How to Use Market Data for Token-Economics Design and the Common Structure of Token Flow
What Is a Token?
New digital currencies and crypto-assets are coming out constantly and developing rapidly. As of today, there are more than 5,000 unique crypto-assets, coins, and tokens being offered to the community. Tokenization and token issue are rapidly-developing movements toward decentralized means of value exchange and crypto transactions.
What is a token? It is a digital footprint of valuable data in IT systems that are tightly involved with blockchain technology. As a critical part of transactions and smart-contract logic execution, a token operates in the context of a specific application or project, performing various functions, like:
- storing, moving, or managing certain data or assets without their actual involvement
- trading of assets through the use of their unique digital footprint
- exchanging
- purchasing certain products/services
- rewards, etc.
A token can be defined as a digital unit with a value defined by a community or self-governed or private organization/entity, to enable user interaction with products or services along with distribution and sharing of token value in rewards and benefits systems for stakeholders without the need for actual asset transactions.
According to technical investor Nick Tomaino, tokens can be divided into four types:
- traditional asset tokens: cryptocurrency representations of fiat assets
- usage tokens: provide access to all types of digital services, such as virtual transactions/payment networks
- work tokens: enable user contribution to decentralized organization workflow
- hybrid tokens: combine features of usage tokens and work tokens, serving multiple purposes
In general, we offer the following definition of that classification:
- Tokens with a universal value under economic consensus: coins and cryptocurrency with features of fungibility and the ability to act as a universal tool for exchange (like fiat money)
- Asset-backed tokens: tokens that represent assets as their digital footprint, with value guaranteed within those assets; this includes tokenized securities that use the same logic.
- Subscription tokens: provide access to all digital services of a certain platform without limitations on their circulation outside the platform; their value is defined by demand for platform services, but could be driven up or down by market speculation. These strategies allow the introduction of rewards mechanisms, but they are extremely volatile.
- Utility tokens: tokens that are used for event activation in a dedicated blockchain that equals to an exact service with the limitation on token circulation
- Hybrid tokens: combine the features of other tokens except for features of cryptocurrency
Within the blockchain and crypto space, tokens act as a digital event activator to exchange value between users in the network.
All tokens except cryptocurrencies have a different purpose and value, thus, the process of economic consensus defined for them, called tokenization, is enforced by token economics.
Token Economics
When speaking about token economics, it’s important to differentiate between coins and tokens.
“A coin is considered to be cryptocurrency that functions as a currency unit and holds certain value. A coin can be used for exchange to purchase a product or service. A token possesses a certain economic consensus, and is linked to an assigned value, like a utility feature or possibly real estate, gold, services, etc. Therefore, launching a coin isn’t considered to be an ICO process, as this launch is conducted separately via the blockchain platform. A token launch, on the contrary, is connected to the ICO process; thus, when launching tokens, they are assigned a particular defined value,”
clarifies Stanislav Sheliakin, Applicature business analyst.
Both coins and tokens can be used for trading purposes, but it should be emphasized that coins have a general currency function while tokens can be involved in trading purposes only within their in-platform project.
When designing token economics, each token or crypto-asset should be built considering the economic reason for its existence. It should have a real utility or consensus value behind it, besides the speculative value or market price. Token economics offers a number of advantageous features and incentives to encourage token-holders.
Tokenization has recently become one of the hottest topics in the crypto community, mostly due to the ICO (initial coin offering), or, more technically, TGE (token generation event) phenomena. During these campaigns, a company issues crypto assets, like digital coins or tokens, for investors to purchase as shares or as a company investment. Consequently, the company or project is capable of raising capital worth millions of dollars using the VC crowdfunding model.
Promoting tokenization on blockchain platforms and decentralized networks creates increased and significant ease of value exchange among the participants. Tokenization allows:
- fair trade
- faster transactions
- cost efficiency
If tokens serve certain purposes from the cryptocurrency aspect, act as fuel for the network, and set economic rules, they get promoted much faster and accomplish a greater number of goals than just fundraising. They should be designed specifically to support a certain industry or network.
Token economics is considered to be well-designed if it not only delivers cryptocurrency liquidity, but also digitizes asset value, proves flexible over time, and promotes work efforts while offering fair exchange options.
