Token Utilization Part 2: Incentive Design (Overdoing It Can Be Fatal)
Introduction
“I’ll give you 100 yen for every chore you do.”
Suppose you make this promise at home. For the first week, they even line up the shoes in the entryway. However, a month later, they won't pick up a single sock without getting 100 yen, and eventually, they start negotiating for a raise, claiming “the going rate for cleaning the bath is 300 yen.” The one who usually gives in first is the household budget of the person paying.
When a company does the same thing with tokens, it happens on a scale that can tilt the entire company. The mechanism of using rewards to motivate people, known as incentive design, is the most powerful area in Web3, and also the one where the most projects have failed.
In this article, I will organize why token incentives work, why overdoing it can be fatal, and how to design them so they don't fail. You can read this article on its own, so newcomers are welcome too.
1. The Idea of Buying Motivation with Tokens
An incentive is a reward used to get people to perform a certain action. Pocket money for doing chores is exactly that.
There are three goals for companies using tokens as rewards.
1. Pinpoint encouragement of specific actions
You can attach rewards directly to the actions you want, such as “when you post,” “when you invite a friend,” or “when you log in daily.”
2. Easy to gather initial members
Even if a service is unknown, people will come if they can “get tokens by participating.” It is the idea of paying with future value instead of advertising costs.
3. Recipients become supporters
The value of a token is linked to the growth of the service. Holders naturally become people who want the service to grow.
However, there is one decisive difference from regular pocket money. Tokens can be sold on external markets, and their prices fluctuate (this mechanism was organized in the previous Token Utilization Part 1. You can read this article on its own).
The appeal of the reward expands or disappears depending on the market price. This is the true nature of what makes incentive design a potent drug.
Here, I would like to introduce a watchword for this field.
Tokenomics
This refers to the design of the entire economy, including how tokens are distributed, used, and recovered. It is a portmanteau of Token and Economics, and this entire theme is about this topic.
2. What does it mean to “die”?
Moreover, this potent drug is most effective in section 1, part 3. People who were supposed to become your supporters turn into something else entirely if the people gathering are only there to cash out.
The title says, 'Overdoing it can be fatal.' This is not an exaggeration; in Web3, there is even a name for this familiar phenomenon.
Death Spiral
This refers to a vicious cycle where both price and users continue to decline, with each drop triggering the next, making it impossible to stop. It progresses in three steps.
Step 1: People who only care about earning gather
The larger the reward, the more you attract people who want to cash out rather than people who love the service. It is like being swarmed by neighborhood kids who only show up to help because they want pocket money.
Step 2: Received tokens are sold immediately
Those looking to cash out sell the moment they receive their tokens. Selling pressure consistently outweighs buying pressure, causing the token price to gradually decline.
Step 3: The appeal of rewards fades, people leave, and the price drops further
As the price drops, the real value of the rewards decreases, causing those who were there to earn to leave first. As people leave, selling pressure becomes even more dominant, accelerating the decline.
In this way, the price and the number of users continue to fall simultaneously, and no matter what the management does, it cannot be stopped, leading to the collapse of the service itself. This is the true nature of 'death,' and it is the pocket money story from the introduction played out on a corporate scale. Just as a household budget cannot sustain indefinitely inflated pocket money, a token economy that distributes too much collapses under its own weight.
3. Deep Dive: The Glory and Cost of Axie Infinity
A real-world example often called the textbook case of a death spiral is the pioneer of Play to Earn (P2E), Axie Infinity.
In mid-2021, players in the Philippines were earning dozens of dollars a day just from game rewards. At the time, the country's minimum wage was around 7 dollars a day. This is why 'people making a living from games' became a social phenomenon. However, this state did not last long; by November of that same year, a survey showed that the daily income of typical players, excluding the top tier, had already fallen below the minimum wage.
Looking at the design, the game had two types of tokens. One was AXS, a Governance Token that had a supply cap and allowed holders to vote on management policies. The other was SLP, which was distributed as a play reward and, at the time, had no supply cap.
The problem was with SLP. As more people came to earn, the supply inflated, but there were not enough ways to use SLP within the game. By early 2022, the amount being supplied daily was about four times the amount being used. It was a situation where there was no use for the pocket money received within the game, so everyone was cashing out externally.
