Token Economics: What Is It and Why Is It Crucial for Crypto Businesses?

What Is It and Why Is It Crucial for Crypto Businesses

Token economics, or “tokenomics”, is about creating a high-value crypto token that can rise to the top in this crowded market. 

So you want to get in on the crypto craze. Well, who wouldn’t? After all, it’s a market worth over US$3 trillion! But before you get started, you need to acquaint yourself with token economics. In crypto, tokens represent assets or utilities that your company offers investors in return for their investment. They differ from coins in the sense that tokens are built on an existing blockchain, like Tether on Ethereum, whereas coins are the native tokens of a blockchain, such as Bitcoin. 

If you want users to use your tokens, your cryptocurrency must offer real-world value. For instance, if people couldn’t use USD to purchase tickets to a Beyoncé concert or anything else, the currency would be worthless to them. Then, the USD would lose all its demand and value. In the end, you want your token to have great demand because that will result in a higher price and profitability. 

That’s what token economics helps you achieve. It helps you determine and improve the quality, or value, of your token, based on its utility, business model and other such attributes. 

At the outset, what are the kinds of tokens you can opt for?

Not all tokens are currency. In fact, most are used to enable activities specific to the project, such as voting or holding shares in a crypto project. Largely, there are five types of tokens: utility, security, platform, governance and transactional. 

  • A utility token offers users access to the various services offered by your project. 
  • A security token derives its value from external, tradable assets and is subject to regulations. It represents legal ownership of the project and can also represent an “off-chain asset”, like real estate property. 
  • A platform token refers to tokens of full-fledged decentralized applications (dApps) or initial coin offerings (ICOs) (i.e. a layer 2 network) that are built on a main or underlying blockchain, like Ethereum (i.e. a layer 1 network). 
  • Governance tokens represent voting rights, thus enabling its owners to decide the direction of your project. 
  • Lastly, transactional tokens, as the name suggests, serve as units of exchange. Given that, you can trade these tokens in exchange for goods or services.

A look at different token economics models

As is the case with any business, picking a tokenomics model that works for your company is crucial. So, here are some popular models:

1. Deflationary model

This is the most commonly used tokenomics model. In the deflationary model, there is a hard cap on the number of tokens that are created. For instance, the maximum number of Bitcoins that can be mined is 21 million. With time, as the number of new tokens available reduces, demand will increase inversely to supply. This will boost the token’s value and price as more people will want to have it. However, the limited supply might also urge people to hoard the tokens. Given that, they won’t spend it, thus reducing its utility and value. That will hurt the price of the token. 

2. Inflationary model

The inflationary model is quite similar to the fiat currency economics model in the sense that there is no limit on their supply. While some startups might limit the token’s creation to a yearly basis, others might circulate as per demand. Either way, there is no hard cap on the number of tokens created, unlike in the deflationary model. An example of this would be Ethereum.

3. Dual-token model

The dual-token model, also known as the “two token model”, refers to a project which has two tokens: one for utility and the other for security. The latter exists to comply with any official regulations while raising funds for their project. The utility token gives users the freedom to interact with and use the services offered by the project. 

The dual-token model improves the usability and overall incentivization of the project. There is more scope to offer upgrades and features with two tokens than it is with just one. For instance, the blockchain game Axie Infinity uses this model. It offers two tokens: Small Love Potion (SLP) and their native token AXS. Using SLP, the utility token, players can buy in-game assets and perform tasks. On the other hand, with AXS, the security token, they can vote, trade and stake. 

While this model has its benefits, having two tokens can be confusing for the user. They might find it complex to differentiate the use cases of the tokens and manage both. 

4. Asset-backed model

In this model, the token acts as an asset-backed security. That is to say that the token’s value is determined by its underlying asset, which is an external, real-world asset with tangible value. For instance, the token Tether claims to be backed by USD

You can also use this model to sell tangible assets, such as gold and real estate, in the form of tokens. Exactly like how it is with a security token, in an asset-backed model, investors gain legal ownership to those assets by purchasing your token. Given its real world connection, this model is less volatile than the others. That said, there have been questions about transparency, as a project’s claims about being backed by such prestigious assets can be dubious. 

P.S. When deciding on your tokenomics model, also give due attention to the consensus mechanism you want to put in place.

How do you circulate your token?

Once you’ve decided on your token and the appropriate model, it’s time to bring it to the people. You could do so in, largely, four ways

  1. Crowdfunding, through ICOs or initial DEX offerings (IDOs).
  2. Airdropping your token—sending free tokens to your community to spread awareness.
  3. Rewarding miners.
  4. Pre-mining—giving certain users exclusive access to your token before taking it public. Note that this increases the chances of certain investors turning into whales and manipulating the cryptocurrency. 

For the greatest chances of success, you can use a combination of the first three ways.

All things considered, the most essential aspect of tokenomics is incentivization. If people don’t see the value in your token, it won’t succeed. You must incentivize your users to use your token, as that ensures the security, credibility and sustainability of your crypto token. 

Header Image Background by Flickr; Edited by Author

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