Money or currency has prominent applications in almost all of the sectors and also for the individuals. You buy products and services for your daily use with the help of money. While an international corporation makes use of them for various business transactions. Although the currency is such an influential element in the life of every individual, it has been subjected to the control of the central institutions like the governments and banks. However, the arrival of the cryptocurrency as well as tokenomics explained in this guide have completely changed the perception of the financial system of the world.
This is exactly where tokenomics has emerged as the most suitable alternative for applying the monetary policy to the blockchain networks. You might feel that the term is very new, and yes, it is. It has recently made profound efforts in altering the conventional norms of economics depending on cryptocurrency. This article offers a detailed guide on tokenomics to aid you understand the concept, how it works and the various use cases or tokenomics examples that it can serve.
What Is The Significance Of Value In Token Economics?
The very first thing that you must notice is the world we see around us simply runs on the incentives. For instance, a child visits a school as it will offer them the opportunity to earn an education for establishing their future. Even the rules that you abide by while crossing the traffic might be more about avoiding the heavy fines rather than just protecting your life.
Thus, the incentive structure is present almost everywhere – institution, business, framework and more. That being said, the cryptocurrencies were never meant to escape the incentive structure and which is why the tokenomics explained model came into existence. Cryptos are basically strings of numbers as well as collection of the mathematical rules for transferring the value besides triggering the computer code. Simultaneously, the underlying economic incentive structure creates a brand new and expanding asset class.
Thus, value is the most important factor that can drive the foundation of tokenomics. Although the cryptocurrency assets have fascinated a huge number of people with a whopping number of promises in the economic opportunity, however, they lack tangibility. This means that you can see and touch a US dollar but the same is not at all applicable in case of the crypto coins.
Token Economics: The Incentive Theory
The token economics makes use of the incentive behaviour in the bid to reinforce and develop the required behaviour in the blockchain ecosystem. The incentive theory is simply a human behavioural theory and implies that the human behaviour usually depends on the desire for reinforcing the incentives or the ability to receive the incentives. Thus, incentives play a pivotal role in token economics as it motivates the users for participating in the exchange of value that is offered by the blockchain network.
Additionally, it can be stated that the incentives are also vital requirements for motivating the users in order to ensure the better protection for the blockchain and transaction validation. Owing to this, the incentives are very important to execute the unique functionality in the concerned blockchain network. The participants who abide by all the rules set by a specific network, often receive rewards in the form of cryptocurrencies or tokens.
That being said, the model of operations in the token economy must be configured for enabling the participants to earn even more tokens with their positive contribution. In such a case, tokenomics make sure that the token incentives are financial in nature for their financial value and the contribution to an overall market capitalization of a project.
What Are Tokens? What Are The Types Of Tokens?
For getting a fair understanding of tokenomics and how it performs, it is important that you have a clearer concept about tokens. So, tokens are basically units serving a particular objective besides holding value on the basis of different characteristics. They are usually recognized as the valuable assets that are capable of serving more than the role of a crypto coin. For instance, the football tickets might work as a token as you choose to watch a match utilising the ticket or even trade the tickets against something.
The model of tokenomics relies a lot on the tokens that are represented in the form of cryptocurrencies. It is a fact that the tokens are capable of serving various functions in a network apart from serving solely the trading assets. The inclusion of Ethereum (ETH) has also offered a substantial boost to the token concept with cryptocurrencies.
The Ethereum network has evolved to be the first blockchain platform providing a wide range of decentralised services to all the participants apart from just enabling the transactions. You can also find ERC-20 tokens in Ethereum.
Coming onto the types of tokens, there are a handful of them such as:
- Layer 1 Tokens
- Layer 2 Tokens
- Security Tokens
- Utility Tokens
- Fungible Tokens
- Non-fungible Tokens
You can do some research on how to decode a token for receiving more information.
How Do Tokenomics Work?
