Money has percolated every aspect of our lives and has prominent applications in every organization and individual’s daily activities. We need money for daily transactions to pay for services, while on a larger scale, multinational corporations need money to conduct businesses. Money influences almost every aspect of our lives. Can you believe something that influences us so much is controlled by governments and institutions such as banks?
In fact, we have developed an entire science, which we call monetary policy, around the control of money by banks and governments. Even today, central banks are the only institutions that are authorized to issue currency to citizens. However, cryptocurrencies have changed this balance in favor of individuals, who can now create their own micro-economies. And this is where tokenomics comes into the picture. Tokenomics takes what we call monetary policy and applies it to the blockchain.
What Is A Token?
Before we get to tokenomics, we need to understand what a token is. If you take real life as an example, there are several examples of “real-life tokens.” A token is something that can represent a quality or a feeling. An everyday example of a token would be your house keys; they represent the fact that this is indeed your house. Your hotel key signifies that you have paid for your room and your membership card to a club or gym indicates that you are a member of those organizations.
Tokens are created on existing blockchains or platforms, and they are a representation of something in the ecosystem. What exactly could they represent? Tokens could represent anything ranging from staking, voting rights or represent value on the ecosystem.
What Exactly Is Tokenomics?
So, tokenomics is a fairly broad term that encompasses more than a couple of things. The word, as you can see, is made up of two words. “Token” and “Economics.” We have seen the word quite often during the launch of a new project when in the announcement, there is a segment titled “tokenomics.”
Tokenomics is the token’s quality that can convince investors and users to invest in the token and build an ecosystem around it. As mentioned earlier, tokenomics is a broad term. Let’s take a look at what makes up tokenomics.
The Team Behind The Project
If a project wants to gain credibility, then it should have a credible team behind it. This is critical for ensuring the adoption of the project and the token. Projects like Algorand and Basic Attention Token (BAT) come to mind, which are both stellar projects and have an incredible team behind the scenes that build the confidence of investors and users in those projects. A project with a “meh” team behind it is not going to get anywhere.
A good project needs a good community to drive its adoption. Even if the project is fundamentally sound, it is likely to fall by the wayside without an active community behind it. Some projects focus more on the project and token instead of the community. However, the most successful projects and the most stable tokens are the ones with an active community behind them.
Token allocation is one of the most essential aspects of tokenomics. This deals with how the token will be distributed throughout the community after the token sale has concluded. Details about the token allocation and details on the lock-up period (how long you need to wait before you can spend the tokens) are found in the project’s whitepaper. Projects with long-term potential have significantly longer lock-up periods.
The core team behind each project drafts rules for how tokens are created and introduced or withdrawn from circulation. Some projects hold a certain number of tokens in reserve, and those tokens are introduced into the ecosystem at a later stage. This is done to promote growth or ensure payments for upgrades. Ripple is an excellent example of this type of governance mechanism.
Some projects are a bit more passive when it comes to governance, with developers on the project not involved in the network’s day-to-day operations, focusing instead on the maintenance of the infrastructure. Augur is an excellent example of this hands-off approach.
Tokenomics is also utilized to give users the power to vote or make decisions, while some networks also provide their users economic incentives for holding and staking tokens.
The tokenomics of a project will also give you a perspective on the project’s real-world utility, which could help you gauge if the project is bringing any real-world value to the markets and its adopters. If a project is tied closely with its token, it is generally an excellent project to invest in from an investment perspective.
These were the essential components of tokenomics. Now let’s take a brief look at the types of tokens.
Types Of Tokens
There are several types of tokens, each of which are divided into categories.
Layer 1 vs Layer 2 tokens
Layer 1 is the main blockchain, and the tokens powering the blockchain are known as layer-1 tokens. Layer-2 is built on the existing Layer-1 blockchain. Ethereum is an excellent example of a Layer-1 and is powered by its token, Ether. Polygon (formerly Matic) is an excellent example of a Layer-2 solution powered by its native token.
Utility vs Security Tokens
A security token derives its value from a tradable, external asset. These tokens are subject to federal regulations. If the ICO of these tokens breaches regulations, they could be penalized. The value of the security tokens is directly related to the company that’s issuing them. Its future valuation depends solely on the performance of the company and its people. Stocks are good examples of securities.
Utility tokens are used to perform certain functions within the protocol. For example, in the Bitcoin network, the BTC token is used as a mode of value transfer. There is no “Bitcoin Company” on whom you are dependent as a holder for the future valuation of your token. The token is there only to fulfill a particular utility, hence the name.
Fungible vs Non-Fungible Tokens
A fungible token is a token that can be exchanged with another similar token. Bitcoin is an excellent example of a fungible token. Fiat currency is also an example of fungibility. You can take a hundred-dollar bill from someone and then return another hundred-dollar bill. Non-fungible tokens, on the other hand, are unique, which means another token cannot replace them. Digital collectible items or even physical collectibles are non-fungible, gaining value from their potential to be unique. Fungible tokens, on the other hand, can be used as payment tokens.
Conclusion: The Importance Of Tokenomics
Blockchain and blockchain technology products have successfully created micro-economies that have their own ecosystem. To ensure the stability of these micro-economies, projects must know precisely how the tokens should function in their ecosystem. Tokenomics is crucial because it allows the teams behind each project to adapt an existing model or create an entirely new model that would work with the project’s goals in question.
Alright, it’s quiz time!
Before you take the quiz, make sure that:
- You have a verified CoinSmart account (to get your reward if you successfully answer all the questions).
- You use the same email in the quiz that you use to register your CoinSmart account.