What is Token Economics?
Combining the words “token” and “economics”, token economics is a concept that is crucial in the crypto space, however, it has always lacked a consensus. However, the words “tokens” and “economics” are a perfect entry point for us.
Economics is a social science that analyzes how individuals, organizations, governments, and nations allocate their resources primarily by producing, distributing, and consuming goods and services. Tokens, on the other hand, refer to non-native digital assets based on existing blockchains (for example, ETH is Ethereum’s native cryptocurrency, digital assets). Combining these two definitions, we can conclude that token economics is the fundamental science for exploring the potential of tokens, including key factors such as their utility, supply, price stability, distribution, and governance.
Why is tokenomics important in cryptocurrencies?
Just as central banks utilize monetary policies related to their respective fiat currencies, proper design, management, and execution of token economics allows project teams to create an efficient economic environment around their products, fostering growth in the ecosystem and token prices.
From an investor’s perspective, token economics is a key factor to consider, as it has a large impact on the future price of digital assets and the ability of a project to achieve the goals set out in its roadmap.
Simply put, regardless of the expertise and dedication of the team, the potential of the concept, and the amount of funding collected from early investors and venture capitalists, poor token economics is likely to lead to the eventual failure of a cryptocurrency project.
Token Economics: 6 Key Factors to Consider
Utility is probably one of the most important elements of a cryptocurrency project’s token economics.
Even if a token is deflationary, has a perfect price stability mechanism, a stress mechanism, and a decentralized and efficient on-chain governance process, if it can’t land in the end, then it’s hard to have a greater value.
The same applies to fiat currency, as it has value only when the citizens of the country use it, for example, for everyday payments, investments and other transactions. And that’s why some central banks have cracked down on digital assets in the past.
To avoid the situation detailed earlier, cryptocurrency project teams must empower their digital assets with multiple usage scenarios that benefit the ecosystem and its participants.
Examples of this can include: enabling token holders to gain profit opportunities through activities such as staking, liquidity mining, and revenue sharing.
In addition to this, tokens can also be a medium of exchange within a platform or an entire ecosystem, collateral for other assets in the ecosystem (such as stablecoins). For example, the main utility of ETH is to pay transaction fees and to deploy DApps and smart contracts, and even to some extent a store of value. Bitcoin acts as both a store of value and a medium of exchange.
Generally speaking, the utility of the token is responsible for creating demand, which drives the value of the digital asset if the supply remains the same or decreases.
Supply and Price Stabilization Mechanisms
Another key factor in crypto token economics is supply and price. Cryptocurrency projects must also carefully manage the supply of their tokens, as it also has a direct impact on their prices in the following ways.
If the supply of a token increases while the demand remains the same, it will cause its price to fall.
The price of the token will increase as the supply decreases (while the demand remains the same).
So, if a cryptocurrency project simply wants to create value for early token holders, it can design the token as a deflationary asset, and over time a significant portion of the token will be removed from overall liquidity removed, but keep in mind that a token with no utility value will not generate higher value even if deflation is present.
An alternative solution is to create an inflationary asset and gradually reduce its inflation rate. A good example is Bitcoin, which halved the new coins that can be mined per block roughly every four years until reaching a maximum supply of 21 million BTC in 2140.
However, in some cases, due to the nature of cryptocurrency project solutions, inflation or lack of maximum supply is necessary for the coin to perform its core function. For example, while there is no hard cap on the supply of ETH, the project mines new coins to incentivize validators to maintain the ecosystem.
Generally speaking, cryptocurrency projects can control their token supply in two main ways:
By limiting (or not limiting) the number of tokens that can be issued (maximum supply)
Tokens roll out total liquidity by implementing price stabilization mechanisms (eg, burns and buybacks, and BTC’s halving mechanism).
In general, before investing in a coin, one must analyze the dynamics and mechanics of the asset that directly affects its supply.
