DAFI — helping Web3 and DeFi protocols reward network adoption sustainably

Rarestone Capital has recently invested in DAFI — a middleware protocol for token-powered Web 3 and DeFi applications striving to optimise for self-sustainability.

In the current bull market, community and user growth are becoming increasingly correlated with the performance of a protocol’s native token. Poorly designed economic incentive models coupled with speculative mania is jeopardising the long-term sustainability and commercial viability of many promising new protocols entering the scene.

At Rarestone, we believe that DAFI can potentially make crypto protocols more resilient against market-associated risks, namely price and economic bandwidth volatility. DAFI aims to offer a plug-and-play economic module that can abstract away the complexities of game theory and implement a token economic engine with self-healing properties, unlike anything we’ve seen to date.

Read on to learn more about why DAFI excites us about the future of token economic system design and self-sustainability for new and emerging crypto protocols.


Disclosures

Rarestone Capital has recently taken a position in DAFI based on the analysis provided in this report. This is meant to disclose any perceived conflict of interest and should not be mistaken as a recommendation to purchase DAFI tokens. This overview has been prepared solely for informational purposes and is not to be considered as investment advice. It does not purport to contain all of the information that may be required or desirable to evaluate all of the factors that might be relevant to a potential investor, and any recipient hereof should conduct its own due diligence investigation and analysis to make an independent determination of the suitability and consequences of any action.


Highlights

Backed by several investors with a strong grassroots presence in crypto and a varied portfolio of layer 1 and layer 2 protocols. These investors will help support the DAFI team make connections to other web3 and DeFi teams in the industry that are potentially strong candidates for DAFI adoption.

Several beta testers have been onboarded, including Gather Network, Elrond, Blockchain Cuties, Router, Bridge Mutual Insurance, and others. These protocols will initially aim to conduct small pilots (A/B testing) using DAFI based on specific network demand factors.


Our DAFI Thesis

Popularised by Jesse Walden, the progressive decentralisation crypto playbook advocates founders to focus efforts on the development of a working product, attaining protocol-market fit and financing the operation with venture capital dollars. Only until these milestones have been reached, founders are advised to consider launching a token.

The playbook certainly has had its fair share of success cases, such as Compound or Uniswap. It’s proving to offer a viable way in keeping founders disciplined, focus on the needs of users versus speculators and mitigate any substantial concerns of regulatory intervention during the experimental and ‘centralised’ phase of development. Nonetheless, we’ve seen the market radically change in the last few months with an astounding resurgence of interest in crypto from the mainstream. Therefore, early-stage founders are feeling increasingly pressured to launch a token pre-PM fit in a bid to growth-hack defensibility against their competition.

With the bullish market sentiment, we bear witness to the resurrection of the start-up token thesis that was universalised in the last market cycle whereby the launch of a token would help new protocols overcome the chicken and egg problem through offering financial utility when application utility is low. In other words, the token would play an instrumental role in helping the project help bootstrap growth and attract early adopters through handsome financial incentives.

Source: Crypto tokens a breakthrough in network design

While this hypothesis bodes well in a bull market, the aftermath of the last cycle revealed it was far from sustainable, ending with aggressive supply/price shocks and community shrinkage. To some degree, we are seeing history repeat itself as the crypto market starts to heat up and speculators pour money in to capitalise on the hype.

Nonetheless, in today’s cycle we bear witness to some fundamentally different design principles and market conditions that fill us with more confidence about the token model thesis that was originally envisioned, them being:

  • The token value accrual narrative is taking shape — ‘work tokens’ (tokens in which offer cash flows to holders participating in the network for activities such as contributing production capital or partaking in exercises such as governance) fill investors with more confidence about value accrual thanks to the productive asset characteristics it offers. Additionally, the narrative surrounding governance tokens and the potential for them to offer cash flows to every token holder once the network is fully decentralised means traditional approaches to valuation such as Discounted Cash Flow Analysis (DCF) can be applied.
  • Many protocols offer product utility — unlike the many aspiring smart contract applications of yesteryear, multi-sided layer 2 protocols launching on smart contract platforms like Ethereum offer genuine product utility to both supply-side and demand-side participants.
  • Greater alignment of incentives between the founder(s) and the protocol’s success — broadly speaking, we are seeing founders raise less capital for a smaller % of the token supply in comparison with the last cycle. Founders are opting to raise enough capital to develop a product and choosing to distribute a larger percentage of the tokens available for users to earn directly from the protocol as opposed to buying them directly from the team or in the secondary markets.
  • Token distribution improvements through incentives — Fewer tokens are consolidating in the hands of non-value adding VCs and retail speculators. Instead, more tokens are finding a way to the protocol’s target demographic users (supply and demand siders). Protocols are achieving this by letting their target users “earn” their tokens through work (e.g. liquidity provisioning) or consumption of the services offered by the protocol.

