This is the final part of the Messari Disclosure Report that this paper will cover. Essentially, this is just information about how much the team obtained through each phase of their sale process.
LTO Network — Token Paper Review
This portion of the report will not be annotated in the same manner as the above section.
For this document, in particular, we will take a deep look at all of the information contained within and objectively analyze and review the merits of each constituent element.
This ‘Token Paper’ was released by the team in November 2018. In the paper, they state that its purpose is to, “Take one step further and zoom into one aspect of modern blockchain solutions: their token economies.”
Overview of Their ‘Initial’ Idea
According to the ‘Token Paper’, LTO’s initial idea was to harness the latent potential of blockchain to create an immutable record of the documents that they were storing for their clients. They claim that their initial efforts “Led to the design of a distributed business process management engine with ad-hoc private blockchains following the Finite State Machine logic.”
The paper then goes on to state that LTO’s initial strategy to harness the blockchain’s capabilities was severely flawed. Specifically, LTO states that they “Set up the token functionality in the form of tokenized licenses”. The purpose of this set up was to grant clients with a legitimate license ‘secure access’ to the LTO blockchain.
LTO established the tokens in a way where, “A certain predefined number of tokens locked in your wallet would represent such a license.”
The paper states that this idea failed for numerous reasons, which include:
- Their setup forced them to rely on a public ledger and, due to this fact, the business incurred transaction fees constantly.
- As a result, the “token did not really capture the value of the solution”.
- The token paper also states that LTO believes this setup inhibited ‘ecosystem growth’.
Creation of a Public Chain
According to the Token Paper, once the team realized the aforementioned shortcomings in their initial token idea, they decided to shift strategies entirely by launching a token from their own public chain.
LTO states that the creation of an independent, public blockchain allowed them:
A) To expand the properties of the network in a way that they could not do on other public blockchains
B) To ‘experiment’ with alternative tokenomic systems and create an exclusive ‘monetary system’ for LTO.
Proof of Stake (PoS) Reward Mechanism
The next part of the paper digs into the PoS aspect of the LTO Network Mainnet.
The LTO team begins by explaining the general ‘software as a service’ model. The way that this model works is fairly simple and its a tried-and-true formula to this day.
Someone wants to use software (let’s say Microsoft Word), but they cannot ‘purchase’ it in the same way that they could purchase a physical item like a television. Therefore, users purchase something called a ‘license’ from Microsoft. Sometimes this license extends forever, but in other cases, this license may be limited to a time frame (i.e., 2 years). Once the license agreement has expired, the purchaser will be revoked access to the related software.
LTO’s Proposed Revision
In the token paper, LTO states that the inefficiency in the above software-licensing model is that users must pay a flat fee for the software regardless of their usage.
Specifically they state:
“[..]You get tied down for a fixed amount of time, paying fees regardless of your actual use. The LTO Network takes a different approach. We make use of the network voluntary. We allow users to discontinue their use whenever they choose and to relieve them from their payment obligations during such time. Hence, we have managed to use token economics and incentivization to create an efficient and flexible user model for our network.”
What LTO Network describes above could be both beneficial and detrimental to customers, depending on the situation that they are in.
Breaking down the positives and benefits of such a system:
- If a customer that purchases a license is a very heavy user of that product, then they benefit from paying a one-time fee to license it versus a pay-by-use model. Thus, if the LTO Network is used frequently by a client, then they will find the costs to be exponentially higher under this model than they otherwise would have been under the ‘standard’ software-licensing model.
- If a customer that purchases a license rarely uses that product, then they more than likely will not receive their ‘money’s worth’ from that license. Thus, if the LTO Network is used infrequently by a client, then they will find this model to be very preferable to the ‘standard’ software-licensing model.
The above bullet points present a slight quandary for the team as they explore an economic solution that best serves their customers.
How Will LTO Implement This ‘License-As-You-Go’ Model?
According to the paper, the team decided to implement the Proof-of-Stake (PoS) consensus mechanism for their public blockchain because they felt that it would be the best way of enabling their ‘license-as-you-go’ structure.
