less optimal solutions to coordination problems in the absence of direct communication. This means that communication must be largely tacit or implicit. The optimality of a focal point is measured by the criterion most relevant to the specific problem that it attempts to solve for. But all specific coordination problems and their specific criterion are aspects of the overall, objective coordination problem of human affairs in general. We can think of digital economy as a market for focal points. And this is hardly the same as a market for memes, or virality. It is actually quite the opposite. The meme is defined by mimesis- how effective its imitation, simulation, and copying. The focal point, by contrast, is defined by originality- how effective it grounds absolute, unique shared organization in the absence of ability to directly communicate. Focal points are the origin of memes; the latter are temporal derivatives of the former.The digital economy is related to the materials economy, because the former generates the distributed self-governance layer of the latter. An efficient materials economy with optimal distribution of goods, is not possible without internal market self-regulation. It is not possible for corporations to function without effectively virtuous corporate governance. This is only possible through distributed negotiation of objective social norms, which are focal points. As Thomas Schelling and Michael Polanyi emphasize, these focal points are often tacit or implicit, rather than explicitly codified.
The idea that internal coordination is equally, if not more significant than price coordination was independently discovered and implemented in OlympusDAO protocol and forked by ValuesDAO for metaverse space. This is very concisely expressed in the (3, 3) ‘meme.’ As already noted, (3, 3) is more accurately defined as a focal point, rather than a meme. The (3, 3) is the focal point solution in the payoff matrix that describes the incentive structure of the Values DAO protocol. The Values DAO protocol essentially has three aspects to its rule-set:
- staking (internal coordination)
- bonding (price coordination)
- treasury (reserve backing)
And this rule-set is governed by three main levers:
- Rewards rate and APY (internal measure of internal coordination)
- Bond control variable (internal measure of price coordination)
- Premium over RFV (price measure of internal coordination)
The policy levers are the main way that the DAO self-regulates irrational, runaway reflexivity in market conditions. The policy levers then act as focal points that either counteract or work with external market forces in order to maintain internal productivity.
Rule-set: Staking (internal coordination): the (3, 3) is a win-win situation in which both players stake their $VALUES tokens. In return for taking them out of circulation, the staker receives compounding rewards based on the rewards rate, which is controlled by the DAO’s policy team. The (3, 3) focal point basically states that internal coordination- universally agreed upon, positive sum, cooperative behavior- is more economically productive than price coordination- zero sum, competitive behavior. Internal coordination forms a demand sync, which draws in economic value proportional to network effects. Price coordination is also a win-win equilibrium, but to a lesser degree than the internal coordination equilibrium. Internal coordination is the generalization of economic demand, whereas price coordination is the generalization of economic supply. Internal coordination theory represents a distributed demand-side economics, or a supply-side self-governance, as opposed to centralized governance.
Bonding (price coordination): The bonding focal point (1,1) is also a win-win situation, to a lesser degree. Bonding is when a buyer purchases $VALUES tokens from the protocol, at a discount from the market price. The buyer provides another asset (a stable coin, or LP token) to the protocol treasury in return for the $VALUES token. The discount is determined by market forces and by the bond-control variable, which is controlled by the policy team. The bond-control variable sets a certain bond capacity or a target limit for much of the given asset the treasury wants to take in over an allotted time. As the amount of bond sales gets closer to the capacity limit, the discount of the bond decreases in order to ensure that the treasury accumulates the right amount. The price coordination equilibrium is the generalization of economic supply.
Treasury (reserve backing): The money from the bond sales goes into the treasury reserves. These are the reserve assets that back the value of each $VALUES token. The Risk-Free Value (RFV) is an amount of stablecoin that backs each $VALUES token that is minted and sold through bonding or through rewards distribution. The treasury must contain this RFV amount of stablecoin for each $VALUES token it mints into circulation. The Market Value of Backing per Token metric, is the treasury reserve backing that is made up of other treasury assets besides stablecoins, which therefore may have more volatility.
