This is a chapter from the book Token Economy (Third Edition) by Shermin Voshmgir. Paper & audio formats are available on Amazon and other bookstores. Find copyright information at the end of the page.
The governance of DAOs is closely tied to the design and distribution rules of their network-native and purpose-driven tokens that steer the actions of stakeholders with automated incentives and disincentives. This chapter will define the term “purpose-driven token” and outline the knowledge domains relevant when conceptualizing a new token system.
Bitcoin’s groundbreaking consensus mechanism launched a new era of socioeconomic coordination over the Internet. Proof-of-Work demonstrated how anonymous network participants could contribute to a collectively maintained public payment infrastructure without central coordinators. Aligning incentives among a community of anonymous Internet actors in a collusion- and attack-resistant manner sparked a new field of research and development around economic coordination games using cryptographic tools. It showed how a reward mechanism tied to a network-native token can steer the actions of anonymous Internet users to collectively pursue a common purpose—which is why I refer to these tokens as “purpose-driven.”
Many developers expanded on Bitcoin’s foundational ideas, tweaking its technical, social, political, and economic design to issue new tokens with varying degrees of success and sustainability. The Ethereum network, along with similar blockchain networks that emerged later, paved the way for the easy technical issuance of tokens—from simple asset tokens that represent private goods to purpose-driven tokens that incentivize the co-creation of public goods. Numerous Web3 protocols have emerged ever since, each steered by purpose-driven tokens designed to incentivize contributions toward a collective purpose. By “purpose,” I refer to a greater goal beyond maximizing personal profit. This might be a P2P payment network (Bitcoin), a P2P social network (Steemit), a P2P stable token (DAI), a P2P telecommunication network (Helium), or a P2P data market (Ocean Protocol). The collective goal could also be the reduction of negative externalities on a public or common good—such as the reduction of CO2 emissions via CO2 tokens or biodiversity tokens (Rebalance Earth).
Unlike conventional economic systems, which focus on individual value creation for private goods, these purpose-driven tokens incentivize collective action toward shared goals by rewarding individual contributions with a network token. They transcend traditional political and economic philosophies such as “capitalism” versus “communism”—philosophies that stem from a pre-Internet era. These tokens are issued according to rules encoded in the protocol, often fulfilling the role of an internal currency. New disciplines have emerged around this idea—such as “Cryptoeconomics,” “Cryptogovernance,” “Token Economics,” and “Tokenomics”—which are all part of a more broadly defined field of “Token Engineering.”
Token Engineering, Token Economics, Cryptoeconomics & Cryptogovernance
The design of token systems in Web3 has given rise to various overlapping terms, such as "cryptoeconomics," "cryptogovernance," "token economics," and "token engineering." Each term reflects a different perspective and historical context, contributing to the broader discourse on how to create sustainable, purpose-driven token ecosystems.
- Cryptoeconomics is a term that emerged within the Ethereum developer community and is often attributed to Vitalik Buterin and Vlad Zamfir. They defined it as the study of economic interactions in untrusted environments, where every actor could potentially be corrupt—combining cryptography, game theory, and computer science. Since the emergence of Bitcoin’s Proof-of-Work, many variations and alternative cryptoeconomic mechanisms, such as Proof-of-Stake, have been developed with the aim of providing a security equilibrium for blockchain networks. Security, however, is not only a technical question but also depends on the resilience of the assumptions made about how network actors will react to economic incentives. It is also subject to the fields of sociology, political science, and behavioral economics—fields that are often overlooked in the Web3 developer community.
- Token economics, or tokenomics, is less rigidly defined than cryptoeconomics, as it does not necessarily imply collusion-resistant mechanisms in a peer-to-peer network of untrusted actors. It emerged from colloquial usage on social media, mostly by people trying to build tokenized applications. It is often employed to describe the economic design patterns of different types of application tokens—from simple asset tokens to more complex tokens that steer any form of decentralized organization. While the term captures the economic aspects of token design, it often neglects non-economic incentives, such as reputation or governance rights. This reductionist focus risks oversimplifying the complexities of token systems, which require an interdisciplinary approach to balance economic, social, and political factors, especially in the case of protocol tokens that steer the actions of large online communities.
