Gary Yang
October 3rd, 2022
As the curtainfalls on Token2049, a silver lining rises in Web3, where the market players areshowing their determination to conquer the bottlenecks and embrace the nextbreakthrough. All professionals in Web3 are striving to become the pioneers ofthe next paradigm upon the current market transitions from bearish to bullish.However, despite the hustle and bustle, investors’ lack of confidence andprojects’ cliche business models are still in the way. When consideringtokenomics and selling pressure, neither traditional finance/gaming experience nor the prevailingponzinomics model in the past year can further help DeFi, GameFi, orSocialFi projects make the deals. Hence, when we realize that there’s great needfor a more organized system and more practical values for the evolution ofWeb3’s financial infrastructure, builders came up with the concepts offinancial engineering and real yield, hoping to build the expectations of a newconsensus.The core valueof the Web3 network comes from the combination of blockchain technology andencryption algorithm, which enables the network system and information systemto turn codes into laws (“code is law”) through protocols. This evolution has significantly innovated the businesscontract tools, hence improved the efficiency and contract performances offinancial transactions, which further improved the overall productive andoperational efficiencies of society.While the infrastructuredevelopment of Web3 is still in its early stage, the evolution of this emergingsystem will inevitably be accompanied by enormous changes around the infralayer, protocol layer, product layer, and application service layer. Financialengineering will play a key role in connecting the technology and marketdemands. It is becoming clear that the financial system and tokenomics buildersin Web3 are very similar to the macroeconomic policymakers in the traditionalmarket. They all use systematic and engineering thinking to modularize socialsupplies and demands, operational flows, management mechanisms, andprofessional services, in order to form a systematic engineering project.Although financial engineering has already matured in traditional finance,there are still a bunch of non-standardized problems in written laws and thehuman processing environment. Thus, the next era of civilization is still aconceptual idea as social efficiency has not been massively improved.Fortunately,the smart contract in Web3’s valuenetwork can solve the problem above. Protocols and contracts can encapsulate financial and tradingbehaviors, commercial needs, and economic strategies into codes, takingfinancial systems and tokenomics into the digital modularization era. Financialengineering would then transform into a financial circuit when theInternet connects the components as a loop.Last year, Iroughly thought about the principle of financial circuit and the concept of financial chips for the first time. Theconstruction of the financial engineering system is analogical to that ofelectric circuits. If, regarded, the cash flow is analogically the electriccurrent, the value difference (the concept will be explained in detail later)is analogically the battery voltage, and cash consumption is analogically theresistance, then a simplest financial circuit is formed. It looks rathersimple, however, there are still concerns remained. First off, how are therelationships of these components interpreted? Do financial tools such aswallets, aggregators, staking, and alike, have clear definitions in financialcircuit? Furthermore, how many more advanced financial components are there andwhat would their internal interactions as well as their commercial implicationsbe like? The questions above all require further in-depth thinking, and will beexplained in detail later in this paper. The evolution of financial circuit will be systematic. As the ecology ofGameFi and Metaverse continues to take shape, various models in financialcircuit will be incorporated by tokenomics builders. Upon that time, thecomplexity and professionalism of the principle will increase rapidly with theiterative market demand, and will soon change our overall perception of thetraditional financial system, eventually leading to the Emergence Phenomenon (Note 1), which may further form theapplication scenarios such as financial AI and financial chips.The financialcircuits can inevitably improve the efficiency of financial market and commercialeconomy, and there would be new things of the next generation that traditionalfinance cannot achieve despite its long history and mature market. This wouldbe as astonishing as how the development of circuits from the 19thcentury evolved to the development of chips and AI in the 20thcentury. There can be a complete innovation achieved in the financialengineering and incoming financial circuit industry, unbelievingly improvingthe social and economic efficiency. The definition and function of Finance willalso experience a more advanced and complex systemization in the future withthe development of science and technology, just as the creation of the firstfinancial derivatives in the 14th century evolving to the formationof a globalized financial transaction system in the 20th century.In thisevolution, the Non-Fungible Token (NFT) is becoming a tool of criticalimportance to achieve the viable development of financial circuits. AlthoughNFTs entered the market in the form of PFPs (profile pictures) such asCryptokitties in 2017, and that the NFTs traded in OpenSea and LooksRare arestill mostly PFPs as of now, its significance to Web3 is profound. In fact, anNFT can be regarded as a container.More precisely, it functions as a digital Metadata container in terms ofTechnology and Coding, and a value container in terms