The most crucial factor in understanding the economics of a token refers to its working. The tokenomics scope in 2020 is the result of years of improvisations. Back in the year 1972, the Harvard psychologist named B.F. Skinner was the very first person who put forward the idea of token economy. As per his assumptions, the economic model of the tokens could aid in controlling the behaviour. Basically, the token economy model is concentrated on offering specific units of recognizable value for incentivising the actions and the reverse.
Over the span of years, the token economics has evolved into a massive discipline that is focussed on studying the economic institutions as well as the policies that are associated with the creation and distribution of the tokenized goods and services. As we have already stated, tokenomics aid us to study the tokens, how they work and the important objectives that they achieve. But, you must keep this in mind the fact that the working of token economics solely depends on the usage of tokens.
Prior to diving into the individual aspects in the working of tokenomics, we must have a basic impression of the same. By this time, it is quite clear that token economics completely depends on the system of incentives in order to encourage desirable behaviour in the ecosystem. The desired behaviours in the intent of the users for making use of a specific token can aid in determining the value of the tokens. Many crypto platforms also offer incentives to the users for carrying out the governance decisions in the form of the newly mined crypto coins.
The blockchain developer employs specific protocols for controlling the rate of creation of the new units and the total amounts of currency in the system for keeping a check on the token supply. The limits that are imposed by the blockchain creator aids in retaining the value of a cryptocurrency via the creation of a sense of scarcity amongst the users.
Common Use Of Tokens in Tokenomics
This is the next step in understanding the token economy via the working of tokens. As the matter of fact, you will know how the token economics work when you are aware of how the tokens actually work. Here are some of the most important aspects that you must look out for in the working of tokens.
1. The Distribution Of Tokens
One of the first aspects in the working of the tokens would definitely refer to the issuance of ICO or Initial Coin Offerings. The projects must possess the ability to distribute the coins to the potential users. In case the project fails to distribute the coins to the interested users, then it would solely exist without anyone being capable of utilising them. As the token distribution was a significant addition to the tokenomics explained in 2020, there are several ways to achieve the same.
The networks could also opt for rewarding the miners or the users who validate the transactions with the newly minted cryptocurrencies. On the contrary, some of the networks attempt to sell a portion of the token supply to the interested users via an ICO or Initial Coin Offering. It is also crucial to note that some tokens abide by the distribution approach based on specific behaviours and actions. “Augur” (REP) is the best tokenomics example of such a token offering rewards to the users for the verification of the facts in its betting network.
2. Price Stability
Tokenomics also makes us understand the importance of studying the implications of the stability in the price. The cryptocurrencies are specially recognized for their volatility, however not in a positive sense. The crypto volatility is one of the most prominent reasons for the fluctuations that can reduce the potential of the investor interest. In addition to this, the fluctuations can also open the road for the speculators in the bid to restrict the network from proper functions via the sale of tokens and mass purchase.
The token projects could also deal with this challenge by making sure that an adequate repository of coins for matching the levels of supply. Thus, the coin price could be stabilised and encouraged the people to make use of the tokens for the designated purposes. Token economics simultaneously helps the companies in stabilising the prices of the tokens via creation of the equilibrium. It could also support a rise in the token prices via growth in the demands.
3. Business Scope
The tokenomics model offers another significant aspect that refers to the business scope of the crypto tokens. The basic utility of the tokens completely relies on the utility of the token in return for the products as well as services that it serves. Several companies have created decentralised marketplaces that offer the users to leverage their tokens for trading in the products and services that are offered on the markets.
Additionally, the companies also ensure the distribution of profit in the form of dividends as well as the other financial advantages to the users. Thus, the companies can easily achieve improved levels of user loyalty. At the same time, the projects could also ensure the availability of the robust network that is characterised by the continuous circulation of the tokens.
The governance aspect of the tokens is undoubtedly a critical one of tokenomics. The core team that is working for individual projects is responsible for creating various rules for dictating the creation or the minting of the crypto tokens. Additionally, the token economics also emphasises the specification of the approaches for injecting tokens into a network and also taking them out. Thus, it is very evident that the various projects would abide by the unique approaches for governance.