- Cryptogovernance is a term that has been used to address the governance layer of Web3 networks, focusing on how decisions over protocol upgrades are made and how voting rights should be distributed. The question of political participation is either completely segregated from the question of economic incentives or blended with the design of economic incentives—often tying voting rights to the amount of network tokens owned. Both approaches have been unsatisfying. In theory, governance is a political science term that describes the general politics of a community of people—including their economic interactions—and not only their political voting rights. Economic design is always a result of a political worldview. What economic system one wants to create is a political decision. After all, Web3 protocols operate like planned economies on steroids, steered by very rigid market rules determining who is allowed to transact under which conditions and how many tokenized rewards they can earn for specific actions. These rules are hard-coded into the protocol. While the term governance should include the questions of market design as well as voting rights, legislative rights, information rights, and executive rights, the interpretation of what constitutes governance varies widely in the crypto community.
- Token engineering offers a more comprehensive and ethically grounded approach. It was notably popularized by Trent McConaghy, who compared token engineering to disciplines like aerospace or civil engineering, stressing the importance of safety and accountability in designing public infrastructure. Just as physical systems like bridges or railroads must be robust and reliable to prevent collapse, Web3 systems must be built to withstand economic and social collapse. Token engineering advocates for a more holistic perspective, recognizing that technology is ultimately created to serve individual human needs and social goals. McConaghy drew similarities between creating token mechanisms and other disciplines that share a heavy dependence on the mathematics of optimization and decision-making. He listed a range of scientific fields relevant to designing these systems, such as electrical engineering, swarm robotics, operations research, software engineering, civil engineering, aerospace engineering, complex systems design, public policy design, economics, robotics, machine learning, and artificial intelligence.
Regardless of the terminology used, the design of purpose-driven tokens demands a balanced approach that integrates technical rigor, political inclusivity, economic sustainability, and legal compliance. By adopting this holistic mindset, one can build token ecosystems that are not only functional but also capable of maintaining sustainable economies over time. To simplify the range of relevant disciplines, I suggest grouping them into four categories: “technical engineering,” “political engineering,” “economic engineering,” and “legal engineering.”
Political & Ethical Engineering
While Web3 provides a technological governance layer for the Internet, its design is fundamentally a political question of what type of system we want to create. Before addressing technological solutions, one must define the political and ethical principles guiding the creation of protocols and their tokens. Think of Web3 networks as the digital railroads of the Internet. Deciding where the rails go and which cities they connect is a political choice, not a technical one. Engineers ensure the infrastructure is safe, cost-effective, and durable, but the purpose and direction are determined by political decisions. The same applies to Web3 networks.
Political, moral, and ethical considerations inevitably arise for any Internet-based network and cannot be ignored indefinitely. The history of Web2 demonstrates that when these questions are addressed only after a system has been deployed, systemic biases become difficult to reverse due to inertia and the entrenched interests of all stakeholders involved. In Web3, this inertia seems to be even greater due to the decentralized nature of its governance structures. Failing to embed political and ethical considerations during the design phase risks creating unintended biases that become hardwired into the protocol and difficult to reverse.
Incorporating engineering ethics with modern AI expertise offers valuable lessons for the cryptoeconomic design of purpose-driven tokens. Developers of Web3 networks must carefully reflect on the long-term impacts of their mechanisms before deploying the first version of the protocol. Among the most pressing political questions are (i) the trade-off between institutional accountability (often referred to as "transparency") and personal privacy, and (ii) the long-term power structures within a network. Depending on the type of protocol one wants to create, other political principles may also need to be established at the beginning of the design-thinking process.
Economic Engineering
Purpose-driven tokens coordinate individual actions toward a common goal by making certain behaviors in the network economically attractive while discouraging others. If designed effectively, economic incentives and disincentives preserve individual choice while nudging participants toward actions aligned with the network's purpose.
Since DAOs resemble nation-states more than companies, economic tools used by nation-states can be applicable to modeling individual behavior in a Web3 network. The economic engineering process must determine how to adapt or repurpose existing economic models for token-driven ecosystems. Key domains include macroeconomics, microeconomics, behavioral economics, game theory, mechanism design, and public policy.