of Finance. NFT is animportant tool to realize the feasibility of encapsulation of financial valuesin the protocol world. In this regard, cutting-edge Web3 projects such as SolvProtocol has built a relatively complete system framework, from the protocollayer to the application layer, coupled with a combination of protocol, smartcontract and detachable NFTs, and is providing more advanced product servicesand more effective financial engineering components for the next stage of thefinancial market.The Web3financial and tokenomics builders need to constantly deal with events such ascash inflows and outflows, liquidity unlocking, selling pressure, burning (consuming),and staking (pledging), among other common operations in project management.Therefore, in the tokenomics design, builders often draw financial flow charts,and design or refer various models, such as the deflation & inflationdual-token model, the staking scheme, the provision of liquidity pool and bonuspool, and the VE mechanism, etc. In fact, Web3 tokenomics builders, projectmanagers and technical engineers are already dealing with the specific problemsof financial circuits in varying levels of complexity. Some professionals haveproposed the concept of Money Lego, which, in my opinion, is not suitable forbuilding the underlying financial infrastructure of Web3. The Money Lego modelcan be regarded as a stack of non-standard business modules, instead of astructured theory; it can be more meaningful for project management in thefuture. The development of financial circuit requires a complete set of basictheoretical system as support, on the contrast, the basic principles of upperlayer applications can be more non-standard.Will financialcircuit have such systematic theory characteristics that are analogical to CircuitTheory? For example, there is Ohm's law in Circuit Theory describing therelationship between voltage and current, and furthermore, there arewell-celebrated theories such as Thévenin’sTheorem (Note 2) and Kirchhoff'sCircuit Laws (Note 3, Note 4), as well as a set of concepts of variousphysical quantities and components. Does financial circuit in Economics havesuch similar theories and concepts as above? The answer is yes. More precisely,the financial circuit theory can be a complete paradigmatic correspondence tothe Circuit Theory, and such correspondence system will be of greatsignificance to the development of financial circuit. The correspondence willbe discussed from the following aspects:•Definitions andExplanations of the Elements in Financial Circuit – the common elements andcomponents of financial circuits•Principles andMeanings of the Financial Circuit – the theoretic meaning of financial circuitand the relationship between its elements and components•Significance ofFinancial Circuit and Discussions of Classical Questions – using financial circuitas a method to solve Web3 problems•Paradigmatic Differencesbetween Financial Circuit and Electric Circuit – interpreting financialcircuits from the perspective of social practice[Definitions and Explanations of the Elementsin Financial Circuit]The essence offinancial circuit is the similarity between financial cash flows and electronflows, as we analogize cash as electrons. Hence, the circuit theories can bepreliminarily applied to the financial circuit theory once the concepts of CashQuantity and Cash Flow are clearly defined. Another key component of thecircuit – voltage, is a relatively abstract concept. What exactly is voltage?It is defined as electric potential difference in Physics, and hereby can be interpretedas "value potential difference"– the essence of value in tokenomics. It is the process of getting rid ofponzinomics to find the value-generating “real yield”. This is a crucialeconomic concept in this paper. If value is seen as an objective field like theelectric field, the definition of voltage would become more evident.The followingparagraphs will define essential elements and components of financial circuits.Understanding these definitions is the first step to build a complete system ofFinancial Circuit Theory; it is also a prerequisite for applying the CircuitTheory to financial circuit and find the correspondence. When defining thefinancial circuit elements and components, the names and symbols that are equalor similar to electric circuits are used to maintain the correspondingrelationships.1. BasicParameters of Financial Circuit•Quantity of Cash (q),cash for short.Quantity ofcash is the most important parameter of financial circuit. It simply representsthe amount of cash in hand or the number of tokens of the project.•Intensity of Cash Flow (i), cash flow for short.The concept ofcash flow is familiar to people who have working experience in businessmanagement or learning experience in the basics of Finance. However, how todefinite it specifically? The definition of cash flow is very similar to thatof the relationship between current and charge, i.e. i = q / t. It isessentially a form of intensity, which is the amount of capital flux per unitof time. The direction of cash flow is simply where the cash goes, which isdifferent from the direction of electron flows (Note 5). However, it is moreexplicit and comprehensive.