Specifically, the paper states:
“In order to achieve this, we decided to implement the PoS concept in our reward mechanism model, letting it control new entries by companies into the network. This was our ‘internal breakthrough’.”
“According to the PoS reward mechanism, the chance of a validator to be chosen is proportionate to the size of his stake relative to the total number of staked tokens. In case his stake amounts to 5% of the total of staked tokens, there is a 5% probability that he will be chosen to validate the block. This would, however, mean that a user would be awarded solely for holding tokens, and not necessarily for using them. This is why we added the ‘Proof of Importance’ concept, which rewards actual use of the tokens.”
The paper goes on to state that the integration of this ‘Proof of Importance’ concept has allowed the team to create a system whereby ‘participants’ in the network can estimate their network usage and increase their stake to the extent where they can offset all fees.
In order to assess the validity of this statement or the veracity of this claim, more information about the network must be gleaned — which is covered at a later point in the ‘Token Paper’ (we’ll also review it at that point as well).
Types of Users in the Network
The paper provides four categories that the LTO Network team uses to sort their network users.
They are as follows:
The paper further defines these categories in relation to the ecosystem in the following ways:
Takeaways From This Categorization System
Below, are some takeaways from this categorization system:
- The idea that there is any entity in this system that is interacting with the LTO Network for a reason that does not involve objectively enriching said entity in some way is implausible. Therefore, the way that ‘Passive Stakers’ are defined seems very limited in scope.
- The paper does not specific what it means in the ‘Figure 2’ diagram where there is a bullet point leading from the ‘Strong passive stakers’ that’s attached to a note saying: “Keep at minimum”
Fulfilling this goal would require undermining the idea of LTO being a public, permissionless blockchain as they have stated they are trying to build in the ‘Token Paper’.
- Two sub-categories of users on the protocol are “Non-clients” and “Clients generating transactions”. This is a bit confusing because the LTO Network is responsible for the initial distribution of their token. Thus, in one way or another, all individuals in their ecosystem should be deemed as ‘clients’.
- The team states, “As [all users] are [part] of the network, they have a direct incentive to care for its stability and functionality. Therefore, we aim for a token distribution in the maturity phase of about ~80% held by Participants.” ← These two statements are contradictory to one another. If all users have a direct incentive to care for the network’s stability and functionality, then why is there a targeted preference for how much of the circulating tokens the participants will hold? (80%)
Reward Mechanism: From LPOS to LPol
In this section of the ‘token paper’, the following is stated:
The above excerpt makes sense. However, the only qualm that the other has is with the last sentence, which states, “Thus we wanted to avoid that and actually push forward better incentives for Joint Business Builders and economically discourage strong passive stakers as they add no value to the network.”
Yet, in the previous section, the ‘Token Paper’ states that “Strong passive stakers have a large percentage of overall stake in the paltform, yet do not generate transactions. They run a node to validate transactions, and in turn receive transaction rewards.”
Given the definition of ‘strong passive stakers’, it is hard to imagine that they “add no value to the network”. This characterization of the ‘strong passive stakers’ makes their role a bit more confusing than it otherwise should be.
The paper then goes on to state:
In order to get a better idea of how this merge was performed, this report will take a closer look at ‘WAVES’s Leased Proof of Stake (“LPOS”) and NEM’s Proof of Importance (“PoI”).
What is ‘Leased Proof of Stake’?
One can find a full Medium article from the WAVES team regarding ‘Leased Proof of Stake’ here:
To summarize, LPoS works in a similar way to ‘loaning hashpower’, which is a common practice that Bitcoin mining pools engage in.
Except, instead of mining power being leased, coins themselves on the protocol are ‘leased’.
The WAVES article provides the following example:
“If example, if a pool has a total size of 100,000 coins, a holder who leases 1,000 coins may receive 1% of rewards (subject to the terms stated by the pool owner).
When leasing a balance, the coins are locked but remain in full control of the owner. They are not transferred to the pool but stay in the same address — just remaining unspendable until the lease is cancelled. Leasing and cancelling a lease can typically be done from an ordinary wallet, with no additional technical expertise needed.”
What is NEM’s ‘Proof of Importance’ Concept?