Policy levers:Reward rate: this measure determines the amount of new $VALUES that is minted for stakers. The percentage of $VALUES that is staked then determines the APY. The amount of bond sales together with the reward rate determines the rate of supply growth. Every $VALUES token that is minted must be backed by one unit of risk-free value. The reward rate combined with the percentage of total $VALUES supply staked, gives the APY, or annual percentage yield. The APY is the primary internal measure of internal coordination. It is the inverse measure of the health of the DAO. When the DAO is doing really well the APY will be lower, because the reward rate will be lower (which means the protocol has been in existence for a longer time), and there will be a high percentage staked (which means that there is long-term internal confidence).
Bond control variable: this measure is partially controlled by the policy team in order to incentivize the precise kind of treasury composition that the DAO wants. There are considerations of what kind of reserve assets the DAO wants to back the value of $VALUES, such as: liquidity provider assets versus stablecoin assets versus layer 1 assets versus other tokens. Each kind of asset has different properties as reserve backing, and these must be weighted in aggregate for healthy growth and adequately stable reserve backing. The bond control variable is the internal measure of external price coordination because it sets the discount rate for buying directly from the protocol, rather than buying from a third party market maker. Thus, the bond control variable is the way that the DAO internally measures and regulates the $VALUES price value in virtue of its optimal treasury composition.
Premium over RFV: this is the value that each $VALUES token trades for above the amount of stablecoin value backing each token. This is a multiple, comparable to a price to earnings multiple that is familiar to value investors in legacy finance. The premium is the external / price measure of internal coordination; the reason that $VALUES trades for a price over the RFV is because there is an external market perception of efficient internal coordination of Values DAO contributors. This external perception reflects investor confidence that the percentage of $VALUES staked will remain high, that contributors will continue to work for the DAO, that the protocol will continue to expand its network to form new partnerships, and that demand for $VALUES will continue to increase. Thus, the premium over RFV is thus a measure of the economic productivity of the DAO, and its expected future cashflows. This measure is set by the market, and not directly by the DAO policy team, but it can be influenced by policy levers.
This is an idealized prototype of the economic flywheel mechanism, meant to be pedagogical rather than precise in detail. It gives an intuition for how the protocol self-regulates and aligns incentives of the three main parties- market/bonders, stakers, DAO policy team. This model shows how the implementation generalizes the economic forces of supply and demand, in order to work with or counteract reflexivity in the market. The bolded terms are the main levers that the DAO can use to internally affect market conditions.The reward rate combined with amount of bond sales sets the rate of supply inflation,
- higher supply → price decrease
- price decrease → lower premium over RFV
- lower premium over RFV → price increase (as price reverts to standard multiple)
- price increase → more unstaking / selling
- more unstaking / selling → higher APY
- higher APY → more demand / staking (3, 3)
- more demand / staking → price increase
The fundamental questions for the economics of decentralized finance (DeFi) are: where does value creation in decentralized finance originate? Or, what constitutes economic productivity in decentralized finance? Or, what economic good is produced by decentralized finance? Essentially the problem is
a.) how to break the circularity of capital flow in DeFi,
b.) how to connect DeFi to the broader financial system, and
c.) how to articulate the source of economic value in DeFi.
Only by answering these questions can decentralized finance be more than a degenerate art form, and be raised to the status of legitimate, economically productive activity. The reserve asset treasury model or “protocol owned liquidity” model (DeFi 2.0) initiated by $VALUES gives the first answer to these questions, through risk free value or intrinsic value, which is familiar to legacy finance. Although it takes a different form in decentralized finance. What grounds the flywheel of fundamental value creation is internal coordination which can be summarized as:
- Because there are significant rewards to internal coordination (staking),
- Then there will be significant rewards to price coordination (bonding),
- Then there will be significant growth of treasury assets (revenues),
- Which provides ensurance that there will be significant rewards to internal coordination.