•Value Potential Difference (v), value for short.Value is thefoundation of financial transactions, and the potential difference of valuegenerates the cash flow. Usually, information asymmetry causes value asymmetry,leading cash to flow from low-value potential to high-value potential. This isthe exact process of cash in the pursuit of value exchange. Cash, however, doesnot flow and exchange in the direction from high-value potential to low-valuepotential, as there is no value potential difference serving as supply for thecash to exchange. Here, value potentialis defined as the objective height of a value in a field. This concept isabstract yet easy to understand. There is always a value potential differencebetween two things with different value positions, and this is the very drive ofthe creation of business, investment, and trading opportunities. It should benoted that information is often asymmetric in the real world of finance andbusiness, causing some of the cash holders to mistakenly believe that they arein the state of high-value potential due to various mentalities, such as fear ofmissing out (FOMO), misjudgment, or being tricked by phishing. The price bias therefore occurs under informationasymmetry. From the micro perspective, price bias essentially means that cashis in a value potential that does not reflect the true condition and may eventuallyfail to remain in that potential due to the release of information or the delayof achieving expectations; thereafter, cash would quickly flow down from theunreasonable potential accompanied by a sudden selling pressure, which is alsothe process of price returning to real value. In the real-world financialmarket, the case of financial circuit is socialized, which is different fromthe classic physical principle of circuits. There would be various types ofcash value dislocation caused by much more severe information asymmetry andvalue asymmetry, where the cash (q)is positioned on the bubbled value potential, or even on the false valuepotential. In these cases, the hidden danger of the cash flow selling pressureis enormous. However, such circumstances can be healthy to the market in a lessextreme environment, for that liquidity is a necessity for finance and valueexchange. Value potential difference is an important concept of financialcircuit. A system without a real value potential difference may only constructa short-term dislocated value opportunity, with the zero-sum game being theonly solution for information asymmetry, which has no use for sustainabledevelopment. It is also a concern from the current investors that GameFi andSocialFi projects are constantly in the involution of ponzinomics.•Resistance of Burning (r), resistance for short.There are many types of resistance of burning. From the very elementalpoint of view, resistance exists in the Web3 financial system objectivelybecause the operational transactions on blockchain require gas fees as paymentto the miners. What’s more, in different protocols and applications, platformand project builders can customize the cost, consumption, and destructionmechanisms, which can all be regarded as different types of resistance. Tooperate an economic system, the macroeconomic managers or the commercialproject builders usually choose certain consumption mechanisms to curb inflation. This is a criticalmanagement process. Meanwhile, on the customers and users’ side, it is alsovery normal for them to spend a certain amount of expenditure when theyaccomplish specific tasks in the system. This consumption process from themacro level to the micro level is an extremely fundamental work in thedesigning of financial circuits and tokenomics, requiring professional skillsto design the appropriate resistance mechanism. However, the concept ofresistance is not easy enough for users and the public to comprehend anddirectly apply in their financial behaviors. Most of the people above pay moreattention to the quantity of cash ortokens burned by resistance (qr),which is the amount of cash consumed for a certain amount of cash flow per unitof time under the condition of resistance r. In other words, how much fee dousers need to pay for the service after the mission is accomplished or thevalue is gained. This is the very concern of the users. In fact, the tokenomicsor financial system builders usually adopt various kinds of liquiditymanagement methods including specific functions and tasks to create resistancewhen they try to curb inflation. These methods are called deflation mechanism, designed to make sure there’s continuousconsumption of cash in the system and control the operational balance of thetokenomics and financial system.2. Important Componentsof Financial Circuit:•The Source of the Real Yield (y), yield for short.A term that hasbeen increasingly mentioned in the Web3 space is real yield, which advocatesthat Web3 should jump out of the cryptocurrency bubble issue occurred inprevious cycles. Hence, a Web3 project is suggested to be undertaken involvingvalue proposition with practical economic and commercial significance, as wellas a solid team which could assiduously deliver real values, no matter thisproject is going to generate liquidity from day one, or execute a traditionalWeb2 business model with MVP (Minimum Valuable Product) or PMF (Product MarketFit) building. The financing or public token issuing of a project isessentially the value potential difference derived from the expectations ofreal yield after the provision of a value proposition narrative, and such value potential difference generates orattracts cash flows for the project (Note 6).Yield is arelatively special financial component and can be analogically regarded asbattery voltage or voltage source in electric circuits as it generates valuesand potential differences. This is the very reason that the cash flows aregenerated in financial circuits. Besides Yield, financial components can beroughly divided into two categories: linearfinancial elements and non-linearfinancial elements. Linear financial elements are relatively common andsimple, which have been widely used by project builders in the current Web3market; they include three forms as follows:•Resistance Elements (r). This concept has been explained previously.- CapacitanceElements of Cash or Tokens (c), capacitance for short.
