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Understanding Tokenomics – A Complete Guide

Written by Janani

September 14, 2021

Money is often used in practically every industry and by almost every individual. Money is used to buy things and services for everyday usage, whereas an international firm uses it for business operations. Despite the fact that money has such a powerful influence on the lives of everyone on the planet, it has always been under the control of central institutions such as banks and governments. The introduction of cryptocurrencies and tokenomics, on the other hand, completely altered the world’s perspective of financial systems.

Ergo, tokenomics bloomed as a viable alternative for implementing monetary policy on blockchain networks. The term is undeniably new, and it has recently made significant progress in challenging traditional economic standards rooted in cryptocurrency.

What is Tokenomics?

Tokenomics (also known as token economics or crypto-economics) is the study of the economic institutions and policies that govern the exchange, fabrication, and distribution of tokenized products and services. On the internet, blockchain technology has become the driving force of innovation. Economic transactions based on tokens that do not require centralized intermediaries such as banks or big businesses have become more portable as a result of these innovations. These commercial systems are distinct from traditional industrial economies in that they are decentralized, require very little capital to scale and provide significant transaction security.

In a typical economy, economists utilize official money supply data to track currency issuance. The numbers they report are commonly referred to as M1, M2, and, depending on the country, M3 or M4. This tokenomics analysis does not go into detail about the four M categories; simply know that M1 is a measurement of the most liquid monies, M2 is less liquid, and so on. These figures aid in the transparency and monitoring of several aspects of a currency’s supply.

Cryptocurrencies and tokens built on blockchain, on the other hand, have pre-determined, algorithmically generated issuance timetables. This means that we can forecast how many coins will be minted by a specific date with a high degree of precision. Though most crypto assets issuance schedules can be changed, doing so usually requires the consent of a significant number of people and is difficult to attain. This offers owners some peace of mind and security, because they know to what extent their asset will be created in a much more predictable manner than governments create money.

What is a Token?

Crypto tokens (or just tokens) are units of value created by blockchain-based projects on top of an existing blockchain, as per tokenomics. Crypto tokens, like cryptocurrency, can be traded and have value, but they are a different type of digital asset. Tokens are value units issued by an organization in general, but in the context of tokenomics, they are developed particularly on top of an existing blockchain. With the advent of blockchain, tokens have been rebranded, yet tokens have always existed. Concert tickets, gym membership cards, and driver’s licenses are all examples of tokens that reflect value but have a narrower scope than currency.

How do Tokenomics Play Out?

To gain a better grasp of tokenomics and how it works, it’s vital to dig deeper into tokens. Tokens are essentially units that serve specific goals while still retaining value depending on multiple features. Tokens are recognized as valuable assets that can be used for purposes other than currency. Football tickets, for example, might be used as tokens because you can use them to either watch a football event or trade them for something else. The tokenomics paradigm is heavily reliant on tokens represented as cryptocurrencies. Tokens could be used for a variety of purposes in a network, not just for trading assets. With the advent of Ethereum, the concept of tokens with cryptocurrency received a significant boost.

Different Types of Tokens & Their Significance

To understand tokenomics, let’s discover the many types of tokens and their significance. Tokens are divided into two sorts based on their structure: Layer 1 tokens and Layer 2 tokens.

  • Layer 1 Tokens – Layer 1 tokens are endemic to a particular blockchain and are used to power all of the blockchain’s services. The BNB on Binance Chain is a famous example of a Layer 1 token in cryptocurrency. The Ethereum network’s Ether, or ETH, is another well-known example of a Layer 1 token in cryptocurrencies.
  • Layer 2 Tokens – In the definition of tokenomics, this form of the token has a one-of-a-kind representation. They’re utilized when a network’s decentralized applications need to communicate with each other. OMG tokens, for example, are classed as Layer 2 tokens since they are used in OmniseGO, a decentralized Ethereum project.
  • Aside from these two notable classifications, token economics also promotes categorizing tokens based on their use. Security tokens and utility tokens are two significant types of tokens based on their applications.