Even though this is all a step in the right direction, many protocols adopting these new design principles above still experience (or at risk of) network implosions reminiscent of the 2017/18 mania.

In our opinion, the main reason stems from the method of token distribution to early users of these protocols. Take DeFi applications for instance. Token rewards for early-supply-side users (otherwise known as liquidity mining rewards) succeed in accelerating growth at the very early stages of the network, however, are showing signs of failing to achieve self-sustainability over time. For crypto protocols that are early stage and pre-product/market fit this has grave consequences that include stark token price crashes and the demise of the community.

At Rarestone, we believe that the problem stems from the economic design inherent to the protocols themselves. The majority of protocols follow a fixed/pre-determined token issuance schedule to entice network growth during the early phases of development. This token distribution approach is executed irrespective of the long term success of the protocol. Therefore, the relationship between token issuance and network demand is mutually exclusive.

The result is a misalignment of incentives between protocol founders and early participants of the network, namely the supply-siders. Opportunistic actors focus their efforts on accumulating tokens without any real care to improve the network through either supporting the platform in acquiring more supply-siders, demand-siders or developers who could help improve user experience. Instead, they are more inclined to provision their production capital over a period of time to accumulate token rewards, foster speculatory driven token price appreciation, dump the token, remove their production capital and then move onto the next project.

Protocol founders need to explore new ways of synchronising the relationship between their token reward distribution methods and the self-healing capabilities of the network until the point where protocol/market fit is reached and demand-side users needs are met without solely relying on inorganic financial incentives.

In this brief, we are excited to present a new piece of technology trying to tackle this problem and the latest addition to the Rarestone portfolio — DAFI. While still very much experimental in itself, we believe that DAFI’s technology could hold the answers to strengthening new and existing Web3/DeFi protocols through a more robust and elastic token distribution model.


Project Description

What?

DAFI helps Web3 and DeFi protocols optimise token reward distribution. These protocols can rely on DAFI to autonomously adjust the supply of their token in a bid to encourage user acquisition and retention while discouraging churn.

At its core, DAFI works by translating network demand-volatility to token supply-volatility. This means that the number of token rewards in user wallets automatically increases or decreases contingent on network demand (as defined by the protocol’s founders).

The result is a positive feedback loop. Early participants are more motivated to improve the overall health and growth of the network so that they can earn more rewards in return.


Why?

Target Markets

  • Existing layer 1 or layer 2 (smart contract layer) protocols —Protocols that have already issued a token and have hard-coded token reward distributions in their architecture, but still have a war chest of the protocol’s native tokens in reserve. These protocols are seeking new ways to engage the community and encourage retention.
  • New layer 1 or layer 2 (smart contract layer) protocols — Pre-mainnet protocols that have yet to formalise their token incentive program for their community and are fearful of opportunistic actors pumping/dumping the token and killing the long-term success potential of the network.

Value Propositions

  • Market-shock resilience and self-healing properties — with DAFI, token rewards and the circulating token supply are reactive to market conditions responsible for impacting network demand. If an opportunistic or bad actor acts selfishly and to the detriment of the network, the token supply adjusts to prevent token supply shocks in the secondary market and spiralling reflexivity events.
  • User retention/stickiness (through voluntary long-term commitment) – DAFI promotes lucrative returns to users who are committed to the long-term success of the protocol as it distributes rewards to early adopters based on network growth instead of a time-schedule.
  • Less prone to opportunistic actors — DAFI’s intelligent game theory seeks to prevent behaviours from network participants that damage the health and success potential of the network.


How?

Determining what ‘network demand’ means

Protocol founders using DAFI will first need to determine which factors (or metrics) in their network are reflective of network demand. Defining ‘network demand’ may vary depending on the stage of protocol maturity.