While some coins can sustain long-term growth during a deflationary process with little increase in demand, there are also coins whose prices collapse due to inflation even after new capital and buyers.
Issuance is not only a key factor in token economics, but a crucial step in the entire token cycle. If a project cannot somehow distribute tokens to its users, no one will be able to use its network because the community will not have access to the platform’s native assets.
There are many ways to introduce their tokens to the market. Some methods are more about rewarding team members and early investors, while others, including a fair launch, are designed to benefit the community.
For example, in the cryptocurrency project below, tokens are issued in the following ways:
- Ethereum started with a crowdsale, with early participants contributing 31,000 BTC. For this, crowdfunding contributors received 60 million (83%) of the initial 72 million ETH, and the remaining 12 million ETH (17%) was split between early contributors and the Ethereum Foundation. After this, a new supply of ETH has been sent to miners as a reward for securing the ecosystem.
- For Bitcoin, it doesn’t matter whether the creator, Satoshi Nakamoto, premined the first few coins, or whether he acquired them as a regular miner. Because the cryptocurrency has a fair launch model in terms of initial distribution. Regardless of whether he participated in mining in the early stage, Satoshi Nakamoto’s about 1.1 million BTC has never been passive, and no coin has been circulated in the market. That is, the remaining bitcoins have been distributed among bitcoin miners (just like ETH).
- The Ethereum-based Uniswap distribution model is quite different, between a fair sale and a 2017-style ICO model (in the latter, the project team, investors and advisors are the biggest beneficiaries). After its release in September 2020, the distribution of the 1 billion UNI supply is as follows: 15% for community airdrops, 2% for liquidity mining, 43% for treasury governance, 21.51% for teams, and 17.8% for For investors, 0.69% is used for advisors (all tokens have a 4-year lock-up period, except for tokens allocated to airdrops and liquidity mining).
The distribution model of tokens is not only the lifeblood of a cryptocurrency project, it also has a huge impact on how the public perceives the project.
On the one hand, a completely fair launch model is conducive to building trust between users and projects. But on the contrary, if the majority of the tokens are allocated to team members and private investors, the community will question the project.
On the other hand, the latter ensures that developers and ecosystem participants have access to the necessary resources to make their vision a reality.
For the crypto community, decentralization and transparency are two qualities that are highly valued, and the community is generally more supportive of projects with a fair launch model.
Additionally, distributing tokens fairly among (tens of thousands) of users, rather than among a bunch of whales or large early investors, is also relatively safe for the project itself, as this greatly reduces factors such as control, malicious attacks, or governance Centralization and other risks.
In token economics, there is another topic that cannot be ignored, and that is governance.
While it has only a somewhat indirect indirect effect on a cryptocurrency project’s future success and the price of its native token, it is still as important as other factors, especially for tokens that are used for governance in their primary function itself.
Just like the influence of the government on the national economy, the core development team or community members of a project make plans for the future of a cryptocurrency through decentralized governance elected governance committees and institutions, which is a very important thing in itself .
In addition, the process of allowing the team or community to govern the project is also very important. In terms of governance models, there are still many problems:
- Degree of centralization (the ultimate power held by the core team compared to a fully decentralized community governance process)
- Whether governance takes place on-chain or off-chain (though, off-chain governance can still be decentralized).
- How accessible the governance process is to ordinary users (e.g. how easy is it to create a proposal and vote on it).
- The minimum share of votes required to approve a proposal.
- If the core team is highly involved in the governance of the project, consider their background, skills and experience.
In general, while decentralization is highly valued in the crypto space, this does not mean that all decentralized projects are necessarily better than fully or partially centralized ones.
Transparency, integrity, collaboration through effective procedures, and a professional team (whether they are core developers or elected community members) are the more important things for the project.
Posted by:CoinYuppie，Reprinted with attribution to:https://coinyuppie.com/compulsory-subjects-for-crypto-projects-token-economics/
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