However, the necessary tools are not found solely in economics. Other fields, such as network science (analyzing and modeling complex network structures), cyber-physical systems (integrating algorithms with real-world systems), computational social science (leveraging data science and machine learning to model socioeconomic dynamics), and sociotechnical systems (studying relationships between infrastructure and human/automated actors), have also developed various models and approaches to formalize economic motives and mannerisms of people and institutions participating in economic systems. Jointly, these fields offer models for understanding and steering the behavior of individuals, many of which are already used by governments, regulators, and institutions to influence market dynamics.
The choice of models and primitives depends heavily on the specific purpose of the Web3 protocol one intends to design. At the time of writing, the field of sustainable economic incentive design for DAOs remains in its early stages. Protocols often rely on trial and error when designing their network tokens. Best practices are limited, and standard economic primitives for token design have yet to be fully developed.
Legal Engineering
Though the legal engineering of Web3 protocols can have multiple aspects, the most important legal challenge when designing token systems is related to the limiting nature of smart contracts. Algorithmically enforced contracts reduce complex realities to predefined models based on probable assumptions of individual behavior and future events, which creates inherent gaps. Legal questions—particularly around contract theory and the concept of “incomplete contracts”—are crucial for understanding the legal engineering process. Contract theory deals with questions of contractual arrangements at the intersection of economics, law, and ethics. It distinguishes complete contracts from incomplete contracts. Whereas complete contracts can specify all possible outcomes in the contract, incomplete contracts cannot express all possible contingencies and need complementary mechanisms to fill this gap. This raises the question of how Web3 protocols can address inherent gaps through mechanisms such as supplementary legal statutes or decentralized dispute resolution (decentralized judiciary, bargaining, or mediation mechanisms). The crypto community can learn from and adapt best practices from existing legal and economic systems.
Legal engineering must also consider the regulatory implications of token systems. Protocol designers must balance political, economic, and ethical objectives with the need for regulatory compliance. A token system deemed illegal by regulators risks collapse, no matter how well-designed. However, starting with legal constraints can limit creative design thinking. Instead, the legal framework needs to build upon clearly defined goals, token properties, and the intended use of the system. Unfortunately, blockchain networks and tokenization have introduced a paradigm shift that is often difficult to reconcile with traditional legal classifications and frameworks. Legal, technical, and economic definitions of token types often clash, creating communication gaps between Web3 founders and regulatory authorities. In the absence of laws that sufficiently cater to the nature of crypto networks, developers, users, and regulators face considerable anxiety navigating this new frontier.
- Asset tokens: For simpler token systems—such as those representing some kind of asset like central bank money, securities or art—established real-world practices provide a solid foundation for the legal engineering process of these tokens. These use cases have long-standing business models, stress-tested governance, and clear regulations. The legal challenge here is to design the token contracts in a legally compliant way.
- Protocol tokens: In contrast, designing purpose-driven tokens that steer complex open and permissionless networks presents greater challenges. Protocol tokens often represent novel mechanisms tied to a new institutional phenomenon that requires regulatory sense-making and new classifications. The challenge here is that the Internet in general, and Web3 in particular, is by definition global. This is in stark contrast to how our analog world is governed. The people on our planet are divided into more than 200 nation-states and their respective jurisdictions. This balkanized governance structure of Earth has not sufficiently caught up with the realities of the Internet—even after decades of its existence. While this is not a new problem, there are particular legal challenges when it comes to the decentralized nature of Web3. Unlike Web2, where centralized entities are bound to specific jurisdictions, Web3 networks are collectively governed and operate across borders, with participants dispersed globally. The question of how regulators can address collectively governed entities without clear ownership, especially when participants live in multiple jurisdictions, has not been sufficiently resolved yet. Furthermore, as tokenization blurs the lines between money, finance, and the real economy, the question of which regulatory bodies determine what to regulate and which authority has jurisdiction also creates considerable regulatory friction for all involved participants.
Technical Engineering
The technical engineering process of Web3 protocols is closely tied to legal, political, and economic considerations. It must account for the constraints and trade-offs of blockchain infrastructure and align them with the project's goals and regulatory landscape. Although it has become uncommon to develop one's own custom blockchain infrastructure, it is still an option but has many trade-offs. Custom-made blockchains offer a tailored infrastructure but come with high development, maintenance, and security costs. Using established blockchain networks, on the other hand, allows projects to focus on the governance and operations of the protocol they want to create while outsourcing maintenance and proven security to an existing blockchain network. Key factors when deciding which blockchain infrastructure to use include security, scalability, decentralization, interoperability, and privacy:
- Scalability & finality: Scalability addresses the number of transactions and additional data capacity per transaction that can be settled per unit of time over the network, often at the expense of decentralization or security. Finality addresses the speed at which blockchain transactions become irreversible. The number of transactions a token system requires and the speed at which they must be finalized will determine the choice of blockchain infrastructure.
