Tokenomics – The Inner Side of the Token Business

Alisa Tkach

The tokens are governed by its monetary policy, created by the communities or foundations themselves.

The tokens are governed by its monetary policy, created by the communities or foundations themselves.

Just as there are economics, giganomics, and other forms of frameworks that govern the circulation of funds and establish the rules organizing the exchange of goods and services for various iterations of units of account, so too does the crypto economy have its own ruleset known as tokenomics.

Token economics, or tokenomics, is the set of rules of supply, demand, distribution, and other mechanisms involved in a blockchain-based project relying on the emission of a cryptocurrency for its subsequent use by community members within the framework of the project’s internal economy. As a rule, tokenomics relies on the inherent qualities of the underlying blockchain system and the characteristics of the cryptocurrency selected for the project’s needs.

Supply and demand are the governing forces of tokenomics, determining the intrinsic value of a cryptocurrency based on a variety of factors, such as usability, real-world object tethering, news backgrounds, potential, trading volumes, partnerships, and many others. Scarcity is one of the determining factors, but it is utterly meaningless if the cryptocurrency is not in demand or has no application within the digital economy as a whole or the economy of the project.

There have been cases when a project could simply run by offering its services and products in exchange for fiat funds, which are still considerably more convenient for the majority of online denizens. Such a dualistic approach negates the need for a token altogether. This is where tokenomics comes in as a foundation for outlining the use cases of a cryptocurrency, setting its value within the ecosystem, and providing benefits and incentives for relying on it as the main unit of exchange.

The Types of Units of Account

The planning of tokenomics starts with selecting the unit of account that will be used within the framework of the project. In essence, there are five major types of cryptocurrency tokens that can be used as units of account for running the internal processes of project economies. Among them are the following:

Platform Tokens

These types of tokens support the Dapps built on the blockchain used as the infrastructure for the project. By leveraging the inherent qualities of the underlying blockchain, such tokens gain security, usability, promotion, etc. In essence, these tokens run the applications they are integrated into and are used as the main unit of account within them, feeding on the blockchain that supports the selected Dapp. Such tokens are incredibly versatile and can be used for anything ranging from running games and exchanges to marketplaces, advertising services, and much more.

Security Tokens

Security tokens are a very specific and strictly regulated type of tokens that represent legal ownership of a physical or digital asset, which acts as the cornerstone of the project’s product or service offering. The main value of such tokens resides in their price-accruing qualities that make them suitable as units of account that can be used for long-term investments. Such tokens are largely sold in batches to investors and used within projects to a limited degree, acting solely as vehicles of rights of ownership and value.

Transactional Tokens

Transaction tokens serve as units of account that can be exchanged for goods and services as part of the project’s economy. Much like their platform token counterparts, these tokens are more like an intermediary currency acting as a unit of account among platform participants who may have different currencies they wish to use to trade. Excellent examples of transactional tokens are Bitcoin and Ethereum. Bitcoin is a unit of account that can be used by two parties for exchanging intrinsic value for a product or service. Ethereum can be used just as much as Bitcoin for the same purposes, and both can be used as an intermediary instrument for conversion into other currencies. 

Utility Tokens

Utility tokens had their heyday during the ICO boom of 2017 when countless projects delved into the concept of tokenomics that relied on the sales of such tokens as access keys to a variety of services and products offered by the projects. Such tokens are integrated into an existing protocol and used to access the services of that protocol, essentially acting as access keys. Some projects with well-developed tokenomics offer users the chance to use both utility tokens and fiat on their platforms but offer significant benefits for token usage. Utility tokens can best be compared to premium currencies within video games, where they can either speed up processes, grant access to special abilities or items, etc.

Governance Tokens

Governance tokens are a special type of digital assets that fuel blockchain-based voting systems. These tokens are essentially representations of voting rights that are popular within staking protocols, Proof-of-Stake networks, or any other project that is decentralized enough to include community governance as part of its development vector or tokenomics. Such tokens have little practical application and are not as popular on exchanges, given their limited functionality. Many projects issue a second type of internal currency alongside governance tokens to boost usability and provide additional incentives to users.

NFTs

Non-Fungible Tokens can also be considered part of tokenomics since many projects rely on their turnover and usability within their frameworks. NFTs have inherent value and usability that allow them to be applied in projects as an amalgamation of both security and utility tokens. First – NFTs accrue value over time, second – they can be used as an actuator of actions within games, platforms, metaverses, and other types of Dapps.

Mechanisms

Tokenomics also considers the business models applied within projects, which also include control of inflation, deflation, circulation, distribution, and price maintenance.

A common deflationary and supply-regulation mechanism employed by many projects to avoid price drops as a result of supply and demand dynamics is Token Burning. The latter foresees the destruction of a certain amount of project tokens each set period to maintain demand by highlighting scarcity. Such artificial mechanisms help projects maintain prices and incentivize users to hold their tokens in expectation of their appreciation after consequent burns.

The circulation of tokens is largely out of the control of projects, but some mechanisms like liquidity pools, staking and Buyouts allow teams to move volumes of tokens on the market. Liquidity pools incentivize users to move their assets about, thus boosting prices, while staking is a proven method for ensuring the availability of liquidity. Buyouts, on the other hand, are another artificial instrument of supply control that foresees the purchase of its own tokens by a project from exchanges to reduce circulating volumes.

Distribution is largely effectuated via sales, airdrops, and the project’s monetary policy that includes a schedule of token issuance. However, the most popular ways of distribution of tokens are ICOs, IEOs, auctions, mining, token farming, airdrops, and others.

Conclusion

Just like a state, a project has to have a comprehensive monetary policy that would control its internal economy called a tokenomy. The instruments available to projects are both reflections of those from classical economics, and some innovative ones that highlight the decentralized nature of the digital, blockchain-based economy.

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