Unveiling Shardeum’s Unique Tokenomics

Since Day Zero, Shardeum has been operating in a DAO-like manner by following the guiding principles of OCC (open, collaborative, community-driven). On 2nd February 2022, we set out to build the first-ever linearly scalable sharded blockchain. Today, we’re thrilled to unveil the MVP of Shardeum’s Tokenomics Dashboard.

Like Shardeum’s approach to scalability, the way SHM is issued is unique and different from the pre-defined issuance policy or a typical mining policy followed by existing chains. The model demonstrates how the Shardeum Foundation/DAO (FDAO) can help maintain a balanced Standby:Active validator (S:A) ratio, promoting efficient network performance and low gas fees forever. Check it out here.

Issuance method and why it’s important

Crypto coins/tokens form the backbone of any network, and pre-defined issuance methods determine how and when the tokens/coins will be released in circulation over time. It can be:

• Linear, where a fixed number of tokens are released into circulation steadily over time. For example, a network that follows this method with a set inflation rate yearly, i.e., the total supply of its tokens will increase by that percentage annually.
• Scaling, where a certain amount of tokens released into circulation increases or decreases over time based on network participation and demand. For example, Bitcoin follows this model by halving the block mining rewards every 210,000 blocks or roughly every four years. Doing so reduces the rate at which new BTC enters circulation over time.

Both have their advantages and disadvantages.

Why doesn’t it work for Shardeum?

After months of research, we concluded that predefined issuance policies would not work for scalable blockchains like Shardeum. Here’s why:

Shardeum uses horizontal scaling to increase network throughput (TPS) by adding more nodes and parallel processing to increase the network’s capacity. So for a sharded, horizontally scalable network like Shardeum, it’s super important to have a pool of nodes on standby, i.e., ready to join the network when the traffic increases. It’s only possible when the network is profitable enough to maintain just enough of these standby nodes without impeding efficiency. However, maintaining a balanced S:A ratio becomes challenging when the network becomes unprofitable, particularly for validators. In such cases, the demand for network resources can surge, leading to congestion, MEV crisis, and significant spikes in transaction fees.

Notably, the risk of unstable validator numbers is relatively lower for non-sharded networks that rely on vertical scaling, achieved by expanding each node’s CPU, RAM, and network resources. This method enhances the network’s capacity without significantly increasing the number of validators. Despite the instability of validators on such networks, the network’s throughput (TPS) may remain constant as determined by the lowest-performing node. Aside from front running and an increase in average transaction fees, vertical scaling leads to higher node operating costs, thereby reducing decentralization.

This brings us to the “issuance trilemma”:

Economic and/or political factors, including bull/bear runs, tremendously impact any network’s price action. In bear markets, if a network’s price goes down and the network becomes unprofitable, it may reduce the APY for validators leading to a  decrease in the number of standby nodes. If the network experiences a surge in TPS during such times, it may not be able to scale effectively due to the insufficient standby nodes available. Similarly, during bull markets, the network will be so profitable that it will cause excess standby nodes to join the network, leading to an unsustainable S:A ratio. The network will be able to scale in case of traffic surges, but, as you can imagine, it will be very inefficient.

“Issuance trilemma” does not pose a big challenge for non-sharded, vertical scaling networks, regardless of whether they use scaling, linear, or hybrid issuance methods. It, however, is a major challenge for linearly scalable, sharded networks like Shardeum. 

So what is the ideal issuance model for Shardeum?

Given the unpredictable nature of factors such as market conditions and price movements, we utilized economic analysis, educated predictions, and logical reasoning to design a unique issuance model that aims to: 

• Have the ability to efficiently respond to bull or bear price action on SHM tokens
• Be able to respond to rapid changes in demand on the network  
• Facilitate the creation of the most efficient network possible (by balancing Security & . Efficiency)
• Keep the network just profitable enough to encourage node operators and avoid exploitation
• Be environment-friendly
• Encourage competition between node providers
• Most importantly: Keep the transaction fees low forever!

Based on the above objectives, we have developed a model that shows the parameters of FDAO, node income, and node reward can affect the overall network and SHM supply. 

Check it out here.

What makes the SHM issuance/tokenomics model unique?

Below are some of the critical variables in the dashboard/model: 

• FDAO: The Foundation or DAO
• SHM Stable Price: The average of the recent SHM price, which is updated on the network once a day
• S:A Ratio: The number of standby nodes to the number of active nodes
• Nodes per shard: These nodes form the consensus group for that particular shard
• Transaction fee
• SHM Price
• Stake amount
• Node TPS
• Network TPS
• Node income
• Network income

Check out each variable’s detailed description and implication in the ‘Background’ section on the dashboard. 

What do the ‘Parameters’ show? It showcases the FDAO’s ability to control or monitor the transaction fees, the S:A ratio, and the node rewards. You can run simulations on the dashboard to understand the impact of the change in each variable on the network. For example, if you make the market APY 30%, the dashboard will reverse engineer the node reward the network will have to give out to match the market APY 30%.

In another instance, if the server rent/hour increases, keeping the transaction fee the same will cause the standby nodes to drop and reduce the S:A Ratio because the network won’t be able to give out enough rewards at the set fee. So, as the variables in ‘Parameters’ change, it alters the network behavior.

If the Revenue/day is greater than the Expense/day, it implies that the network is generating more income than it’s giving out as rewards which cause the Delta SHM/day to be positive. It means we are burning more SHM daily than we’re issuing; hence, the actual SHM amount will decrease.

Here’s how this model solves the issuance trilemma: Regardless of the price action driven by bull or bear markets (or other economic factors), this model allows Shardeum to issue enough SHM to keep the network nimble. Also, if there’s a spike in TPS, the network remains profitable enough to maintain the appropriate S:A ratio so that there are enough standby validators to join the network when it needs to scale at any given time.

Try it out for yourself

You can also use the ‘Simulations’ section to model what would happen to the SHM supply based on the network price action. For example, suppose SHM followed ETH’s price movement and the Ethereum network’s level of transactions with the rest of the variables set. In that case, you will see how the SHM supply would go up quickly without reaching an equilibrium. You can also change any of the parameters or upload custom files to alter the supply trajectory of SHM.

This model proves that FDAO will ensure that there’s always an equilibrium level of SHM supply (less than the maximum supply), low transaction fees forever, and profitability for validators irrespective of the price and transaction action.

Please note this is an MVP of the dashboard, and we will continue to enhance it. Feel free to share feature requests/bug reports regarding this dashboard by clicking here.

• Link to the dashboard here
• Link to the feedback form/bug report form here