This virtuous cycle relies upon the foundation of internal coordination as economic productivity, within a specifically digital economy. The third element beyond supply and demand- internal coordination- allows the DAO to exercise policy levers and control treasury composition, in order to offset the runaway reflexivity of irrational market forces. This is what provides the investor confidence that staking will continue to be a profitable financial strategy. It is this third element that paradoxically breaks the vicious circularity and gives foundation for virtuous circularity and substantive reflexivity (rather than irrational, chaotic reflexivity) that benefits the market. Through internal coordination, the DAO has the means to self-regulate and self-govern market conditions for itself and for a whole ecosystem of interdependent, interoperable protocols. In order to have an adequate theory of economic productivity in digital economy, we must have a good description and explanation of what internal coordination (3, 3), as economic productivity is. And a good explanation of exactly why it is more important than price coordination (1, 1). In order to do this, we look at the history of economic theories of value. We show that value and productivity in digital economy is a certain combination of prior value theories in the next section. Values protocol was created through internal coordination or entrepreneurship. It was created as an innovation from algorithmic stablecoin models. The algorithmic stablecoin model is essentially to have an over-collateralized basket of reserve assets that ensures the stablecoin will maintain its dollar peg, by always correcting the market when the value goes above or below its price peg. The innovation of $VALUES over this model is to create, not a stable coin, but a floating price reserve asset that is backed by risk-free value of treasury assets, rather than pegged to the US dollar. The price of $VALUES therefore can command a premium over the risk-free value of its treasury backed assets. This premium over the risk-free value can be considered a measure of economic productivity in digital economy. And it can be considered as analogous to a price-to-earnings multiple in the conventional stock market.
There have been four major theories of value in the history of economic theory over the past three hundred years; labor theory (Smith, Ricardo), marginal utility theory (Walras, Menger, Jevons), game theory (Von Neumann, Schelling), and demand theory (Keynes). Each of these arose in particular historical circumstances to explain their own time.Economic productivity and value creation in digital media is undoubtedly within its own historical circumstance, and therefore, requires a paradigmatic theory of value and understanding of economic productivity. This theory must be accurate in explaining the unique properties of digital economy. Yet it must also be continuous with previous understanding of economic theory. We can define economic productivity in digital media as a combination of the four prior value theories. These are integrated into a single concept: internal coordination. This concept of internal coordination is distinguished from external / price coordination.Demand theory, or self-demand: John Maynard Keynes starts from the position of rejecting a basic tenet of classical economics- Say’s Law- which is analogous to economic equilibrium. This law says that supply generates its own demand. This “supply-side” economic perspective was taken for granted in classical political economy. Supply side versus demand side economics refers to the question of which is more appropriate for a healthy economy: distributed planning by market participants (supply side) or centralized planning by government policymakers. Keynes, living through the experience of the 1930’s, originated the idea that the business cycle cannot regulate itself. Economic demand must be stimulated top-down, by central bank policy makers, in order to regulate the busts of the business cycle. By contrast, in internal coordination, demand is stimulated by bottom-up, distributed self-demand. This self-demand is the personal moral responsibility to create or discover value for the community through positive sum collaboration; the entrepreneurial spirit. Self-demand discovers the precise focal point that effectively solves an existing coordination or communication problem. This self-demand, once realized in positive-sum game dynamics, then externalizes itself into economic demand or price coordination, through power laws of network scaling.From self-demand, comes labor in the digital economy. Labor corresponds to the quantity of hours spent working in efforts towards productive action. This effort usually consists of digital media communication and/or building software infrastructure. This involves trial and error, a mix of successes and failures. It is quantitative in the sense that there is a definite quantity of hours. And it is qualitative in the sense that it involves first-hand, experiential trial and error experimentation.As a result of labor, there is utility or marginal utility in digital economy. This is the usefulness of the experimental labor hours- how successful the trial and error experimentation is; how trial and error labor becomes a calculus of opportunity costs, transaction costs, and substitution rates of how to proportionally allocate quantities of time between many specific efforts, in order to achieve productivity. This can be quantified in a sense, through Bayesian decision theory or through Markov chains, in an incomplete way. It always involves immediate, qualitative, unprecedented risks / reward payoffs, above discrete quantification. And so it is more accurately described as a proportionality or correspondence between internal and external reality.This calculus of opportunity costs leads into game theory of digital economy, which is how effectively the utility of labor forms a collaborative, non-zero sum social interaction environment. This occurs when multiple people converge almost simultaneously on the same focal point solution to an existing coordination or communication problem. Once they each realize a threshold of marginal utility in relation to one other, this interdependence compounds in its effectiveness. Then self-demand, labor, utility, positive-sum dynamics, are then seamlessly externalized into economic demand / price appreciation, through network effects. Internal coordination generates price (supply and demand).