This is arelatively easy concept, meaning the containers of cash, tokens, and digitalassets. In a real-world financial circuit, the most common capacitance elementsare wallets and aggregators. The wallets can be an App of DEX or an accountof CEX which contains a series of addresses. In any case, these capacitanceelements provide users with a place or a carrier to store the cash. Once thecash flows into these capacitance elements, users can have an independentcontrolling right of liquidity. Generally, users would not withdraw all thecash at one time, nor would they keep all the cash without any activity in thewallets. Although the entire financial system does not have a micro-levelcontrol of an independent capacitance element, it enjoys the buffer effect generatedfrom the accumulation of capacitance elements, where cash flows becomedispersed and asynchronous, alleviating the liquidity pressure of the financialsystem. The value generated by capacitance elements is different from that ofstaking elements. When systematic problems occur, many users of the systemwhere the capacitance element is incorporated would adopt the same or similarstrategies at the same time, such as withdraw/deposit their liquidities from/tothe wallets all at once, resulting in the expectations of death spiral or flywheeleffect.•Staking Elements of Cash Flow or Tokens (s), staking for short.In thereal-world financial circuit, the staking elements are embodied as staking mining, liquidity pool, linear prizepool, digital assets in thetokenomics, or other cash flow staking schemes with preservation andappreciation functions. Here are the characteristics of staking elements in thefinancial circuit. When the financial system and the cash flows are relativelystable, staking is not a necessary element (although practically most financialsystems are unstable without the functionality of staking). When the cash flowsfluctuate drastically, it is necessary to keep the cash in a certain place byvarious staking methods and balance the cash flows of the system by takingadvantage of time difference. This usually requires the tokenomics design toinvolve a rewarding mechanism where users who participate in the stakingactivities are rewarded. The biggest difference between the staking andresistance mechanisms is that the former does not cost cash from the users, onthe contrary, it subsidizes users with a certain reward when the staked cash isreturned to the users after some time (The reason of resistance not beingapplied in here is that the users need to be motivated to maintain thestability of overall cash volume and liquidity of the financial system). On theother hand, the biggest difference between staking elements and capacitanceelements is that users do not have a strong control of the cash flows instaking. Instead, the liquidity principle is signed in the protocol and smartcontract created by the project/financial system. After a period, theproject/financial system would perform the contract and reward the users. Uponthe performance of contract, the project/financial system can obtain themanagement dominance of cash flow liquidity for a period, when they may balancethe time differences in the financial circuit loop to prevent the system from flow depletion or flow excess.Apart from thethree basic elements above, respectively, residence elements, capacitanceelements, and staking elements, and collectively as financial circuit impedance (z),financial circuits will evolve and give rise to more complex non-linear financial components, whichare similar to components in electric circuits such as PN junction, as well asthe diodes and triodes generated from it. This evolution may also generate afinancial component marketplace and even a financialchips industry. Some Web3 projects have already applied non-linearfinancial components through random functions and non-linear functions by wayof random prize pools, blind box lotteries, or random airdrops. These are veryelementary applications that are still in the early stage, though, the market ofnon-linear financial components is going to a very promising one.[Principles and Significance of FinancialCircuit - the comparison of financial circuit and electric circuit]According tothe definitions of basic elements and key components of financial circuit inthe previous section, a conclusion can be drawn that financial circuit andelectric circuit are running under the same paradigm in terms of nearly all basiccharacteristics. Thus, a complete set of principles and paradigms of financialcircuit corresponding to that of electric circuit can be created, which isundoubtedly good news for incumbents building the Web3 financial system.The functional relationship of variouselements and components of a financial circuit conforms to basicprinciples and laws of financial circuit that is transferred from the electriccircuit paradigm. The following paragraphs will focus on selected principlesand laws in financial circuit, which will be interpreted in terms of theirgeneral formulas, financial meanings, practical features, special scenarios,and extended meanings in the most explicit way.Here, areflection is needed on the most basic concept of financial circuit – cash flow.In financial circuit, it is defined as the amount of cash passing through anode per unit of time, i.e. i = q / t. Cash flow can be analogical toelectricity, water flow or blood flow, and cash flow management can be regardedas circuit design, urban water management system or the process of blood flowsdelivering nutrients to the whole body. It is not only the carrier of theeconomic cycle but also the core drive of the operations in financial circuits.Below is thediagram indicating how the three most basic financial components - resistance of burning (r), capacitance elements of cashflow/tokens (c) and staking elements of cash flow/tokens (s) - workunder a certain value of yield.- FinancialResistance Ohm's Law，Financial Property of CapacitanceElements, Financial Property of Staking Elements
- FinancialResistance Ohm's Law
