What is Tokenomics?
Tokenomics (token economics or crypto-economics) study the economic institutions and policies of the distribution, production, and distribution of goods and services that have been tokenized. Blockchain technology has become the driving force of innovation on the internet.
Such developments have mobilized economic transactions that rely on tokens and do not require centralized intermediaries like banks or big enterprises. The nature of these commercial systems differs from the traditional industrial economies as its characteristics are decentralized, requiring very little capital to scale, and offering significant security of transactions.
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What is a Token?
Tokens, in a general sense, are units of value issued by an organization, but in the context of tokenomics, it is more specifically built on top of an existing blockchain. Tokens have been rebranded with the advent of blockchain, but tokens have always been around. Concert tickets, gym membership cards, and drivers licenses are all examples of tokens representing value with a more specific use case than currency.
This value may be in the form of access to a service, rights over an asset, ownership of an organization, etc. Tokens can thus fulfill different roles in any given native ecosystem by codifying all kinds of values.
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Tokens vs. Cryptocurrency
Tokenmomics is still a developing field, and unlike established sciences, it does not have rigorous scrutiny over its taxonomy. One of how discourse in the field is problematic is how tokens are treated as cryptocurrency. Unlike cryptocurrency, many tokens are created without the intent to represent money or monetary value at all. Thus “tokens” are opposed to “cryptocurrency” is a more generic definition to include more than just asset tokens.
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Types of Tokens
Before we introduce the basics of tokenomics, we must familiarize ourselves with the intricacies of tokens. Properties of Tokens can be classified under the following heads:
Layer 1 vs. Layer 2
Layer 1 (protocol tokens):
These tokens are the underlying blockchain itself. E.g., Ethereum powered by ether (layer 1 token)
Layer 2 :
These tokens are built on top of the existing layer 1 blockchains. E.g., OmiseGO, built on top of the Ethereum blockchain and powered by OMG (layer 2 tokens)
Security vs utility
Security tokens are those that pass the Howey test, classifying them as securities. Most ICOs (Initial Coin Offering) are investment opportunities in the company itself. Thus, most tokens count as securities.
On the other hand, utility tokens are issued to raise funds for a project that can later be used to purchase the project’s goods or services.
Fungible vs. Non-fungible
Tokens may be fungible (i.e., can facilitate interchangeability of units of a commodity with other units of a said commodity) like Bitcoin or Ethereum. Non-fungible tokens, on the other hand, are unique and thus cannot be interchanged. ID cards or gym membership cards are examples of non-fungible tokens.
Tokenomics is evolving with innovations in tokens, and thus there is a growing number of tokens with more refined properties. These tokens, apart from the classifications mentioned above, can be based on the following perspectives:
- Rights: tokens may give the holder property rights or give the holder access rights.
- Durability: tokens can remain stable in the face of censorship and attacks.
- Regulatory: tokens are easy to classify and regulate (if required)
- Purpose: tokens are created to serve as proof of behavior (value creation) or represent existing assets/access rights
- Supply: there may be a fixed supply of token or unlimited
- Token-flow: tokens can be generated linearly (destroyed after use) or remain in circulation
- temporal: tokens may or may not have an expiration date
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What makes Tokenomics Different?
Having briefly understood what tokenomics is, let’s explore why it is fundamentally different from the economics we generally operate in. In the modern economy, economic forces that govern our lives have, over time, become increasingly channeled in a few centralized bureaucratic institutions.
With access to the internet and distributed ledgers, resources of various kinds (including financial capital, supply chain information, etc.) are now flowing through these information networks. Developments in blockchain provide secure and reliable ways to model token economies to reflect better markets’ underlying logic in the face of new technologies.
Some applications of token economies are as follows:
1. Full cost accounting
Tokens can be coded to reflect both economic and social costs while accounting. For example, one can code into the price of diamonds that are sourced ethically vs. those not.
2. Better alignment of producer and consumers
With token-based economies, one can bypass big enterprises that may not align with the consumers’ values. This can be done by replacing organizations with token-based blockchain networks wherein producers and consumers can find each other for their specific needs and bypass a bigger platform.
This replaces big businesses with community-based solutions. As the network scales, the profits don’t get sucked by big centralized management but are instead distributed throughout the network’s token holders.
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3. Triple entry accounting
It is the proposed enhancement of double-entry bookkeeping by cryptographically sealing all entries dealing with an outside party with a third entity. This third entity is the blockchain, where these entries are posted as both receipts and transactions. This replaces the administrative costs of auditing complex organizations.
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4. Incentive systems
With tokeneomics built on blockchain protocols, tokenization will become a reward for an increasing array of transactions. Every source of value can be tokenized to build microeconomics that aligns individuals’ incentives with the goal of growth of the ecosystem.
Investments and Tokenomics
With a greater number of projects funding themselves using ICOs, it has become important for investors to develop tools to analyze the viability of their investment opportunities. Factors that investors may consider in assessing a token project are as follows:
The team: the credentials and reliability of the team that is behind the project
Business model: how robust is the business model, as the complexity of tokens scales from simple payment mechanisms
PR and branding: how well the project is being able to mobilize the community
Legality: legality around tokens remains murky in many jurisdictions, and thus projects need a good legal team to make sure the project has sound legal grounds
Token structure: technical aspects of the nature of the token
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Conclusion
Tokenomics remains a field in its infancy. Considering that it changes a lot of the foundational cornerstones of the current world economy, there is a lot to be explored. With the wider adoption of tokens, they are developing more complex and specific use cases every day.
Tokenomics is the study of highly disruptive technology. Its growth will depend largely on the government’s regulation of token economies and the ease with which organizations, producers, and consumers can be tokenized.
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