  • Security Tokens – Security tokens are referred to as investment contracts, and they must meet a number of requirements in order to do so. Security tokens must have a monetary commitment, a common enterprise, and income from several contributors’ computation work. The Howey Test, a sophisticated process for contract verification, is used with security tokens. Tokens that pass the Howey Test are given the designation of security tokens. The way the Siafunds or SF on the Sia network work is one of the most noteworthy examples of security tokens.
  • Utility Tokens – Another significant type of token that is vital in tokenomics. Utility tokens are used to fund a network and are released through an initial coin offering (ICO) (Initial Coin Offering). The ICO is critical for project development money. The BAT, or Basic Attention Token, is an example of a utility token that was initially distributed through an ICO. BAT could now be used for decentralized advertising on the Ethereum-based Brave browser.
  • Fungible Tokens – Fungible tokens are recognized for having the same value as well as the ability to be replicated. The case of Ether (ETH) on Ethereum is a perfect example of the fungible token. The value of ETH tokens is the same, and they can be used interchangeably.
  • Non-Fungible Tokens – non-fungible tokens do not have the same value, implying that they are one-of-a-kind. NFTs have gotten a lot of news lately, and they’ve sparked a lot of interest in tokenomics, especially with high-profile NFT auctions. The use of NFT to tokenize assets such as photos, collectibles, real estate, and artworks has sparked a new wave of digital ownership revolution while also demonstrating the possibilities of tokens. NFT usage cases bring a higher value to non-fungible tokens than fungible tokens because there is no scope for replication.

Popular Uses of Tokens in Tokenomics

Popular Uses of Tokens in Tokenomics

Popular Uses of Tokens in Tokenomics

Token economics has thus far focused on the importance of value in the crypto ecosystem, the many types of tokens, and the incentive behavior supported by token economics. The next stage in understanding well about the token economy is to get a gist of how tokens work. In fact, once the behavior of tokens is clear, it’s easy to understand its economics.

  1. Token Distribution – It is necessary for projects to be able to transfer currencies to potential consumers. If this is not the case, the network will exist but no one will be able to use it!This can be carried off in a variety of ways. Validators, or miners, are rewarded with newly minted tokens, while others sell a portion of the token supply to potential users in an initial coin offering (ICO) (ICO). Other tokens are distributed to users as a result of specific activities or behaviors. People that verify facts on Augur’s betting network, for example, get rewarded.
  2. Price Stability – The volatility of cryptocurrencies is well-known. This is an issue since swings attract speculators who can disrupt the network’s operation by buying and selling in vast numbers. Projects can combat this by ensuring that there are sufficient coins to match supply levels. This serves to keep the coin’s price consistent, encouraging individuals to use the tokens for their intended purpose.
  3. Scope in Business – The commercial scope of tokens is another important factor to consider in a tokenomics strategy. The basic utility of a token is determined by the token’s utility in exchange for the items and services it provides. Many companies have developed decentralized marketplaces that allow users to trade tokens for products and services available on the platforms. In addition, businesses ensure that profits are distributed to customers in the form of dividends and other financial benefits. As a result, businesses may be able to simply increase user loyalty. Likewise, projects may ensure the availability of a stable network with consistent token circulation.
  4. Governance – Each project’s core team creates the rules for how tokens are created, or “minted,” as well as how they are injected into and disconnected from the network. Different projects take different approaches. There are some projects which include tokens that are held in reserve and then added to the ecosystem later as a way to boost growth or pay for system maintenance. A nice illustration of this is Ripple. Other projects, on the other hand, adopt a deliberately hands-off approach to the network’s operation. Augur’s developers, for example, have no say in how the network operates; all they do is keep the infrastructure operational.
  5. Into the Future – Tokenomics is also heavily reliant on knowing how a token initiative will address future challenges. Many of the teams responsible for the existence of a network in the crypto realm do not become its overlords. As a result, developers must be aware that what works now for their token projects may not work in the future. The network’s growth and maturity may necessitate changes to token governance structures.