During the earliest phases of development, founders may wish to optimise more for bolstering the qualities that attribute to the financial utility of the token. Therefore, founders may select factors such as price, transaction volume, staking or liquidity provisioning volume as the key indicators of network demand. In the latter phases, protocol founders can adapt the network demand parameters by selecting factors more geared toward product utility, such as supply-side (e.g., TVL) and/or demand-side traction.

Users of DAFI will be able to pick their network demand factors of choice via an intuitive, self-service user interface. Once selected, the DAFI protocol will be relying on third-party data oracles (e.g., API3, ChainLink, etc.) to collect and aggregate off- and on-chain data required to calculate the network demand score.

DAFI’s data analytics model used to determine the scores has been developed by the DAFI founding team. To support the robustness and accuracy of the coefficients that correspond to the array of network demand factors available to choose from, the DAFI team has been back-testing the model against historical data and activity on several DeFi and Web3 applications.

Achieving programmability through synthetic asset creation

For a protocol to be able to implement the token elasticity feature-set offered by DAFI, it must give DAFI control over the underlying native token.

Founders achieve this through depositing a percentage of their native protocol token supply into the DAFI smart contract, which will in turn generate a DAFI-native synthetic version (1:1 peg) of the asset. Generating a synthetic version of the underlying asset gives DAFI programmatic access to the token.

Network demand-based token release schedule

Protocols using DAFI will now be able to proportionately reward synthetic asset token holders based on the network demand factors through autonomous adjustments to the circulating supply of synthetic tokens.

In short, when the network demand score rises above (or falls below) a certain threshold, network contributors and/or users are rewarded with more (or less) tokens directly to their wallet.

Holders of the synthetic assets may wish at any point in time to redeem the native token at a 1:1 ratio by burning the synthetic asset via the DAFI protocol.


DAFI Token

Based on our analysis, we believe that the DAFI token will capture value due to the following features:
  • Buy and burn — DAFI tokens will be used as a means-of-exchange by customers that wish to create synthetic versions of their network’s token. DAFI tokens used for payment will be collected in a reserve and may be subject to burning at a later date.
  • Governance — DAFI will in the future be structured as a governance token and encourage community participation, code contributions and technology improvements. As a result, further ecosystem integration of the token is up to the token holders to decide. 

DAFI itself will be utilising its own technology to promote the desired behaviours from its users and token holders. In the early phase of development, DAFI’s objective is to advance the financial utility features of the DAFI token. Therefore, the network demand metrics the founders have chosen as the key determinants are: price, TVL, trading volume and number of transaction volumes per day.

As DAFI matures, the network demand metrics chosen may be subject to change and will be geared more towards product utility success factors such as the number of protocols adopting DAFI. In short, the more protocols integrating DAFI into their protocol, the more DAFI tokens are rewarded to the synthetic DAFI token holders.


Executive Team & Advisors

Zain Rana | Founder & CEO

  • Former Co-Founder and CEO at BluePatient
  • Former FX analyst at a capital markets research boutique
  • BSc Biomedical Science (1st Class Hons)

Babar Shabir | Head of Partnerships

  • Former Head of Partnerships at Mobilum (payment gateway and fiat-to-crypto on-ramp company)
  • Former Partner at BlokTide (blockchain consulting and advisory service provider)
  • BA Accounting and Finance

John Milburn | Technical Advisor

  • System architect at WOM Protocol
  • Early EOS blockchain engineer
  • Former President at CDNetworks (multi-national CDN provider)

Shreyansh Singh | Partnerships Advisor

  • Marketing Lead at Polygon/Matic Network

David Atkinson | Token Economics Advisor

  • Holochain core team member

Kal Ali | Operations Advisor

  • Head of Operations at Orion Protocol


Stage of Maturity


Links


Disclosures

Rarestone Capital has recently taken a position in DAFI based on the analysis provided in this report. This is meant to disclose any perceived conflict of interest and should not be mistaken as a recommendation to purchase DAFI tokens. This overview has been prepared solely for informational purposes and is not to be considered as investment advice. It does not purport to contain all of the information that may be required or desirable to evaluate all of the factors that might be relevant to a potential investor, and any recipient hereof should conduct its own due diligence investigation and analysis to make an independent determination of the suitability and consequences of any action.