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Tokenomics consists of two words: token and economics, and is also called cryptoeconomics. It is defined as the quality of a token which will convince a user or an investor to adopt it and helps in building the ecosystem around the underlying project of that token.
But you must be wondering now, hey, what do you mean by quality? Well, to put it simply, anything which impacts the token’s value is a part of tokenomics. You can say that tokenomics is a pretty broad subject and includes a variety of components.
The primary one to consider is how the nature of such commercial differs from traditional industrial economies, as its characteristics are decentralized, require very little capital to scale, and offer significant security of transactions.
What is a Token?
Well, in real life, a token is a thing which serves as a visible or tangible representation of a fact, quality, or feeling. To be more clear, you can even say that you’re having an empty pocket right now and you will still stumble across real life tokens.
For example, your gym membership card is a token that represents the fact that you have subscribed to a gym. Your driving license is a token which represents the fact that you have taken training required to drive in your country. Your hotel key card shows that you have paid the hotel for your room.
Similarly, in the cryptoverse, a token is a representation of something in its particular ecosystem. It could be value, stake, voting right, or anything. Just note that a token is not limited to one specific role and can fulfill a lot of roles in its native ecosystem.
Furthermore, broadly you can say that a token represents an asset or utility that a company has, and they will usually give it away to their investors during a public sale.
Token vs Cryptocurrency Explained
The biggest difference between the two is that cryptocurrencies have their own blockchains, whereas crypto tokens are built on an existing blockchain. Also, do note that cryptocurrencies are built keeping in mind the monetary benefit, whereas many tokens are created without the intent to represent money or monetary value at all. Moving further, it’s time to discuss the types of token we can use to best suit our possible requirements.
Types of Crypto Tokens
Layer 1 vs Layer 2 Token
Here, layer one is the underlying or the main blockchain. The token which powers this blockchain is the layer one token. Layer two is the decentralized app or ICO built on top of the underlying blockchain.
Confused? Let’s take an example to better understand it. Omisego is a project that is built on top of the Ethereum blockchain. In this case, Ethereum is layer 1 and is powered by Ether, the layer 1 token. Omisego is layer 2 and is powered by OMG, that is the layer 2 token.
Here you’ll notice that the well-being of the layer 2 application is completely dependent on the overall well-being of layer 1. If there are some issues with the layer 1 blockchain, for example, a hack or a bug, it’s going to affect the overall well-being of layer 2 as well.
While there are many projects that are working on making layer 1 and layer 2 as independent as possible, but if you yourself think on a more practical level, it would be a lie to suggest that these two have no connection whatsoever.
Now, if a layer 2 application is doing well, then it reflects positively on layer 1 as well. As such, many layer 1 projects try their best to attract as many developers as possible to their platform. So as a conclusion, we can say that the higher the quality of layer 2 application, the better will be the value of layer 1 network.
Original Chain vs Forked Chain | Blockchain Forking
This second category is mostly about layer 1 protocols, which is to differentiate whether the protocol is original or has it been forked off some other protocol. For example, Bitcoin and Ethereum are examples of original protocols, while Zcash, Bitcoin Cash, and Litecoin are all examples of forked chains since they have been forked from the main Bitcoin protocol.
Utility vs Security Token
Because most of the ICOs are investment opportunities in the company itself, most tokens qualify as securities. However, if the token doesn’t qualify in the Howey Test, then it is classified as a utility token. These tokens simply provide users with a product and/or a service, and you can more of think of them like a gateway token.
To state broadly, utility tokens have the following properties:
- They give holders a right to use the network.
- They give the holders the right to take advantage of the network by voting.
- Since there is an upper cap on the maximum token availability, the value of the tokens may go up because of the supply demand equation.
On the other hand, a crypto token that qualifies the Howey Test is deemed to be a security token. These usually derive their value from an external tradable asset. Because these tokens are deemed as a security, they’re subjected to federal securities and regulations. Lastly, do note that if the ICO doesn’t follow the regulations, then they could be subjected to penalties.
Fungible vs Non-fungible Token
To state tokens may be fungible, that is, they can have interchangeability of units of a commodity with other units of the same commodity, like Bitcoin or Ethereum, or non-fungible, which on the other hand are unique and thus cannot be interchanged.
ID cards or gym membership cards are examples of non-fungible tokens. Further, you must understand that tokenomics is evolving with innovation in tokens, and thus there is a growing number of tokens with more refined properties.
These tokens, apart from the classification we just discussed, can be based on the following factors:
- Rights – tokens may give the holder property rights or give the holder access rights
- Durability – tokens can remain stable in the face of censorship or attacks
- Regulatory – tokens are easy to classify and regulate
- Purpose – tokens are created to serve as a proof of behavior or value creation or to represent existing asset or access right
- Supply – tokens either have a fixed or unlimited supply
- Token flow – tokens can be generated linearly and destroyed after use or remain in circulation
- Temporal – tokens may or may not have an expiration date
What Makes Crypto Tokenomics So Different
Having briefly understood what tokenomics is, let’s now 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 by a few centralized bureaucratic institutions.
With the access of internet and distributed ledger, the sources of various kinds including financial capital, supply chain, information, etc., are now flowing through these informational networks. Similarly, the development in blockchain provides a secure and reliable way to model token economies to reflect better markets and serve as underlying logic in the face of new technologies.
Applications of Token Economics Explained
Some of the applications of token economics are as follows:
It offers full cost accounting.
Tokens can be coded to reflect both economic and social cost while accounting. For example, one can code into the price of diamonds that are sourced ethically versus the ones that are not.
There’s better alignment of producer and consumer.
With token-based economies, one can bypass big enterprises that may not align with consumer’s value. 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 primarily replaces the big businesses with community-based solutions, and due to such a solution, as the network scales, the profits don’t get sucked by big centralized management but are instead distributed throughout the network’s token holders.
They offer triple-entry accounting.
For those who don’t know about this, it is a method of proposed enhancement of double-entry bookkeeping by simply cryptographically sealing all entries dealing with an outside party with a third entity in the system.
This third entity is the blockchain where these entries are posted as both receipts and transactions. This, if used well, easily replaces the administrative cost of auditing complex organizations.
It can create incentive systems.
With tokenomics built on blockchain protocols, tokenization will become a reward for an increasing area of transactions, that is, every source of value can be tokenized to build microeconomics that aligns individuals’ incentive with the goal of growth of the ecosystem.
Factors to Consider in Assessing a Crypto Project
Now, with a great number of projects funding themselves using ICOs, it has become important for investors to develop tools to analyze the viability of their investment opportunities.
The Team
You must check the credentials and reliability of the team that is behind the project.
Business Model
How robust is the business model they are offering? As the complexity of token scales from simple payment mechanisms to the greater ones.
PR and Branding
How well the project is being mobilized to the community? Because in the end, community matters.
Legality
Now legality around tokens still remain in the dark in many jurisdictions, and thus projects need a good legal team to make sure that the project stands good on the legal grounds.
Token Structure
This is very important, and you must understand the technical aspect of the nature of the token which is being developed or distributed.
Conclusion
Lastly, to conclude, we can say that tokenomics as a field is still in its infancy, and considering that it changes a lot of foundational cornerstones of the current world economy, there’s a lot to be explored. Along with a wider option of tokens, many organizations are developing more complex and specific use cases every day.