The Token Economics Model
To understand token economics, its process should be divided into six main stages of value creation in the token workflow. It should also guarantee token necessity within the platform.
1. Rights
Token ownership should have an engagement purpose and bestow rights to the following features:
- product usage
- governance
- contribution
- voting
- product/market access
2. Value Exchange
A token, being an atomic unit, should have the purpose of transactional economy creation between the parties. The value exchange combines such features as:
- buying/selling options
- spending
- work rewards
- active or passive work
- product creation
3. Tolls
From this point of view, a token should be considered as the fee paid to use a product within the blockchain infrastructure. A toll ensures that all involved participants are running a financial risk of investment, and thus have skin in the game. This process includes:
- smart-contracts implementation and use
- deposit fee payments
- transaction fees (or usage payments)
4. Token Function
A token should be used to enrich the token-holder’s experience, which includes such basic options as:
- joining the network
- connection and communication with users
- incentive for participants
5. Currency
It should be noted that the currency aspect applies only to coins (as they can be used for general payment purposes), while tokens are involved only in certain platform trades.
As an efficient method for payment transactions, a coin acts as a key to enable frictionless transactions. To avoid centralized control and high cost of payment processes, companies can act as payment/transaction units themselves. Hence, payments can be processed faster, more securely, and more efficiently in certain markets.
6. Earnings
As a result, at the end of any campaign, tokens should increase in value. Earnings or profit should be distributed between the participants, and enable:
- profit-sharing
- benefits-sharing
- inflation benefits
The Token Flow and Its Structure
Token flow is a critical element of token economics, as it ensures volatility-prevention measures with appropriate supply-and-demand order. Key theoretical concepts for token flow can be found in the experiments of economist and Nobel Prize winner Vernon Smith. They reveal how some token-holders behave if they are interested in token utilization, while others receive tokens only with a speculative purpose. As a result, these tokens are always accumulated by interested parties.
This idea must be applied to the token economics approach. Each token issuer should consider key market actors interested in token utilization. Considering that these actors will accumulate tokens, issuers must define rules for how those tokens will be distributed after token utilization within a wide community (for higher speculator demand) or within interested parties (lower demand, but less speculative volatility).
One of the most suitable approaches allowing limitation of the utility transaction amount, which is also leaner on fees, is to use a kind of subscription in which users stake their tokens to access the platform. Activities include the option of changing account balances. After this activity is finished, smart-contract or multi-signature (escrow) transactions release the remaining funds back to the user.
How to Use Market Data for Token Economics and Workflow
There are two approaches for defining the number of tokens for issuance. For this purpose, micro and macro approach can be used.
The micro approach is used directly from the company’s point of view. When the total amount of funds necessary for product development is defined, the company issues a certain number of tokens according to the ICO launch cost. Consequently, the market defines the price of the token, depending upon the product’s supply and demand on the global market. In this model, the company fully depends upon product demand and the market defining the token price.
The macro approach is an assessment of market data according to which the token economics plan is built. If the company wants to conquer the market and avoid price volatility, the macro approach is chosen, as it allows one to decide how many tokens to issue and at what price.
If blockchain technology is implemented in order to tokenize a certain market, or if we want our token to serve as currency for a specific market segment, the perfect solution is to set the ratio at 1:1.
If the market segment is evaluated as a $250 million/year turnover and the company wants to tokenize this market with the help of its platform, the company must issue an exact number of tokens (250 million). Hence, ICO cost is defined according to the number of issued tokens: if the company needs to raise $25 million and the market segment equals $250 million, then the company issues 250 million tokens with the price of 10 cents, with the potential to grow up to $1 if the team reaches its targets.
Conclusion
It is obvious that token economics is crucial in the ICO launch process. In order to issue strong tokens that will later be in demand, they have to possess cryptocurrency features, act as fuel for the network, and set economic rules. If a token is designed specifically to serve a certain industry, has defined purposes, and is necessary within the project, it gets promoted quickly and accomplishes different goals. In order to decide the number of tokens to issue, there are two approaches to choose from: micro and macro. The micro approach is used when the company defines the number of tokens to issue depending upon ICO launch costs. The price, however, is regulated by the market. If the company wants to conquer the market and avoid price volatility, the macro approach (market data assessment) is chosen, as it allows one to decide the number of tokens to issue and at what price.
