As the core concept of cryptocurrencies, token economics has always been an important topic in the structural design of a project. Yet it is complex and confusing. This article is a comprehensive introduction and reference guide for developers, publishers and investors. We’ll cover it from cryptography, applications, and the motivation behind it.
Token economics is an organic combination of “tokens” (especially crypto tokens or currencies) and “economics”. The term represents the process and state of the interaction of multiple blockchains and decentralized technologies.
Ideally, token economics should align with the motivations of the various parties involved. It’s critical to grow from a simple model that makes money for developers to a decentralized project with millions of participants and a multi-billion dollar market cap.
We need to coordinate the distribution of interests among these contributors, participants and investors in the cryptocurrency “game.” They may derive several different “kinds” of benefits from the operation of a project, and these roles become increasingly complex and ambiguous: participants may become investors, investors may also participate in project construction, and so on.
Therefore, a correct and appropriate token economic model is the basis for the success of a crypto project. Especially once the tokens and smart contracts have been deployed and rolled out around the world, it is difficult, if not impossible, to change.
A well-designed token economic model leads to a pleasurable experience, added value, and improved profitability. Conversely, a bad token economic model will lead to rapid depreciation, poor experience, loss of users, and even the financial collapse of the project’s core.
There are several examples in gaming, gambling, business and finance. For example, P2E (Play-to-Earn), “playing gold” and “power leveling” in MMORPG (which stands for World of Warcraft) have existed for decades, in “Magic Online” and “Second Life” etc. There are many similar concepts in places. We can even observe how large, complex game economic structures interact with traditional banking in the real world at EVE Online. At the same time, governance tokens function like stocks, and token exchanges are similar to existing stock markets.
On the other hand, key concepts in the crypto space: decentralization and autonomy, play an important role. The development and construction of economies and commodities (products) is driven when participants and contributors work together and have the same goals. While DAOs (Decentralized Autonomous Organizations) are not the focus of this article, various topics related to them will be covered.
We will also avoid discussing the technical and legal elements of token economics, as these are equally broad and complex fields. The mechanisms covered in this article assume that the tokens involved are based on the Ethereum blockchain or derivatives, have a similar feature set, and comply with your local country’s regulatory requirements.
The purpose of this article is to disassemble and analyze the participant incentive mechanism and token economic model. When these ideas come together, a better idea emerges when you think about and design your token economic model.
Mastering and building token economics requires an understanding of the tools at your disposal. Specifically, what methods are used to generate, bootstrap, and modify tokens, and the pros and cons of these programs. Therefore, this section will provide an overview of the basic token mechanics, as well as related systems and situations.
Tokens and Currencies
Currency is the native store of value for the blockchain. For example, ETH is the native coin of the Ethereum blockchain, while BTC is the native coin of the Bitcoin blockchain. These currencies are often used as rewards for consensus methods such as mining in Proof of Work or staking in Proof of Stake.
Tokens, on the other hand, act like currencies in terms of how they are transferred between addresses. Unlike currency, a token is user-defined, which means it is generated from a designated address through a programmable technology.
Within Ethereum, the ERC-20 standard is a widely used general-purpose token structure. This standard enables tokens to behave and act in predetermined ways. Thanks to this standard, ERC-20 tokens can interact, like trade, in a predictable way, even if the individual tokens are unknown.
Tokens have multiple utilities, including:
- Securities (or governance): These tokens function like shares, allowing holders to vote on certain issues and share profits.
- Platform: Platform tokens, which can be exchanged for things like computing time.
- NFT: A token with unique information that may be used for governance or practical use cases such as access to private chat rooms.
Fungibility is a core concept in token economics that allows for different behaviors through the exchange of one token with other tokens.
Fungibility means that anything can be exchanged similarly (such as a $1 bill) without losing its function or value. If an item is unique (like the Mona Lisa), it is considered irreplaceable because it cannot be replaced without losing its value.
As such, fungible tokens are ideal for intra-project currencies as they can be freely awarded, traded and spent. On the other hand, NFTs have their own set of information that differentiates them from other tokens. NFTs are ideal for items within a project, such as roles, attributes, because of their informative and irreplaceable nature.
Because of their variety and non-unique nature, fungible tokens are often traded readily on secondary markets through automated exchanges that dynamically value each token (or token-coin). On the other hand, non-fungibles have a wider range of values due to their unique properties and limited availability. As such, NFTs are often traded and purchased on secondary markets through auctions or prices set by sellers.
Smart contracts are pieces of code that automate the interactions between currencies, tokens, and external inputs, and are generated on the blockchain.
For example, smart contracts could allow players to pay in currency tokens and choose an NFT, and then execute the contract to increase the properties of their NFT.
External data can also be pulled into smart contracts. In Ethereum, this is done by using “oracles”. An oracle can be used to provide real-time weather data to a smart contract, which can then be used to determine whether crops (such as carrot tokens) succeed or fail in farming.