General Formula: i = v / r (Cash Flow = Value / Resistance)Financial Meaning: In the presence of value potential differences, the cash flow is inversely proportional to the resistance of burning.Practical Feature: In a market, if there are real valuesthat users and investors are interested in, there will be demands forinvestment or spending; if the project or the system sets a relatively high resistance,such as high transaction fees or lots of extra costs, it will curb investors orbuyers’ enthusiasm and reduce the cash flows; and vice versa.Special Scenario: If the resistance isinfinite, the cash flow becomes zero, that is, in the scenario of extremeresistance of burning, there will be no cash flow in the project for the use ofits product even if it has real value; if the value potential difference iszero, the cash flow also becomes zero, which means if the project or product has no value, there is no liquidity of cash flow, even under the circumstance of no resistance.Extended Meaning 1: Given that i = q / t, then qr = vt / r, meaning in the scenario of constant value and resistance, the loss of cash qr is proportional to time.Extended Meaning 2: The series and parallel connections of resistance.Seriesconnections of resistance mean chaining two (or more) resistance elements toincrease the cash flow consumption. Parallel connections of resistance are morespecial in financial circuit: they only capture values when the project declares that the user has tocomplete both or all of the task lines, which equals to the parallel connectionin circuits; however, parallel connections of financial resistance usually causesthe user to choose only one of the circuit line (task line) to run the cashflow for the value exchange, discarding all the other circuit lines; in this scenario,a circuit switch is actually used to disconnect all the other circuitlines. In addition, the financial circuit switchneeds to be defined by the project party. With the addition of the switches,the parallel connection can express a more practical situation in thereal-world financial circuits.•Financial Property of CapacitanceElementsGeneralFormula: i = c · dv / dt (liquidity = capacitance parameter *rate of change of value)Financial Meaning: When the value changes, the cash in the capacitance element will immediately generate a cash inflow or outflow.Practical Feature: Only if there are changes in real external value, will people consider withdrawing/depositing their cash from/to the wallets; in summary, the value changes generate the cash flows. If the external value remains constant,which means there is no investment or consumption opportunity, the quantity ofcash in the capacitance elements remains constant, and no liquidity isgenerated.SpecialScenario:If the value is constant, i.e. dv/dt = 0, the cash flow will be zero regardless of the cash quantityin the capacitance element; If the capacitance element cannot carry cash, that is c = 0, there will beno cash flow no matter how much the value fluctuates, for there is no availablecapacitance element such as a wallet in the financial circuit.ExtendedMeaning: c = ∫ i dt / v. When the valuepotential difference is found, cash will continuously flow out of thecapacitance element. After a certain period, the total quantity of cash outflowwill be equal to the carrying amount of the capacitance element (More precisely,it is the product of the capacitance of the capacitance element and the value. Thisdefinition may vary with the different dimensions of the capacitance elementdefined by different tokenomics)•Financial Property of Staking ElementsGeneralFormula: v = s · di / dt (value = staking parameter * rate of changeof cash flow)Financial Meaning: When the cash flowchanges, the staking element will carry an independent value (potentialdifference).PracticalFeature: Essentially, the significanceof the staking process is generating stationary value. From the user’s point of view, bothstoring cash in the liquidity pool to obtain interest and investing money intoan NFT asset to complete certain tasks are linked to the concept of periodiccash flow lock-up. In essence, it is an expression of the user's recognition ofthe local value within a period. From the macro standpoint of policymaking orthe perspective of a project designer, if the cash flows do not fluctuate bythe user’s decisions to buy or sell, the value is then controlled by the projectteam. Hence, there is no need to establish a stakingmechanism to balance the cash flow momentum. However, usually the project team orthe financial system managers can no longer control the value and price of themodel holistically after the release of a certain proportion of the cash ortokens into the market. A great deal of buying and selling transactions will beconducted in the marketplace in theform of C2C. At that moment, it is necessary to withdraw some liquidityindirectly by way of staking to reduce the pressure of system management. Somefinancial forms in macro economy such as national debt, pensions and positiverepurchases have just the similar properties.Special Scenario: When the cash flow rate of change lowers to zero, the staking element stores no value; oppositely, if the cash flow volatiles drastically, then the value stored by the staking element can be very high, for it is proportional to the cash flow rate of change. In the real-world, there would be a threshold of the sentimental indicator, or a systematic entropy increase, which forms a singularity problem in mathematics, resulting in the staking mechanism to fail with the phenomenon of liquidity trap (Note 7).Extended Meaning: s = ∫ v dt / i. After the stakingelements take effect due to the volatility of cash flow, the sum of therelative value within a certain period is equal to the product of the capacitanceof the staking elements and the liquidity flowing through the staking elements(depending on the different dimensions of staking elements defined by differenttokenomics).In the Web3 financial system, tokenomicsbuilders usually apply various combinations of the three basic financialelements above in the liquidity management with models functioning like theseries and parallel circuit connections.One point that was not discussed in detailpreviously is the financial meaning of the source of the real yield. For thebuilders, the process of considering whether applying the single-token model,dual-token model, or introducing a new NFT digital asset (Note 8) into thetokenomics is also the process of increasing the sources of real yield infinancial circuits. Different sources of real yield play different roles like abattery pack, a good example being the functionality of deflation and inflationin the financial system. Many sources of real yield are not activated or shownexplicitly at the very beginning, yet are gradually generated through capitalfinancing, such as private investment, public listing, and liquidity pool.With the support of these models and structures, the framework of financialcircuit can be drafted, and it can be referred to as a tokenomics networkin Web3. The graph below a visual example of the financial circuit framework. It is a sketch of a real-world Web3 project with basic structures and isfor reference only; to come up with a complete tokenomics, furtherjustifications are needed.