In case of specific projects, the reserved tokens might also be included in the ecosystem at a very later stage. The primary objective of such an initiative also refers to an avenue for promoting the growth or even ensuring the payments for the system maintenance. One of the most common instances of such a kind of governance token is Ripple (XRP).
Some of the other token related projects in tokenomics explained pursue a deliberately hands-off approach in the working of their network. A worth mentioning example of such an approach has been evident in the work of Augur. The Augur developers do not have much impact on the operations of the network and solely take care of the infrastructure maintenance.
The companies can also go ahead and implement token economics in their respective governance models to allocate the voting and decision making rights to the users. In this case, the tokenoimics price governance relies on the users staking or paying tokens. Some networks even offer incentives to the people for ownership, use of tokens and holding from restricting people from hoarding coins.
Thus, it can ensure that the crypto tokens work as expected as per their design. It is also crucial to point out your attention towards the Proof-of-Stake or PoS systems that depend on the validators for putting their own coins at stake. As a result, the application of token economics for governance can also aid in ensuring honest and fair conduct by the participants.
5. Future Readiness
Tokenomics also profoundly depend on understanding how a particular token project can tackle the future challenges. Many teams that are responsible for the network development in the crypto zone do not end up as its rulers. Thus, the developers are required to understand that the things that work presently for their token projects might not work in the coming days. The growth as well as the maturity of the network could imply the requirement for modification in the approaches for the governance of tokens.
Though some projects have come up with the measures for adapting to the future changes, most of the others have to catch up. The successful token projects have also employed effective consensus mechanisms to ensure provisions that dictate the capacity of the network users. The consensus mechanism introduces the effective modifications in the approaches for the token management in the users’ ecosystem.
Design Of The Token Economics
Following a detailed overview of all the crucial aspects of the tokenomics, it is pivotal to reflect on its design. It is quite important for ensuring that a token economics model is durable and highly secure. That being said, any signs of weakness in the infrastructure might lead to profound discrepancies. For instance, the malicious participants could find the opportunities to exploit the network solely for their personal advantage. Thus, it is important to design a good model depending on a comprehensive understanding of the concept “what is tokenomics”.
The correct token model is also capable of avoiding several critical issues and also requires considerable resources and effort. A reliable model of token would usually depend on a team consisting of economics, programmers as well as mathematicians with both academic and industry expertise. All of their inputs in creating a scope and developing the model for tokens might play a formidable role to ensure its effectiveness. Although the process might appear to be very complicated, it usually rounds upon the consensus mechanism.
Consensus Algorithm Selection
While most people believe that the token model design is a complicated process, it just rests on the consensus algorithm. The consensus algorithm plays a very crucial role in tokenomics as it encourages the users on the network to achieve consensus during the validation of the transactions. You will also be able to find the PoW or Proof-of-Work Model as the consensus algorithm for Ethereum (ETH) and Bitcoin (BTC).
As per this algorithm, the miners verify the transactions for securing the network via a solution of the cryptographic puzzles in the blocks. The growth of a network usually leads to a reduction in the number of the coins that are awarded to the miners. Thus, the equations that you are required to solve in order to verify the transactions on the network become even more challenging. You must keep your worry aside as this mechanism aids in creating scarcity in addition to avoiding inflation.
The tokenomics model design also considerably depends on another kind of consensus algorithm, the PoS model. Ethereum is also planning to shift from the PoW consensus algorithm to the PoS one. The other noteworthy crypto projects like the DASH and Tezos are currently using the PoS consensus model. The PoS consensus algorithm aids the cryptocurrency holders for staking their value in a digital wallet.
Simultaneously, it also enables the crypto wallets to serve as the security deposits in a validator that then works for validating the blocks. The users possessing the most tokens are likely to receive a reward for solving the next block. Thus, the PoS model improves the efficiency of the approaches to achieve consensus. The PoS model is favourable in tokenomics explained since it fails to stimulate competition amongst the participants in the network. On the other hand, it can also lead to the specific users accumulating the substantial token value to exercise more control over the network.
How Efficient Is The Token Economics Model?