“Proof of Importance can be regarded as a novel consensus algorithm because, unlike existing consensus mechanisms such as
proof of stake, it seeks to take into account one’s overall support of the network. For example with proof of stake, an argument can be made that it rewards coin hoarders. Under the proof of stake model, nodes are limited to ‘mining’ a percentage of transactions that is reflective of their stake in a cryptocurrency. For example, a proof of stake miner who owns 10% of a cryptocurrency would be able to mine 10% of blocks on the network. The limitation with this consensus model is that it incentivizes nodes on the network to save their coins, instead of spending them. It also produces a scenario in which ‘the rich get richer’, as large coin holders are able to mine a larger percentage of blocks on the network.
Proof of Importance looks to overcome the problems that can be found in the proof of stake model by identifying an account’s overall support of the network.”
Integrating LPoS and LoI Into LTO’s System
When taking the above definitions of ‘LPoS’ and ‘LoI’ into account, it seems that they would both be integrated into LTO Network in the following ways:
- LPoS would allow for greater flexibility on the part of businesses (Joint Business Builders) that can lease their share of tokens to clients or other businesses that may need them at a time the Joint Business Builder does not them. This obviously would enhance the monetization capabilities of the LTO network.
- LoI would help significantly with incentivizing users of the LTO Network to actually use the token rather than ‘hoarding’ them for the purposes of acquiring a higher stake in order to win more rewards through the platform.
Of course, in terms of PoI, the only way to really assess the effectiveness of its implementation would be to see how heavily the constituent factors are weighted on the protocol (i.e., transactions, stake, etc.).
Fortunately, this information is provided in the ‘Token Paper’.
It is posted below as well for convenience:
In addition to the PoI formula described above, there is also a ‘raffle factor’ that is attached to the consensus algorithm.
In examining the third figure posted above, it appears that preference is given to those that maintain the ‘net zero’ goal that was discussed in the beginning of the ‘Token Paper’.
Thus, one’s chances of successfully being elected to submit the next block in the network is determined by their ability to maintain an even ratio of staked tokens as a percentage of all tokens to transactions completed as a percentage of all transactions, rather than those that are able to gain a larger allocation of tokens.
So, for example, if a node is responsible for 20% of all transactions and they also hold a 20% stake of all tokens on the protocol, then that node will receive a higher ‘raffle factor’ than a node that holds 40% of the token allocation while being responsible for 20% of all transactions.
Given the above, it would be in the latter party’s best interest to actually sell/distribute their tokens in order to match their transaction percentage of transactions on the network in order to garner a higher raffle value.
Possible Flaws/Exploits in This System
The most obvious flaw/exploit that critics of the system will point out is that the meaningfulness of the transaction is not factored into the PoI formula. Therefore, from what has been described above, it seems that one would be able to ‘game’ the system by simply automating transactions between users on the protocol for no economically beneficial reason in order to satisfy the transaction % portion of the PoI formula.
LTO Network’s Answer to ‘Spam’ Transactions
According to the Token Paper, the LTO Network Team was cognizant of this possible exploit and thus, created the infrastructure of the blockchain in such a way that it would deter meaningless transactions.
Below is an excerpt of the formula that the team developed as a ‘proof’ that ‘gaming’ the consensus algorithm would not be profitable for bad actors:
According to the ‘Token Paper’, the above formula, “Proves that it’s impossible to gain directly from spam transactions, with a maximum raffle factor of less than two. A raffle factor close to 2 would make spam transactions nearly free. Increasing the importance on the network for little to no costs is undesirable, as it could aid an attacker trying to undermine the network with a 51% attack.”
LTO Network’s Desired Structure
According to the ‘Token Paper’, the reason for a partition of ERC-20 tokens and Mainnet Tokens are to assist with the reduction of price volatility in order to make the costs of using the network more predictable.
Since the mainnet tokens are not tradeable on the open market, the ERC-20 token version of $LTO serves as the ‘entry point’ for all those that are looking to join the network that have not done so already.
Specifically, the process of transferring tokens to and from the Mainnet and ERC-20 sides of the ‘bridge’ are as follows: