What Is Tokenomics: An Ultimate Guide
Recently, very often, such a thing as “tokenomics” has surfaced in the media. This word means the study of the operation of digital currencies in crypto networks. It also includes the distribution of tokens and the mechanisms for using them for positive behavior on the blockchain. The question has become relevant since tokens are declared as a full-fledged replacement for money. Ordinary people and corporations now use such assets. That’s why financial governors try to control its release and circulation. A whole economic science has arisen around the relationship with cash. It’s called monetary policy. However, the advent of crypto coins has completely changed the rules of the game. Let’s take a closer look at what tokenomics is and by what laws it works.
What is tokenomics?
So, tokenomics is the science of the economic component of synthetic digital assets (tokens). This discipline addresses all issues related to creating a coin, its management, and even the removal of a token from the network. We’ll talk about these and other concepts of tokenomics in our article.
The token economy was first heard in 1972. Then a similar idea was proposed by B. F. Skinner, a psychologist from Harvard University. The scientist believed that such an economic model could also control people’s behavior. Thus, a digital image of a known value will call for positive action and vice versa.
Tokenomics is extremely important in terms of fundamental analysis of cryptocurrencies. Now there are hundreds of tokens on the network, and even more of them will appear in the future. Therefore, it’s almost impossible to find the only way to assess the value of such assets.
Moreover, the blockchain industry is still young. For this reason, analysts cannot use the latest development and exchange rates of tokens. If you add some unpredictable factors (for example, speculation), the task will become even more insoluble.
Therefore, tokenomics appeared. Its main goal is to help understand the value of digital coins. Once a person understands the essence and principle of a digital asset, he will undoubtedly assess its prospects before buying.
What is tokenomics and what it studies
The concept of tokenomics (like classical economics) is usually divided into two separate areas: macrotokenomics and microtokenomics.
Macrotokenomics deals with the collective properties of the blockchain network. Its study’s subject is the general relationship of the token with the blockchain economy, including the relationship with other market participants (crypto exchanges or management).
The task of microtokenomics is the study of individual network factors and the analysis of variables that change the functions of various parts of the distributed ledger.
At the same time, tokenomics also consider 4 main questions:
- The purpose of the token. What is a digital asset for, and what is it used for? Is it a method to accelerate the search for a project’s investments, or does it have a more critical, global, and long-term goal?
- Digital asset function. Can a token scale and can it be sold on a cryptocurrency exchange?
- Token value and stability. The exchange rate of a token is quite challenging to predict. It depends on many factors, including fluctuations in liquidity on crypto exchanges. Various projects can make the token more stable and guarantee a sufficient supply of coins to cover demand.
- Distribution of digital assets. They must be somehow distributed among the network users. It can be done through the accrual of rewards, the initial placement of coins, an airdrop (distribution of coins for the fulfillment of some conditions), and lock drop (distribution of coins to those who have blocked a certain amount of currency in a smart contract). It takes into account important factors, including the volume and timing of token issuance.
Now let’s look at some of these fundamental questions in more detail.
Distribution of tokens
Each project should be able to distribute digital coins to potential blockchain users. If it’s impossible to implement, no one will be able to use this network because there is no interest in the crypto community.
Tokens, as we have already said, can be distributed in different ways. Some networks give digital coins to validators or miners as a reward. Others sell these assets during an initial coin offering (ICO) or initial exchange offering (IEO).
Other digital coins are distributed to users after certain conditions are met. So, the Augur blockchain network gives tokens for checking the facts in its bookmaker network.
Cryptocurrencies are very volatile, and this is the problem. Fluctuations in exchange rates attract the attention of speculators who disrupt the blockchain’s normal functioning by uncontrolled buying and selling. It prevents other network users from doing their job.
Distributed ledger projects can combat this by issuing enough coins to meet supply levels. It allows setting a stable price for the token, encouraging other people to use the assets for their intended purpose.
The core development team of a blockchain project establishes a set of rules based on three key factors:
- creation of new tokens and their appearance on the market;
- the input of assets into the distributed ledger network;
- withdrawal of assets from the blockchain.