By now it is clear that a proper consensus algorithm in place is able to aid you to design an effective tokenomics model. The design of a token model is just more than reflecting on the answer to what exactly tokenomics is. You are required to think about the future as well as the objectives that you would like to achieve bearing a specific token project. Both the PoW and the PoS models for the consensus leverage the incentives for encouraging the members of the network. The consensus algorithms can also increase the participation in the network while improving the security.
The token economics can also ensure an authentic confirmation for the transactions while it maintains the integrity of the network. All of these actions serve as a vital aspect in token economics as they result in currency value inflation. Bitcoin leverages its consensus mechanism in order to reduce the number of coins that can be mined by half at an interval of every 4-5 years.
Significant Benefits Of Token Economics
The study of token economics is a pretty expansive domain considering the latest trends and principles gaining recognition every day. Here are some of the key benefits of token economics:
One of the notable topics that you will come across in the token economics guide is staking. In staking, the network stores value in a wallet. As the validators possessing more value in their wallets can have the better chances of reaping the massive rewards in the bid to verify the transactions.
A perfect example of the use case of token economics in staking is the Delegated Proof of Stake Model. The basic difference of this model from the PoS model is the random selection and delegation. Thus, the participants having the highest stakes might find it difficult to receive the validation rewards constantly. So it offers a credible approach for sharing the wealth.
2. Value Exchange
Tokenomics have been highly in use owing to the fact that it offers exchanging values. A formidable example in exchange for value of the same is Bitcoin. However, Ethereum has also been successful in proving that the token projects can also use tokenomics in order to both create value and exchange value. It can simultaneously encourage the fundraising activities as well as for launching the decentralised applications of dApps.
3. Project Contributions
Tokenomics can also be very well used in the developments of the crypto projects. The example of STEEMIT clearly displays the use cases of tokenomics explained by encouraging contributions to a project. It rewards the users with tokens for their contributions as moderators, content creators and commentators.
Moreover, the platform also incentivises the users to drive traffic to the content that is pretty interesting according to their perspective. The rewards for the moderators, content creators and the commentators can play a vital role in expanding the STEEMIT platform. The users could also cash out their token rewards in STEEMIT dollars for their work in developing a bigger and better STEEMIT platform.
4. Value Of Tokenomics
Value of tokenomics is something that cannot be excluded. It could help in reflecting on the economics and the social costs in accounting for the token projects. This is a heavy requirement in a time when one can expect the tokens to represent almost any real-world asset like real estate, precious metals, collectibles and artwork. Above all, tokenomics explained is essentially capable of providing the value of community-based solutions that aligns with the values of the consumers.
Why Do You Need To Know About Tokenomics Being An Investor?
It is essential for the crypto investors to learn about the demand and supply factors of the cryptocurrency market for the following reasons:
- It offers an understanding of the short-term performance of the cryptocurrency market, as per Seth Klarman’s book, ‘Margin of Safety’.
- Tokenomics aids in ascertaining the future worth of a crypto asset.
- It offers an insight into the profitability of one crypto asset over the other in future.
However, the following factors help the investors to get hold of tokenomics explained:
- The knowledge of use of digital currency and the direct connection between the services being built and the digital asset.
- Finding out the total number of the existing tokens, their future stock limit as well as when they will be created.
- Know the owner of the digital coins and if they are reserved to be released later to the coin developers.
- Information suggesting a large number of coins has been burned, lost, deleted or are somehow unusable.
It has been clear that the term “tokenomics” is not just limited to two words “token” and “economics”. Slowly, the tokens are emerging as the new digital representations for the real-world assets. Simultaneously, the representations of the cryptocurrencies as the tokens also emphasises the requirement to learn the token economics. However, the path of token economics is still in the earliest stages of maturity.
While token economics has the potential to transform the global economy, token economics needs a lot of introspection and review. As the tokenomics explained has to deal with the potentially disruptive trends and technology, it is crucial to focus on all the influencing factors. The rising interest in the blockchain careers and the crypto space offers a favourable opportunity to learn tokenomics. Even some of the companies are trying to build a tokenomics calculator.