Tokenomics Designing

Tokenomics Designing

Tokenomics Designing

After a comprehensive review of all major characteristics of tokenomics, it’s vital to think about its design. It’s critical to make sure that a token economics model is both secure and long-lasting. Any evidence of infrastructure failure could lead to major inconsistencies. Malicious users, for example, may be able to take advantage of the network for personal gain. As a result, it’s imperative to build a good model based on a thorough grasp of “what is tokenomics.”

The right token model has the potential to help avoid many critical challenges, but it also needs a significant amount of time and resources. A team of programmers, economists, and mathematicians with academic and industrial experience would be designed to establish a reliable token model. The programmer’s insights into the scope and development of a token model could be crucial in assuring its effectiveness. Despite its complexity, the procedure commonly revolves around the consensus mechanism.

Use Cases of Tokenomics

It’s worth noting that the direction of tokenomics price evaluation is also influenced by use cases. The research of various token economics use cases might provide a clear picture of how it would shape the future of crypto and blockchain technology. Here are a few significant token economics uses.

  1. Staking – Staking is one of the most valuable aspects you’ll find in a tokenomics handbook. Validators with more value in their wallets have a better chance of reaping big rewards for confirming transactions, and validators with more value in their wallets have a higher chance of reaping massive rewards for verifying transactions. The Delegated Proof of Stake model is an excellent example of how token economics can be applied to staking. The random delegation and selection are the main differences between this strategy and a PoS model. As a result, high-stakes users may find it challenging to receive validation incentives on a consistent basis. As a result, it provides a credible technique of wealth distribution.
  2. Value Exchange – The most common example of tokenomics use cases also relates to the use of tokens to exchange value. Bitcoin is a prime example of how token economics may be used to exchange value. Ethereum has successfully demonstrated that token projects may use token economics to both exchange and add value. It can make use of token economics to encourage financing as well as create decentralized applications (DApps).
  3. Project Contribution – The contributions for project development were one of the many use cases of tokenomics in 2020. The use case of tokenomics for incentivizing contributions to a project is vividly demonstrated by the example of STEEMIT. For their contributions as content creators, moderators, and commentators, STEEMIT awards users with tokens.
  4. Tokenomics Value – A tokenomics guide’s final addition would undoubtedly refer to the value it adds to the table. Token economics may be useful in considering both economic and social costs when accounting for token projects. This is an important necessity in an era where tokens will be used to represent nearly any real-world asset, including precious metals, real estate, artwork, and collectibles. Above all, tokenomics is capable of providing the value of community-based solutions that are aligned with consumer values.

Tokenomics Empowering NFTs

NFTs represent a digital property on a blockchain and are not interchangeable. They are used to enhance scarcity and uniqueness in the digital realm. We may foresee a huge upheaval in the video gaming business as digital artists adopt blockchain technologies in order to sell NFTs.

Since the launch of the first consoles, the videogame industry has evolved at a breakneck speed. With the explosion of broadband communication and smartphones, there has been a further progression toward the use of gaming platforms that do not require the purchase of specialized technology and allow players to interact with others across the world. As a result, video gaming has evolved into a social activity comparable to sports played in gyms or on courts.

Many video game start-ups and projects could be launched thanks to the ability to raise substantial funds through crowdsourcing platforms like Indiegogo and Kickstarter. Entrepreneurs have frequently sold utility tokens in exchange for funding, tokens that will be utilized in games once they are released. This not only empowered them to get the project off the ground, but it also meant that they had a lot of clients before the game was ever released.

Additional financing sources for NFT could be obtained by pre-selling unique items for the next game.

To finally conclude, tokenomics is still a developing field. Given that it alters many of the present world economy’s underlying cornerstones, there is a lot to learn. They are building more intricate and particular use cases every day as token acceptance grows.

The study of extremely disruptive technology is known as tokenomics. The government’s regulation of token economies, as well as the simplicity with which organizations, producers, and consumers can be tokenized, will be critical to its success.

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