Minting refers to the process by which a contract with a specific address produces tokens (fungible or non-fungible) on the blockchain. When minted, tokens must meet a number of conditions, including:
The name of the token is its name. For example “carrot” (a hypothetical token).
- Abbreviations, such as “CRT”, are used as symbols.
- Decimal: The maximum decimal for a token. To declare that a token is an integer, it can be set to zero.
- The total number of tokens that may be generated is called the total supply.
- The total supply cap imposes an immutable limit on the number of tokens in circulation. The benefit of this is that the apparent finiteness of the token reduces supply, creating scarcity, which in turn increases price.
Issuance is the process of purchasing, trading, or otherwise distributing new tokens. Tokens can be issued in various ways:
- Pre-sale: A method of selling fungible or non-fungible tokens before the tokens can be used. This is often used in the same way as crowdfunding campaigns, where tokens are purchased by future holders to support future development.
- An initial coin offering (ICO) is a form of pre-sale or public offering of security tokens, similar to an IPO (initial public offering) on a stock exchange.
- Holder Purchases: Holders make purchases.
- Holder Rewards: Rewards for participating in a project, such as winning a contest.
- Developer Rewards: Rewards for project parties to propose and deliver features, bug fixes, or other software development, including bug bounties.
- Payments are made to third-party advisors, such as token economic model developers, to align their goals with the long-term sustainability of the token.
- Faucet: A website where project participants can earn tokens for free or by completing tasks such as filling out a survey or joining a mailing list.
- Airdrops: Free distribution of tokens to addresses to promote the tokens or their associated projects, these are usually distributed to those who have registered for the airdrop or are active members of the community.
Note that this is not a complete list of all distribution mechanisms, and some of these techniques may overlap. For example, a pre-sale might include an airdropped reserve of tokens to reward those who buy at random.
Additionally, issued tokens may be subject to a staking period that avoids a quick sell-off by holders after purchase.
The opposite of minting issuance is burning, i.e. burning (or otherwise permanently removing from circulation) a token or group of tokens.
Destruction of tokens can be accomplished in two ways: by programmatically reducing the total supply (via a smart contract); or, by sending the tokens to an address with an unknown private key (i.e., an unreachable wallet). The former is a hack and probably against the wishes of the original coin developer, but it would be great if the coin was set up to interact in this way.
There may be some burn as part of the deal. For example, use the breeding token to breed two NFTs to mint (yield) one NFT. On this basis, the tokens are burned and new tokens may be generated later.
The benefit of burning is to reduce the total supply, thereby creating scarcity, which may increase the price of the token to the benefit of holders. Therefore, when there is a pre-determined supply cap, token holders often choose to burn tokens, making tokens deflationary.
Inflation occurs when the total circulating supply (or cap) of a token increases due to continuous minting and issuance. Despite the increase in circulation, these tokens may not become liquid, i.e. cannot be traded on exchanges. Instead, beneficiaries may hold or stake new tokens (see the Staking section).
Inflation tokens have the advantage of making tokens more accessible (cheaper and/or more liquid) to participants, and they often earn money for creators through direct sales. However, if the demand for the token does not increase as much (e.g. new participants), the higher supply reduces the demand, thereby reducing the market value of the token.
When there is a burning process but infinite (or extremely high cap) issuance, the supply is called a floating supply. That said, the coin may experience inflation or deflation at any time, depending on current market conditions.
This works well for creating a self-balancing system in which prices try to stay consistent regardless of the presence or absence of individuals.
Staking is the practice of locking tokens for a predetermined period of time in exchange for compensation. Often the reward is more of the same token, but note that this does not necessarily represent a “positive return”.
Through the PoS consensus mechanism, people with economic interests in the chain are guaranteed to verify the blockchain. During operation, it is often used to distribute token income, usually with the help of a treasury (see the treasury section).
Staking a token can increase its value in two ways. First, staking incentives means locking up tokens for passive income, so the minimum value of tokens is a multiple of the value of future rewards. Second, locking the token so that it cannot be exchanged has the auxiliary effect of reducing the market supply and increasing the price of the token.
A vault is a collection of addresses that pool and distribute cash and tokens. These cash and tokens may have been obtained from the sale of other tokens, or they may have been deposited due to specific events such as breeding.
A number of techniques or rules can be used to automatically diversify its holdings:
- Staking: Staking tokens for a share held by the total vault or a chance to win a share.
- Development and advice: Compensation for consultants, internal or external developers. External developers can advise on an initiative and, upon acceptance and delivery, get paid.
- Participant Rewards: These are rewards given to participants based on their performance, such as winning a game.
Tokens are provided for liquidity in certain components of the larger economy, such as automated exchanges, to avoid price manipulation.
Tokens can often be used to vote on issues related to participation in governance, treasury or community. This is also why voting tokens are often referred to as governance tokens (or security tokens), the latter referring to their resemblance to corporate stocks.
