Token Economics 101
Cryptocurrencies have evolved far beyond simply being used for digital payments. With the swift advancements in cryptocurrency and blockchain technology, it’s increasingly clear that cryptocurrency can do a range of things such as tokenizing assets, leveraging dApps, being a symbol of ownership of digital items and allowing one to become a participant in decentralized platforms. This has also resulted in the creation of new economic models, called “token economics.”
But even though these new systems have a name, they aren’t always easy to understand. Cryptocurrencies can be programmed in a variety of ways and vary in their usage and features depending on what blockchain or platform they are built on.
Generally speaking, token economics refers to the study, development, and deployment of economic systems based on blockchain technology. Every blockchain platform and blockchain application, including games has its own token economic model.
One of the basic guidelines behind good token economics is that there are incentives in place that reward users for acting in ways that are beneficial to the network or platform. This creates a sense of loyalty within the community and means the ecosystem has a better chance at longevity.
Long before a cryptocurrency is launched, the company or developers behind it have to decide how their token will function on their platform and create a set of token economic principles that govern it. This model has to be solid, as any weakness will be exploited by unscrupulous users as soon as it’s discovered.
Next, the decision has to be made whether to use a consensus model or consensus algorithms, ie the Proof-of-Work used by Bitcoin and Ethereum. The latter works by having miners solving blocks which verify transactions and secure the network. The reward for solving a block is an amount of cryptocurrency. Another algorithm is the Proof-of-Stake, whereby holders of the platform’s cryptocurrency stake their holdings in a wallet to solve blocks. Holding more tokens increases one’s chances of that user’s wallet solving the block and being rewarded with tokens.
These consensus models depend on the cryptocurrency functioning as an incentive for network members to participate in securing the network, verify transactions, and overall, make the ecosystem more stable. This brings more cryptocurrency into the ecosystem, causing inflation, for which every consensus model has its own rules. Another important aspect of token economics is the idea that there is a total amount a cryptocurrency which is limited, in order to prevent endless inflation, and in comparison with fiat currency, prevents the erosion of trust in the value of a cryptocurrency as the value can only fall so far before it recovers given the quantity of a digital currency available.
With that being said, there are a number of additional steps needed to make a new model of token economics complete, with developers having to:
- Create a model for token usage.
- Devise an incentive program for miners and other users.
- Layout payment method for transaction fees.
- Determine network governance and contribution guidelines.
These rules may remain the same as when they were originally conceived, but often the activity and feedback of a community and behavior of the broader cryptocurrency industry has an impact on a company’s token economics to some degree and adjustments are made to compensate.
The process of working out a new model for token economics isn’t one that can be done quickly, and as blockchain technology continues to move forward, this system is likely going to become even more complex. The upside of this is that companies and platforms built on blockchain are creating more secure ecosystems which offer a range of incentives to users who contribute to building the community, making the users invaluable to a token ecosystem’s success and the best projects those which listen to their users and implement those suggestions which will have the best results for everyone.