The result followed the steps in Chapter 2. The price of SLP plummeted, and in February 2022, the management eliminated rewards for the computer-battle mode and daily quests, where players could earn up to 50 SLP per day, effectively cutting the daily supply by more than half. Although the price rebounded temporarily immediately after the announcement, the downward trend itself did not stop.
AXS, which had a supply cap, was not unscathed either. Its price fell from a peak of around 165 dollars in November 2021 to under 1 dollar by June 2026. However, the drop for the infinitely minted SLP was even more severe, falling from around 0.4 dollars in July 2021 to below 1 cent. While a free-to-play mode has been introduced and updates have continued into 2026, the fervor of its heyday has not returned.
Notably, the management later set a supply cap for SLP in 2024. They shifted from a design that minted infinitely to one based on caps and token burning.
A token distributed with a cap versus a token minted infinitely to encourage behavior. The difference between these two in the same game serves as a lesson in itself.
4. Three Designs to Prevent Failure
So, how can you design it to avoid failure? There are three principles.
① Ask first if it works without tokens
A service where everyone leaves the moment you take away the rewards is a red flag from the start. In terms of helping out, you should first create a situation where the act of helping itself is fun or meaningful, and use the pocket money as a supplement. In the initial pocket money story, the reason they stopped picking up socks the moment the 100 yen was taken away is because this was not achieved.
② Create an exit (use case) first
Before distributing tokens, prepare a place where they can return to the service, known as a sink (a way to use or collect tokens)—a place to use or recover tokens. Examples include exchanging them for limited items, paying for service features, or designs where they disappear upon use. It is like putting a candy corner in the house where they want to spend their pocket money first.
③ Do not limit rewards to one type
Instead of relying solely on tokens that can be converted into cash, mix in rewards that cannot be sold, such as titles or exclusive experiences. Non-sellable rewards do not push down the price because they are not sold on the market, and they resonate deeply only with those who love the service.
⚠️ Calculator first, tokens later
Before deciding on issuance, be sure to estimate the amount to be distributed and the amount to be recovered per day. If your estimates show that supply will consistently exceed recovery, you must not release that design to the world. As discussed in Chapter 3, it is extremely difficult to tighten things up after you have already started distributing.
💡 Even if you follow these three principles, price risk will not be zero
These three principles are designed to make it harder to fail, but they are not a guarantee that the price will not drop. You can only control the supply side through design; the risk of a decline due to market conditions or popularity will always remain. Not confusing these two is also part of the designer's job.
Summary
Token incentives are a powerful mechanism that can encourage behavior, gather allies, and build a fan base.
However, because the appeal of the rewards is linked to market prices, they are more potent than ordinary pocket money or points.
The end result of overdoing it is a death spiral: people join for profit → tokens are immediately sold → the appeal decreases and people leave, creating a vicious cycle.
In Axie Infinity, supply significantly exceeded recovery, and it could not be stopped even after tightening later. For incentives, the design for recovery is more important than the design for distribution.
The three principles to prevent failure are: ask if it works without tokens, create an exit first, and do not limit rewards to one type.
However, these three principles are designed to make it harder to fail, and price risk due to market conditions will not be zero.
Keywords for this session
Incentive
A reward used to encourage people to take a certain action. By using tokens, you can attach rewards directly to the actions you want to promote.
Tokenomics
The design of the entire economy, including how tokens are distributed, used, and recovered. It is a portmanteau of 'Token' and 'Economics'.
Play to Earn (P2E)
A game mechanism where you can earn rewards such as crypto assets by playing. Axie Infinity is considered a prime example of this.
Death Spiral
A vicious cycle where a decline triggers further declines, making it impossible to stop. It refers to a state where both price and user count continue to decrease.
Governance Token
A token that grants the right to vote on service operation policies and similar matters. In Axie Infinity, AXS serves this purpose.
Sink
A use case or recovery mechanism where distributed tokens return to the service, such as item exchanges or usage fees.
Conclusion
Rewards can move people if used effectively, but if overused, they drive people away and cause the entire service to collapse. Overdoing it can be fatal. However, if the dosage is just right, there is no medicine more effective. Whether it brings life or death depends on whether you have prepared an exit before you start distributing.
Next time, in 'DAO Utilization Part 1: How is a DAO Different from a Company?', we will delve into the structure of organizations born on the internet that function without presidents or bosses. Stay tuned for the next installment!