Due to the intricacy in the practice of theproject, non-linear financial elements already exist in this tokenomics model, where y2 is the non-linear adjustable source of real yield, and r1, r2, r3, rm1, rm2 are non-linear adjustable resistance elements. Practically, project managerstend to avoid revealing all the functions and structures of the tokenomics,especially when many conditions that trigger resistance elements consumptionare hidden ones. Usually, linear components and linear parameters represent themain rules or simple rules of the tokenomics, while non-linear parts may eitherbe published selectively by project builders and managers or soon be derivedand calculated by users or researchers with data in the OTC market.In addition to the basic principles above,there are more in-depth theorems in the Circuit Theory that are also applicableto financial circuit. The paragraphs below take Thévenin’s Theorem andKirchhoff's Law as examples, corresponding their paradigms to the fundamentaltheorem of financial circuit:- FinancialThévenin's Theorem
Any lineartokenomics network that contains independent sources of real yield and linearfinancial circuit impedance can be replaced by an equivalent combination of asource of real yield y in a series connection with afinancial circuit impedance z.Similar toThévenin's Theorem in Circuit Theory, Financial Thévenin’s Theorem is an analyticalmethod for simplifying the toekenomics network, which can be used to convertthe complex financial circuits and tokenomics networks into simple equivalentnetworks. It will bring much convenience for project comparative analysis and investmentanalysis in the future.- FinancialKirchhoff's Laws
- Financial Kirchhoff's Cash Flow Law
For any node in a financial circuit, the total cashliquidity entering the node is identical to the total cash liquidity exiting inthe node.Formula expression: Σik = 0 (k=1,2,…,n).- Financial Kirchhoff's Value Law
The algebraicsum of all value differences around any closed loop is zero.Formula expression: Σvk = 0 (k=1,2,…,n).For the law ofcash flow: This is very comprehensive. For any node, such as a wallet address,the total amounts of cash inflows and outflows are equal. Assuming the inflows arepositive, and the outflows are negative, their sum of the two amounts will beconserved to zero. (Do tokens or NFTs issued by a project break this rule? No, asthese assets are not nodes but sources of real yield.)For the law ofvalue: In a close cycle tokenomics system, the sum of the cash flow valuepotential differences is zero as the events all occur in the inner loop. Thisleads to two potential results: the sum of value potential differences isultimately balanced; or the sum of value potential differences remains zero dueto the constancy of information asymmetry and value asymmetry within the closedsystem, which means that there will always be someone who misjudges his/her ownvalue potentials.Apart fromThévenin's Theorem and Kirchhoff's Laws, there are many other theorems inelectric circuits, such as Norton's Theorem, which can also be transformed intofinancial circuit corresponding theorems such as Financial Norton's Theorem.Below isthe comparison table of parameters between financial circuit and electriccircuit for reference: Comparison Table of Parameters of FinancialCircuit TheoryandCircuit Theory| Financial Circuit Elements & Components | | Circuit Elements & Components | |
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| Value Potential Difference | | Potential Difference/Voltage | |
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| Capacitance Elements of Cash or Tokens | | | |
| Staking Elements of Cash Flow or Tokens | | | |
| Financial Circuit Impedance | | | |
[Significanceof Tokenomics and Discussions on Classical Questions]
The abovefinancial circuit principle can be effective for structural analysis oftokenomics, which can further contribute to the engineering and quantitativedesign and management of Web3 projects. The pattern can be generalized toconduct market data research from a micro-to-macro perspective. Additionally,it can also be used for module classification to perform quantitative analysisof the local structures in finance and commerce.Accordingto the real-world projects described above, the economic model can be clearlyexpressed by the tokenomicsnetwork diagramon a basis of the financial circuit theory. Financial circuit can also be used for project management and datasynchronization, team communication, work allocation, and task adjustments. Inaddition, on a certain time scale, the tokenomics network simulated byfinancial circuits can be used for numerical simulation of financial circuits, numericalcalculation of financial circuits, and sandbox simulation of tokenomics to predict trends of the financial market,the commercial value, and digital economy.In the past few years, we have seen lots of projectsencountering problems in the initial stage of their tokenomics designs due totheir lack of systematic strategies from day one. In their project development,only urgent adjustments are made in partial areas, which makes it challengingto achieve an overall balance. Some projects are popular in the market as someof their specific application functions are innovative; however, the lack ofproject completeness makes it hard to maintain their leading market position,especially when more problems arise during their middle-to-late developmentphases. Unfortunately, there are no remedies when they lose theadvantages. The abovephenomenon is coming to an end with the initiation of Web3. When the tokenomicstools are continuously evolving with the development of Web3 financialengineering, the entire market will usher in a new development stage.Financialcircuit and tokenomics networks are essentially a way of thinking that helpexplain value propositions, business models, and market behaviors. The Q&Abelow will discuss some fundamental questions:Q1: How is theselling pressure formed?A1: Thisquestion is quite classical and has already been explained to some extent