All projects have their approach. So, in some cases, a particular share of tokens remains in reserve. All so that they can be used a little later to stimulate growth or maintain the network’s health. The Ripple blockchain project uses a similar approach.
Other projects may be more cautious. Thus, the Augur team doesn’t actively participate in the work of the blockchain. The task of the developers is to maintain the stable operation of the entire infrastructure.
However, there are exceptions when stablecoin networks “burn” tokens to maintain a stable token rate. It’s what the Tether developers did at the end of October 2018. Although, according to the official statement, this happened as planned.
Tokens as management
Some of the networks encourage users to buy, store and use digital coins. All of this is done to prevent coin holding and to keep the blockchain running as it was intended.
Proof-of-Stake (Proof-of-Stake) systems, where validators take the principal place, guarantee fair and stable work. It’s done by “freezing” part of the personal funds of the validators. If they break the rules, the deposit is non-refundable.
Most of the teams creating projects on the blockchain will not be solely managing them. But at the same time, most developers understand that their projects may not work in 10-15 years.
And there’s a reason for that. The way digital assets are managed can change as the blockchain scales and evolves. Several projects have created terms that show how users can effectively modernize how they manage digital tokens through consensus building.
Examples of tokenomics in action
Naturally, we wouldn’t give pure theory without sample examples. Let’s take a look at how the token economy operates on three major blockchain networks.
Satoshi Nakamoto created this network protocol so that digital assets constantly enter the network through block generation rewards. After successfully checking the block by miners, they receive a certain amount from the newly created BTC for this.
However, miners don’t get instant access to the reward. Before that, 101 more blocks must be confirmed. It motivates miners to check more transactions. At the same time, the reward is gradually halved. All this is done so that too many Bitcoins don’t appear on the BTC network at the same time.
As with the BTC, these coins are constantly distributed as a block reward. Even during the initial ETH offering in 2014, the developers sold around 7 million tokens.
However, the project has an essential difference from BTC. It’s the absence of restrictions for Ethereum. It means that the asset can continue to grow as the network scales. However, it’s not known what the ETH tokenomics model will become after the network finally switches to the PoS (Proof-of-stake) algorithm.
The network of this token is divided into several levels with separate management. Therefore, decision-making is done in a more decentralized and efficient manner.
Automated mechanisms control the addition of new tokens to the Tron blockchain. At the same time, the asset price remains stable. However, if such a scheme does not work, the community will independently decide on the price change.
Why is tokenomics important?
The well-known American investor Seth Klarman explains in his famous book “Safety Margin” that market prices in the short term are determined only by supply and demand. And if we apply this theory to digital currencies, we will better understand the factors behind stock price changes.
It will make a huge difference. So, the most important thing is to understand what the token will be used for. Is there a clear connection between the crypto asset or the platform used (created by the service)? If there is such a connection, you need to buy a digital asset to use the service. Moreover, it can rise in price. If there is no connection, then what else is the token needed for?
Also, when studying tokenomics, it’s crucial to answer the following questions:
- How many digital coins or tokens in the market are currently offering?
- How many similar assets will there be in the future?
- When will digital images of value be created?
- Who owns digital coins? Are there reserves set aside by developers for future use?
- Is there any data on the network about possible loss, “burning,” or removing coins? If so, how many tokens will be lost?
Besides, tokenomics will help understand the change in the value of an asset in the short and long term. Therefore, such knowledge shouldn’t be neglected.
So, our article has come to an end. Let’s sum it up. The basic principles of digital coins are still being tested in practice. After all, you need to understand which algorithms work and which don’t. Dozens of models will no longer be used, so that these projects will disappear. However, if the projects remain true to their principles, they will motivate the developers of young projects on the blockchain.
Tokens issued based on a distributive ledger of some digital currency but are such. However, they can have other equally valuable apps. One cannot compare the stablecoin Tether (token of the ERC-20 standard) and the digital currency Bitcoin Cash (fork of Bitcoin). The secure Tether token is a synthetic dollar that allows you to hedge the risks of any crypto quickly. At the same time, Bitcoin Cash has no actual app. There are dozens of similar USDT tokens on the market. Hence, there’s no doubt that all world finance will soon wholly switch to the use of tokens.