Defining tokenomics

The blockchain and cryptocurrency space is ever-changing. A few years ago, no one talked about initial coin offerings (ICOs), security token offerings (STOs) or even token models that seem commonplace today. Similarly, new words like hodl or altcoin are used by crypto insiders like they have been around for years, even though many people have never heard of them. The issue with the speed with which these words change and are used, is that you lose efficiency. On the one hand, you may not know what someone is talking about. On the other, two people who do think they know what they are talking about may have different opinions of the exact definition of a new word such as hodl, or as we’ll talk about in this blog post, tokenomics.

So to provide some much-needed clarity, we’ll use this article to shed some light on tokenomics, a concept that is inherently part of our business offering and services. Hopefully in this way, we can take a (small) step in changing these inefficiencies and offer some guidance to those who have no clue of what tokenomics entails.

 

Tokenomics versus Cryptoeconomics

But before we talk about what tokenomics is, let’s first get one thing out of the way. At Infloat, we see ‘tokenomics’ inherently different from cryptoeconomics (or cryptonomics).

Specifically, if we talk about cryptoeconomics, we mean the incentive structures designed to ensure the creation and transaction validation of a specific cryptocurrency (or cryptotoken). Let’s give a prevalent example. The cryptoeconomics of bitcoin is designed to ensure that bitcoin miners have a reason to mine new bitcoin. Miners validate bitcoin transactions and receive (or create) newly minted bitcoin in the process.

On the other hand, individuals, businesses and other bitcoin users pay a transaction fee for miners to include their transaction in the next block. This ensures that even when all bitcoin have been minted (to the tune of 21 million, which should happen in around 2140), bitcoin miners are still incentivized to keep ‘mining’ (i.e. validating transactions).

This example shows how the supply of bitcoin and the validation of its transactions is structured; something we would call ‘cryptoeconomics’. And in a sense, tokenomics is quite similar to cryptoeconomics, because both involve the incentivization of certain stakeholders to ensure particular behavior.

However, with tokenomics we focus specifically on the application layer of a token. This means that the goal of tokenomics is to ensure a cryptotoken (in whatever form, regardless of the token’s type or category) is used in the token’s ecosystem as intended.

So in our view, tokenomics is not about the supply and transaction validation of a token, but rather, tokenomics is about everything that happens afterwards. In other words, with tokenomics we try to answer what is the token used for, and what behavior does it elicit?

 

The Different Aspects of Tokenomics

Now that we have clarified that tokenomics is not the same as cryptoeconomics, let’s start defining what tokenomics exactly entails. As noted earlier, tokenomics does not have one fixed definition. It has different meanings according to different people. For some, the tokenomics of an ICO simply covers particular token metrics such as total supply and the amount of tokens reserved for advisors or the founders of the project. For others, tokenomics is a four-layer model, combining token functionality, token distribution, token governance and token workflow.

In our opinion, the still very new field of tokenomics covers a broad range of topics around token design, including but not limited to the token’s purpose, utilisation, functionality, distribution, and value. Let’s tackle these one by one.

 

Token purpose

It almost goes without saying, but a token has to have a purpose. What are you trying to achieve by creating a cryptotoken? For many projects, particularly during the ICO boom, the purpose of a token in a so-called ‘whitepaper ICOs’ was purely raising funds for the business in question. But times have changed, and even if your main goal is to raise funds, your token still needs to have a secondary purpose. In the end, you’d like investors to actually want to use your token, and not just buy into it for purely speculative reasons.

Perhaps you want to use your token to kickstart an online platform, as Storj has done. Or perhaps you’re trying to incentivize your users to show another particular kind of behavior. Whatever it is, it’s imperative that the token’s purpose is clear. In order to set up a token that is sustainable in the long-run, you should design your tokenomics with your token’s purpose clearly in mind. If not, you run the risk of not achieving that purpose, which will hurt your business or project.

 

Token utilisation

A second aspect of tokenomics is token utilisation. If you have clarified your purpose, you should start to think about whether your token will actually be used, when, for what reason, how (often) and by whom?

Even if you have a clear purpose for your token in mind, that does not mean that people will start using it. You need to do token research, get a clear idea of how your token will be used, and whether the projected token usage is in line with the token’s purpose.

Clearly, token utilisation also relates strongly to token value. As an example, what happens when your token increases in value due to speculation? In such a case, the users of your platform will be less inclined to use the token as a payment method. In this case, users will prefer to hodl your token, not use it and simply cash in at a later date. This may mean a great opportunity for speculators, but it will hurt your token’s utilisation in the long-run.

 

Token functionality

Cryptotokens have also been called “programmable money“. So supposing you have an idea of what you want your token to do, you now need to figure out what kind of functions your token needs to have.

As token consultants, we can take one of our clients’ projects as an example. At Infloat, we recently worked on a security token offering, allowing a company to issue its shares as tokens. The purpose of these tokens are to provide a financing mechanism for the company, while simultaneously providing value for shareholders. But in order to provide this value, we needed to set up the token in such a way that it allowed for people with tokens to vote and receive dividend payments.

So things like voting or dividend payments are clear examples of functionalities that you may want to program into your token.

 

Token distribution

The fourth aspect of tokenomics in this list is the token’s distribution. Many ICO projects make a crucial mistake in their token distribution, making it a fixed distribution that is issued at one moment in time.

However, if we look at standard (fiat) currencies, their supply is never fixed. The central bank may print additional paper money, or your local bank may provide a loan, also effectively creating money where none was before.

So something we can learn from traditional currencies, is that a fixed token (or money) supply may have adverse effects on the token value, inflation and in the end — usage. It’s therefore incredibly important to determine how you will distribute your token. This means looking at for instance:

  • When will you put a token into circulation,
  • when will it leave circulation,
  • how much you will release in the first instance (particularly in the case of an initial coin offering),
  • and how the token’s current and projected distribution, utilisation and value will interact.

 

Token value

Token value is another part of tokenomics that we wanted to touch upon. When issuing a share as a token, or some other kind of security token, the token value should be straightforward. For instance, with a company valued at $20 million, and 10 million equity tokens, you expect the shares to be worth each $2.

However, with a token that does not have a clear underlying value, things get more complicated. For even if you think your token is worth X, the market may determine it is worth Y. And this gets particularly complicated when you want to allow users to exchange your token for certain services; if the market price for your token falls, you should adjust your prices or suffer the consequences.

 

Designing tokens that work in the long-run

Clearly, tokenomics has a lot of different facets. So far, we’ve covered token purpose, utilisation, functionality, distribution and supply, but there’s many more.

From mechanism design to stakeholder interviews and from financial projections to token governance; designing a token is not as easy as some would make it out to be.

And even if you’ve covered these parts, you’re not there yet. To properly set up a tokenized business, you need to align your ecosystem, business, vision, token and tokenomics.

This means looking at a variety of other aspects of your business, such as your token market (and secondary market), the link between your token and revenue model, your business’ technical infrastructure, etc.

But still, this article does give you a place to start. We’ve provided a definition of what tokenomics is, how it’s different from cryptoeconomics, and how you can apply some of its aspects when you’re designing your own token.

But should you still feel overwhelmed after reading our overview, do not hesitate to contact us.

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