- Security & Durability: Security is ensured through cryptoeconomic mechanisms that protect against manipulation and attacks. Durability refers to the ability of a blockchain to reliably sustain token operations over time. Blockchain networks with proven security records are preferable, especially compared to new or self-built ones, as unreliable infrastructure can render tokens unusable, akin to a perishable currency.
- Decentralization: Monolithic blockchain ecosystems often need to sacrifice decentralization for scalability. Modular approaches offer potential solutions, but their suitability varies depending on project needs and the desired level of decentralization.
- Interoperability: Since blockchain networks lack native communication capabilities to settle token transfers across different blockchain ecosystems without intermediaries, the choice of blockchain ecosystem becomes critical to minimizing lock-out effects and maximizing network effects. Lock-in effects might become less of an issue as interoperability becomes more seamless.
- Token standards: Standardized token contracts simplify development and reduce costs while offering proven security. Selecting established standards mitigates risks associated with custom token logic that has not been sufficiently stress-tested and might be prone to economic exploits.
- Privacy: Privacy-focused blockchain networks use alternative cryptographic techniques to enhance privacy, but these solutions increase complexity and regulatory scrutiny. Anti-Money Laundering (AML) rules often conflict with privacy goals, presenting additional challenges for designing privacy-preserving protocols that align with global privacy regulations or the preferences of one's own community.
Emergent Power Structures
Power structures naturally emerge in any socioeconomic system, and Web3 networks are no exception. The design of tokens, their properties, and distribution mechanisms significantly influence the initial conditions and long-term dynamics within a network. Founders and protocol designers effectively shape these systems, and their decisions can have lasting consequences. Once power structures manifest, reversing them becomes increasingly challenging as the system scales and stakeholders gain autonomy. Imbalances often result from how rights—such as property, access, usage, voting, execution, or information rights—are allocated through tokens. These imbalances can widen over time if minting, expiry, or transferability rules are based on flawed assumptions about how network participants will behave. How power dynamics play out over time also depends on the specific use case and the type of stakeholders involved, as well as external macroeconomic and regulatory circumstances.
- Legislative Powers: Early blockchain networks relied on voluntary developers, creating power asymmetries in protocol evolution. High-net-worth individuals or institutions funding developers can influence code changes aligned with their own interests instead of the network’s interests. Newer models incentivize developers directly, using mechanisms such as smart contract-based proposals tied to token rewards upon approval. Alternatively, funding development through treasury contracts has become somewhat of a standard, but this introduces its own centralization risks and principal-agent problems.
- Voting Powers: Without real-life identification, egalitarian voting systems based on a “one person, one vote” principle are unfeasible. This is why many early Web3 protocols originally tied voting rights to the number of network tokens held, making these systems plutocratic rather than democratic, concentrating voting power in the hands of a few wealthy individuals and institutions. Various Proof-of-Personhood mechanisms—based on social trust networks, biometrics, zero-knowledge proofs, identity tokens, or event-based verification—have been proposed. While they can address this issue, they also introduce new challenges. In addition to Proof-of-Personhood mechanisms, many protocols have implemented novel voting methods, such as “quadratic voting,” “conviction voting” or “multi-hop delegated voting” to accommodate the diverse governance needs of decentralized networks. While these approaches resolve some issues, they also introduce new voting power dynamics.
- Executive powers, elected representatives, treasury & resource allocation: Certain functions of Web3 protocols can be decentralized via automated coordination mechanisms and spontaneous network contributions that are rewarded with network tokens. How inclusive contributions to network functions are depends on protocol rules and can vary. Examples will be analyzed in more detail in the use case chapter of this book. Other executive functions of a DAO—such as funding research, public relations, or legal support—cannot be decentralized via automated mechanisms and require more conventional funding through a common treasury to ensure sustainable operations. These decisions are often managed by elected representatives or protocol founders, depending on the network’s governance rules. This creates hybrid organizations that function more like decentralized organizations (DOs) than fully autonomous decentralized organizations (DAOs), concentrating executive power around the founders, their organizations, and elected representatives.
