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Tokenomics is the study of how cryptocurrencies function within the context of the larger ecosystem. This includes things like token distribution and how they may be used to reward beneficial network behavior.
Money is used in every situation. International firms conduct business in it; residents pay taxes in it; and without it, individuals would struggle to meet their fundamental needs: food, clothing, and a roof over their heads.
Such a pervasive asset used to be – until very recently – controlled by governments. Central banks were the only institutions in most states authorized to issue currency to their citizens.
A whole science, that we now call monetary policy, has developed around this process. Cryptocurrency has changed this. Individuals can create their own micro-economies. Tokenomics essentially takes what central banks use as monetary policy and apply it in blockchain networks.
What is tokenomics?
Tokenomics is the science of the token economy. It covers all aspects involving a coin’s creation, management, and sometimes removal from a network.
We break down each of these concepts below.
Did you know?
The idea of the token economy was propounded first by the Harvard psychologist B.F. Skinner in 1972. He believed a token economic model could control behavior. Giving some unit of recognizable value would incentivize positive actions and vice versa.
Projects must be able to transfer currencies to potential consumers. If this is not the case, the network may exist but no one will be able to access it!
This can be accomplished in a variety of ways. Validators, or miners, are rewarded with newly generated currencies, while others sell a share of the token supply to potential users in an initial coin offering (ICO).
Other tokens are distributed to users through specific activities and behaviors. Augur, for example, compensates users for confirming facts on its betting network.
Cryptocurrencies are notorious for their volatility. This is a problem as fluctuations attract speculators who can stop the network from working properly by buying and selling en masse.
Projects can combat this by ensuring there are enough coins to match the levels of supply. This helps to create a stable price for the coin, which encourages people to use the tokens for what they’re designed for.
The core team behind each project creates the rules for how tokens are generated, or’minted,’ as well as how they are injected into and removed from the network. Different projects employ a variety of approaches.
Some projects may include tokens held in reserve that may be introduced to the ecosystem at a later date to boost growth or pay for system upkeep. Ripple is an excellent illustration of this.
Other initiatives, on the other hand, adopt a deliberate hands-off approach to how the network operates. Augur’s developers, for example, have no say over how the network operates; they only maintain the infrastructure.
A network like Tether however, in October 2018, ‘burned’ tokens to help regulate the coin’s value in the marketplace. The act of burning happens when currency is sent to a wallet that no one knows the address.
Did you know?
Although the word “tokenomics” is used in the business, it has yet to gain universal acceptance. The Oxford English Dictionary, widely regarded as the authoritative source on the English language, currently lacks an item for tokenomics.
Tokens as governance
Some networks incentivize users to own, hold, and utilize tokens in order to keep individuals from HODLing money and preventing the network from being used as intended.
Proof-of-Stake (PoS) systems, which require validators to ‘stake’ their own coins, assist to guarantee that they operate honestly and fairly. Their tokens may be forfeited if they do not follow the guidelines.
Most teams that construct a network will not become its overlords. Decentralization does not function like that. Most developers, however, understand that what they design now may not function in the future. As the network develops and matures, the way tokens are regulated may need to change. Some, but not all, have devised mechanisms for network users to effectively modify the way tokens are maintained inside the ecosystem via consensus.
Examples of tokenomics in action.
Satoshi Nakamoto built the system to provide a continual flow of tokens into the network via block rewards. A’miner’ receives newly created bitcoins after properly validating a block. Before the miner can get their reward, another 101 blocks must be validated; this incentivizes them to continue confirming transactions. To prevent too many bitcoins from entering the network at once, the number of tokens awarded for each verified block is gradually reduced.
Tokens are constantly distributed as a result of block rewards. During its initial coin offering (ICO) in 2014, the project raised around $7 million in Ether to aid in the project’s widespread acceptance. There is presently no hard limitation on Ether, which means that the token supply can rise indefinitely as the network grows. However, it is unclear how Ethereum’s tokenomics model will alter if the network switches to a PoS consensus method.
The network is managed at several levels in order to make decision making decentralized but effective. Automated processes govern how Tron tokens are introduced to the network to guarantee that there are enough in circulation while keeping the price consistent. If this fails, the community can determine whether to increase or decrease the amount.
Why is tokenomics important?
Micro-economies can be created using blockchain technology. To become self-sustaining, they must choose how tokens should function inside their ecosystem.
When it comes to tokens, there is no such thing as a one-size-fits-all approach. Blockchain technology has enabled a wide variety of use cases and applications. Tokenomics enables teams to design a new model or adjust a current one to fit the needs of the project. If done correctly, this can result in a high-functioning and reliable platform.
The concepts, beliefs, and models that drive tokens, currencies, and the initiatives that support them are still in the early stages of experimenting with what works and what doesn’t.
There are several models that will not work, and we anticipate that those initiatives will be abandoned. Those who succeed, on the other hand, will go on to inspire and direct future endeavors.