whendefining the value potential difference. Selling pressure usually occurs due toinformation asymmetry or unexpected events that lead to value dislocation,resulting in a price deviation, that is, cash is in an inappropriate valuepotential. Cash holders originally thought they were at a high value position,however, with the release of information and occurrence of emergencies, or whenthe overall expectations could not support the high value potential, they wouldsoon discover the problems, hoping to quickly move the cash to a reasonablevalue potential. This process of cash dumping is selling pressure. It isessentially the process where prices return to the actual values.Q2: Do someprojects add invisible consumption in the tokenomics design?A2: Yes. Inaddition to gas fees, project-defined transaction fees, and various declaredconsumption scenarios, there are many invisible resistances hidden in thetokenomics of projects. Some invisible resistance particularly lies innon-linear financial elements. There are many hidden details covering the adjustableresistance in the seemingly simple business model, and such approach has beenwidely used in traditional finance and business.Q3: Will AutomatedMarket Makers (AMMs) repeat the same mistakes of Luna/UST, and is there aneffective way to solve the loss of balance of UST's AMMs?A3: I think thereare ways to solve the issue. Simply define in the protocol that non-linearincremental resistance can be added after the transaction volume is overlylarge or the price bias reaches a certain level (such as 0.5%).Q4: Is itpossible to prevent the problem by setting up a special hysteresis resistancein the protocol that can be triggered when the selling pressure causes severe priceslippage?A4: Thisquestion is a derivative question that I posed on a panel based on Q3. Myanswer is yes. In future finance, this may be a solution like the slow-releasecircuit breaker.Q5: Willfinancial circuit and tokenomics networks imply the things that only beachieved in Web3 instead of “traditional finance + Web2”?A5: There’s alot. The launching of OpenDAO’s $SOS is adding a source of yield to thetokenomics network after OpenSea’s decision to not issue tokens. Sameprinciples apply when projects like People capture value from the traditionalworld and Klima DAO capture value from the blind spot (Note 9) of the classicalmacroeconomic theory.Q6: Is it only ashort-term solution for the projects when they provide staking mechanisms?A6: No. Justlike the importance of inductance in the Circuit Theory, staking in thefinancial system is an important part of stabilizing the system cycle by takingadvantage of the time difference of cash flows.Q7: Many Web3projects have realized that issuing linear rewards in the form of POW wouldaccelerate their way to the death spiral in ponzinomics. How can the liquidity bebetter managed in this issue?A7: Fundamentally,tokenomics with no real yield is generally driven by ponzinomics, which would eventuallyencounter the problem of death spiral. Thus, can the project better control theliquidity before it finds the real yield? In fact, a slight modification to thePOW linear reward model would greatly alleviate such pressure. At present, manyprojects have abandoned the linear incentives and are using a fixed amount of dailyor weekly incentives to motivate their users. This approach encloses thenon-linear source of yield and ensures that the controllability of the totalexternal releases.Q8: Is thesingle utility token model likely to resist inflation?A8: This questionis a derivative of Q7. Also, in the absence of real yield, these are just emptytalk. Also, moving away from linear POW incentive schemes can mitigate thetiming of inflation.Q9: What are theattributions of bonds, options, and financial derivatives in financial circuit?A9: Many basicfinancial derivatives such as bonds can be regarded as staking elements orcombinations of such elements. Futures, options, warrants, and put warrants canbe regarded as various combinations of staking elements and the switch. Furtherquestions such as how to define the execution rights of the switch, and whetherthe execution rights are linked to credit and cash, will not be discussed here,however, your feedback is most welcomed.(There are many morequestions that can be asked, and we welcome your letters)Based on financial circuits and tokenomicsnetworks, the marketspace for financial circuit components is likelyto grow rapidly, and that the Web3 financial derivatives market also has a huge potential due to its flexibility. Generally, financial derivativesmay witness the following three scenarios in the next stage. First, there can be corresponding versions of financial instruments and commodities intraditional finance createdand rapidly expanded in Web3 in the next few years, such as bonds, options, and other financialproducts mentioned in Question 9. Second, there can be more advanced financial products andderivatives converted to Web3 through the various arrangements of protocols. The market adoption period of these products is about ten years; however, they can embark a very bright future. Finally, there can be pure Web3-nativefinancial derivatives that are builton financial circuits and tokenomics networks and can be completely detached from traditional financemodels. Examples include separable financial units, AI financial units, and non-linear and non-analyticalfinancial units.[TheParadigm Differences between Financial Circuit and Electric Circuit]Finally,let's look at the paradigmaticdifferences between financial circuit and electric circuit. When applying economic theories to practice,especially those inherited from physical theories, rigidity and dogmatism should be specifically avoided as there are significant differences between physical particles and people, objects, and events in the social and economic context; the latter carry the characteristics of individuality, discreteness, and randomness. In fact, the theoretical models can only be reflected in practice on a relatively mid-to-macro level.