- Market Powers: The providers and consumers of network services are the two main stakeholders in a Web3 network. A sustainable economic system depends on inclusivity for both service providers and users. Token distribution strategies that concentrate ownership of network tokens among a small group of participants can discourage long-term participation, leading to system collapse. When a large share of network tokens is held by a limited number of token holders who know each other, they can easily collude against the best interests of other network participants. The difference between bad market design and poor economic policy choices in Web3 versus those of nation-states is that in Web3, participants are not forced to remain in a network. Providers and consumers of network services can exit at any time or collude with others to create a copy (i.e., fork) of the protocol, modifying the rules to their liking and forming their own alternative DAO.
- Judiciary Powers: While code can simplify bureaucratic interactions, it remains susceptible to human bias and errors. Formal verification in software development can reduce human error, but it cannot eliminate all mistakes or short-sighted assumptions. Smart contracts can only serve as a default mechanism, which may need to be overridden by supermajority consensus in unforeseen events. Web3 protocols and applications require procedures for negotiation, mediation, and arbitration, enabling disputing parties to present their cases, select arbitrators from a pool of qualified individuals, and obtain binding decisions. Such dispute resolution mechanisms could potentially use professional judges as “human oracles,” appointed through a distributed sortition-style selection process. While these mechanisms are important, they also introduce new power structures that must be accounted for. At the time of writing, these systems are in early development and lack the robustness of traditional judiciary systems, necessitating further innovation.
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Footnotes
[1] Presentation at CryptEconomicon 2015 titled “What is Cryptoeconomics,” Mountain View, CA, January 26-29.
[2] https://medium.com/@VitalikButerin/the-meaningof-decentralization-a0c92b76a274 and https://www.youtube.com/watch?v=pKqdjaH1dRo
[3] https://thecontrol.co/cryptoeconomics-101-e5c883e9a8ff
[4] Catalini, Christian, and Joshua S Gans. 2016. “Some simple economics of the blockchain.” National Bureau of Economic Research.
[5] https://research.wu.ac.at/ws/portalfiles/portal/19008630/Foundations+of+Cryptoeconomic+Systems.pdf
[6] https://research.wu.ac.at/ws/portalfiles/portal/19008630/Foundations+of+Cryptoeconomic+Systems.pdf
[7] https://blog.oceanprotocol.com/towards-a-practice-of-token-engineering-b02feeeff7ca
[8] A good example of this is the Cambridge Analytica scandal and the discussions about privacy, control, and social media governance that followed in its wake, and the challenges the Facebook network is facing right now.
[10] [11]
[12] In law, whenever there is a statute regulating contractual relationships, parties do not have to identify all details themselves in the contract. E.g, if there is a timeline specified in a contract as 14 days, but parties have not defined how to calculate the days when the 14th day comes to a weekend – the statute tells the parties whether to count the weekend or not. If there is no statute, there might be case law filling the gap. If those resources do not exist, a dispute resolution mechanism will be needed.
[13] Recital 11 of MiCA : "This Regulation should also apply to crypto-assets that appear to be unique and non-fungible, but whose de facto features or whose features that are linked to their de facto uses, would make them either fungible or not unique."
[14] “Complex systems theory investigates the relationships between system parts with the system’s collective behaviors and the system’s environment. Complex systems differ from other systems, in that the system behavior cannot be easily inferred from the state changes induced by network actors. Properties such as emergence, nonlinearity, adaptation, spontaneous order, and feedback loops are typical to complex systems. Modeling approaches that ignore such difficulties will produce models that are not useful for modeling and steering those systems.” Voshmgir, S.; Zargham, M.: “Foundations of Cryptoeconomic Systems.''
[15] In many democracies, when citizen voting processes were first introduced, only a limited group of people could actually vote. It was often only men, and their votes were weighted according to the wealth they held. Eventually, all men could vote equally, but often women, slaves and other members of society were excluded, such as for example the indigenous population of some colonized countries.
References & Further Reading
This link leads you to a page that contains all the references to the source materials used for the research of the chapters and should also provide a reading list for those who are interested in a deeper dive into the topics presented in this chapter. Where possible, the links will be updated on a regular basis to prevent the issue of broken links.