This allows an L1 platform to jump-start its national economy over time through a flywheel between financial speculation around its native token and the actual creation of applications and activities in its ecosystem. When the price of the native token increases, it attracts more monetary liquidity to the country, which funds more applications built on its territory. This, in turn, expands use cases and increases the channel’s “gross domestic product”, which attracts more users and creates a greater network effect. The demand for the native token increases accordingly and the price of the native token increases.
Such a system is similar to how traditional currencies work for the physical economies of nation states. You need USD in almost all economic transactions in the United States. When US GDP increases (values and number of transactions increase), the demand for USD increases, all other things being equal. This is one of the reasons why when an economy is growing rapidly, its currency tends to appreciate relative to others, barring foreign exchange interventions from the national government.
This is consistent with the price movements of the Layer 1 Chain tokens over the past few periods. As blockchain platform economies have exploded with the growth of DeFi and NFT, native Layer 1 token prices have outperformed the overall crypto market. At the end of 2021, eight of the top 15 crypto assets by market cap were Layer 1 PoS tokens (counting Ethereum, which is transitioning to PoS). Yet five of them weren’t in the top 15 two years ago.
Layer 1 PoS chains can then leverage their monetary cushion to further grow their network by issuing new tokens. As the on-chain economy grows, the demand for tokens native to the blockchain nation increases, allowing the platform to issue more tokens as rewards for validators without affecting the price. of the token market. These rewards in turn attract more participants to the ecosystem, fueling future growth. For example, Solana has grown its validator network more than 20x over the past year and a half to reach over 1,300 active validator nodes by the end of 2021.
No savings will in a straight line forever. Activity levels always fluctuate. In the real world, we call these economic cycles, economies that go through ups and downs. Nation-state governments have long used fiscal policy (taxes and government spending) and monetary policy (interest rates and money supply) tools to try to dampen recessions and booms. Blockchain nations also have tools for fiscal policy (transaction fees) and monetary policy (staking yield, token issuance, and burning). And in many cases they can work better than the economic policy tools of governments.
When an economy is overheating with excess demand, a national government typically tries to tighten fiscal policy by raising tax rates and cutting government spending. And when the economy is in recession, it does the opposite.
In reality, however, these countercyclical fiscal policies are rarely well executed, due to the limited time horizons and errors of judgment by policymakers. In good times, fiscal tightening is difficult because the government has more revenue to spend. When the cookie jar is overflowing, few have the discipline or the political courage not to eat more cookies. In addition, recency bias can lead the government to believe that if the pot is full today, it will also be full tomorrow, and that it is preparing poorly for the possible recession. By the time the recession hits, the fiscal cushion is too small to stimulate the economy significantly without taking on more debt.
In contrast, the tax policies of blockchain nations are pre-programmed into self-executing smart contracts and therefore immune to human discretion. Take Ethereum. Think of the gas fees paid to the Ethereum platform on each transaction as value-added tax or sales tax. The base rate is pre-programmed to adjust according to the level of network congestion. When the network utilization rate exceeds 50% (economic boom), the basic charge increases to 12.5%. If the activity level is less than 50% (economic recession), the base fee decreases. The counter-cyclicality of on-chain fiscal policy is imposed by code. No individual or entity, however powerful, can change it on a whim.