Token holders use their tokens to vote on proposals following a (usually web-based) system process in which there is a link between the number of tokens owned and the number of votes cast — for example, 10 tokens Equal to 10 votes.
Voting allows token holders to make decisions on issues that directly affect them, which can give investors a sense of belonging.
Voting, on the other hand, is an important part of autonomous development, where engineers can theoretically be separated from programmers, with the community overseeing and choosing the future direction of the product.
The technique of linking the value of one token to the value of another is called peg (or some other asset like fiat currency).
When a coin is pegged, it indicates that it can trade a certain amount of currency at any time. For example, casino chips are tied to a monetary value (such as British pounds) because they can be bought or sold at face value. To do this, the casino’s cash reserve is equal to the number of chips in circulation. So a £10 casino chip always has the same value.
Similarly, Tether is an Ethereum-based token (USDT) that can be bought and sold at $1 per token from its issuer (Bitfinex), which allegedly holds the equivalent of the entire USDT supply cash reserves. That is to say, Tether is pegged to the US dollar and maintains a consistent price, thus earning the title of “stablecoin”.
Alternatively, stability can be achieved using algorithmic tweaks such as Dai’s Target Rate Feedback Mechanism (TRFM), which can maintain stability around $1 without margin, with DAI still being worth $1.
The benefit of pegs is that it reduces asset volatility over time, making trading and pricing more predictable. While token trading is possible, this is more applicable to various scenarios where excessive speculation is preferred.
External: DeFi and Exchanges
One of the properties of tokens is that they do not only exist in wallets and their associated applications. In other words, they can exist within the wider crypto ecosystem.
For example, if on a sidechain, a token can be bridged to a mainnet like Ethereum (a mainnet is a fully functional, operational blockchain network, as opposed to testnets and regtest networks etc.).
There are two key advantages to connecting a token to the mainnet:
- Utility: Connect to the wider DeFI world, allowing your tokens to connect to decentralized exchanges (DEXs). In addition, other dapps (decentralized applications) allow borrowing of tokens (such as NFTs), and there are other applications that create financial derivatives to enable further speculation on assets.
- Portability: Public chains allow data to be used in multiple projects without permission. This means that the project can be extended through open source, community building or other commercial means.
Giving up access to your tokens means giving up control over your tokens. Maybe even fall victim to some scams. In addition, mistakes such as minting and smart contracts are irreversible and require us to be cautious.
If you are new to the field of designing crypto projects, you can read our blogs on building economic systems, retention frameworks, balancing, LTV, and monetization catalysis.
Detailing the entire tokenomics design process from start to finish is beyond the scope of this article. However, there are some questions to ask yourself or your team to clarify the basic idea:
- Who does your project serve?
- How will you attract players, investors and others from the crypto and various industry ecosystems? How does it keep participants interested while providing a lasting experience and/or economy?
- What motivations attract participants?
- Why did your participants participate and continue to participate in the project? For example, do the motivations of participants and investors complement or interact with each other as part of a balanced token economic model?
- What is the core mechanism of the project?
- How are the project mechanics different, interesting, marketable and compatible with the token system? How can the project be maintained and adjusted while maintaining its core appeal and community? How do you ensure a meaningful experience for new participants, while also serving existing participants who have invested a lot of energy and money?
- What is the central anchor value?
- Anchor values are resources from which the designer can connect other resources through one or more transformations. For example, a project’s “tokens” can be used as the core currency to exchange for other in-project currencies, to purchase in-project items, or to provide liquidity. A carefully conceived and integrated anchor value allows developers to model, build, and refine a project’s economic structure—and its monetization potential. Carefully consider how your peg value and in-project economic structure relate to project tokens. Check out our in-depth Axie Infinity breakdown for examples of successful cryptoeconomic models.
- What model should be applied?
- Modeling allows you to explore and plan the various components of a system and token economic model. You can model user acquisition, lifetime value, retention, and monetization using common proven tools. However, for crypto projects, you also need to model the interactions between the tokens within the project, participants, and the broader token economic model. While a crypto project that makes quick money in a short period of time brings some value, building a crypto project that is durable and maintainable is more worth the effort.
Cryptocurrency technologies are as complex and diverse as the human motivations that drive them. It is time consuming and difficult to fully grasp everything from mining, investment practices, economic theory, project design and web3, but in essence, there are only three areas to consider:
- Mechanisms: Which mechanisms are supported by the technology. Means how tokens and currencies interact and flow on-chain and off-chain.
- Motivation: Participant participation, developer build and improvement, and investor speculation and profit motivation.
- System: How the mechanism ties it together and tunes those motivations.
As with any project design, people need to be combined with technology to create the experience. Whether it is a project party, a participant or an investor, the new feature of crypto projects is the transparency and close connection between these participants. It creates a great experience for everyone and brings everyone together to make the product a success.
Posted by:CoinYuppie，Reprinted with attribution to:https://coinyuppie.com/token-economics-a-guide-to-designing-economic-models-for-crypto-projects/
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