To that,it is vital to choosethe appropriate time scale in financial circuit. Managersand builders of different tokenomics networks should choose the time scale according to their project economic scale. Similarly, each model has adifferent amount ofcash flows required toform different scale effects. Therefore, concepts such as the minimum applicable scale and the minimum grid scale should be taken into consideration throughout the numericalsimulation and sandboxsimulation. (Note 10).Due tothe discreteness, randomness, microscopic volatility, and instability mentionedabove, it might be necessary to introduce stochastic mathematics theories andfuzzy mathematics theories in the quantitative simulation applications offinancial circuit and tokenomics networks in the future. As the market matures, pulse equations andrelevant methods can also beintroduced for simulation and resolutions.Note 1:EmergencePhenomenonEmergence wasmentioned in the book Life3.0 written by Max Tegmark in 2018, andits extended meaning is adopted here: When there is enough amount of basicparticles and components, the whole thing composed of such components will forma new phenomenon, which will be a process of quantitative change to qualitativechange from micro to macro.Note 2:Thévenin’s TheoremFor any linearelectrical network containing only voltage sources, current sources andresistances can be replaced by an equivalent combination of a voltage source Vthin a series connection with a resistance Rth.Note 3:Kirchhoff’s Circuit LawsKirchhoff'sCircuit Laws are the basic set of law of voltage and current in electriccircuits. It was proposed by German physicist G.R. Kirchhoff (Gustav RobertKirchhoff) in 1845. Kirchhoff's laws include Kirchhoff's Current Law (KCL) andKirchhoff's Voltage Law (KVL). Kirchhoff's laws can be used for the analysis ofboth DC circuits and AC circuits, as well as non-linear circuits containingelectric components.This law, alsocalled Kirchhoff's first law, or Kirchhoff's junction rule, states that, forany node (junction) in an electrical circuit, the sum of currents flowing intothat node is equal to the sum of currents flowing out of that node; or equivalently:The algebraic sum of currents in a network of conductors meeting at a point iszero.This law, alsocalled Kirchhoff's second law, or Kirchhoff's loop rule, states the following:The directed sum of the potential differences (voltages) around any closed loopis zero.Note 4: Therewill be non-linear financial components such as financial chips in a complexfinancial circuit system. The financial Thévenin’s Theorem, which will becovered later in this paper, cannot deal with the problems of non-linearfinancial components.Note 5: Thecurrent flow direction in an electric circuit is the direction of positronmotion. Given that the electrons in the metal conductors on the Earth aremostly negative electrons, the current flow direction is reversed, that is, thecurrent flow direction in the circuit is opposite to the electron flowdirection.Note 6:Attracting cash flows and investments is also a native source for real yield inthe Web3 system, just like the token issuing. Assuming that the Web3 system is anindependent economy, attracting production funding and production materials fromthe Web2 world or traditional financial market and transferring them into theWeb3 world can be regarded as opening a wormhole in a semi-closed system,transforming supplies from other space systems, and becoming the source of itsown in Physics.The liquidityTrap is a hypothesis put forward by Keynes, which states that when the interestrate level in a certain period is reduced to the possible lowest level, theelasticity of demand for money will become infinite, that is, no matter howmuch money is increased in society, it will be stored by people. Thecorresponding meaning of the paradigm in financial circuit is relativelyabstract: when the project team or managers fail to manage the violentfluctuation of liquidity, staking and various value assets cannot carry cash,at which point the liquidity will return to the staking elements or cause the valuedepreciation of the system - inflation.Note 8: NFT willbe a very special tool in financial circuit. It is a special container, whichcan be active or passive. When NFT is active, it becomes a battery that acts asa source of yield of financial circuits; when NFT is passive, it can either bea capacitance element or a staking element (more of a staking element inpractice), depending on its specific definition in the tokenomics design in theproject protocol.Note 9:Traditional Macroeconomics states that non-market industries like ESG, urban planning,and elderly care need subsidies to form a cycle like market-oriented industriesdue to their characteristics of public welfare. I regard it as a point where thetraditional theoretical system of market economy is incomplete, in other words,it is a blind spot.Note 10:Grid scale is a common concept of numerical calculation in numerical simulationof physical models, which refers to the spatial scale size of the smallestcalculation unit. Numerical calculations can only simulate the environmentabove the grid scale,whilst manyrandom or unmeasurable factors in mathematics are ignored due to their high levels and small quantities below the grid scale. Asa result, such numerical calculations often incur errors after a certain time,which are caused by the overflow of uncertainty within the scale.Before writing this article, I alsoassociated kinematics with electronic circuits and was highly inspired by theirsimilarity. In kinematics, tie rods, dampers, and springs also comprise theessential three elements, showing a mathematical differential progression relationship.In addition, the mechanism of gravitational potential difference andgravitational field is very similar to the electric potential difference andelectric field. However, it is challenging to generate comparative discussionsbetween graviton and graviton flow due to the lack of relevant resources.Founding Partner, SkySaga CapitalManaging Partner, Eureka Meta CapitalInvestment Partner, Solv Protocol