And so we now realize the reason that Keynes rejected Say’s Law. He sensed that something beyond mere supply and demand was needed to regulate the business cycle. But he does not allow the market a capacity for self-regulation from within. Keynes, or at least his interpreters, would have the centralized government body dictate demand to the market by monetary stimulus, work programs, and demand-side economics to regulate the business cycle.If we instead generalize supply and demand, into price coordination versus internal coordination, we do not have to reject Say’s Law at all. Through internal coordination, the market still always inclines towards the equilibrium state. But the business cycle is not to be regulated externally by a centralized body, but is rather self-regulated internally, through the discovery of focal points by market participants. These focal points are forms of coordination equal to, or more significant than, the price mechanism. And thus, they can operate through conventional business and entrepreneurship practices to correct. Thus, we obtain the means for a distributed demand-side economics or a supply-side economics of self-governance. This can show the government how to ensure economic security for its citizens in a more robust way; through efficiency rather than bureaucracy.The reigning dogma would have it that problems with social norms cannot be addressed through market mechanisms, but rather require political representation. Internal coordination theory rejects this idea. Through the economy of digital media, problems of social normativity have objective logical solutions in focal point discovery. The digital economy is a market for focal points that works with supply and demand when appropriate and counteracts supply and demand when appropriate. This kind of market of focal points is only possible in digital economy, that is the primary, unique economic property of digital media.
- Thomas Schelling "Strategy of Conflict" (1960)
- David Lewis, "Convention" (1970)
- Robert Axelrod, "The Evolution of Cooperation" (1984)
Transaction cost economics:
- Ronald Coase, “The Nature of the Firm” (1937)
- Douglass North, “Transaction Costs, Institutions, Economics” (1992)
Reflexivity / Mimesis:
- George Soros "Alchemy of Finance" (1987)
- Rene Girard, "I See Satan Fall Like Lightning" (2001)
- Hillaire Belloc, "An Essay on the Restoration of Property" (1936)
Tacit Knowledge / Spontaneous Order:
- Michael Polanyi, "The Tacit Dimension" (1966)
- Friedrich Hayek, "The Use of Knolwedge in Society" (1945)
Classical Political Economy:
- Adam Smith, "An Inquiry into the Nature and Causes of The Wealth of Nations" (1776)
Digital Asset Fundamental Valuation:
- Joel Monegro, "Fat Protocols Thesis" (2016)
- Nick Szabo, "Money, Blockchains, and Social Scalability" (2017)
- John Pfeffer, "An Institutional Investor's Take on Crypto-Assets" (2017)
- Kyle Samani, "Crypto Mega Theses" (2019)
- Hasseeb Qoreshi, "Why Decentralization Isn't As Important As You Think" (2020)
- Raoul Pal, "The Inconvenient Truth About Crypto Currencies" (2021)
Foundations of internal coordination theory / objective situational analysis:
- Aristotle, "Nichomachean Ethics"
- St. Thomas Aquinas, "Summa Theologiae" (1485)
- Wilhelm Gottfried Leibniz, "Discourse on Metaphysics" (1686)