What to understand by the Token Economics?
Token economics is understood as a subset of economics that studies the economic institutions, policies, and ethics of the production, distribution, and consumption of tokenized goods and services.
Blockchain technology seems to be the driving force of the next-generation internet. Dubbed by many as Web3, it enables tokenized economic interactions without intermediaries. Web3 is an idea for a decentralized and public blockchain-based version of the Internet. Web3 is heavily based on various cryptocurrencies and blockchain technologies such as NFTs. Some visions are based on the decentralized autonomous organization (DAO) concept, which seeks to ensure that many people have equal ownership and governance in an organisation. Decentralized finance (Defi) is another key concept where users exchange money without bank or government intervention. This unique state layer on Web3 allows us to send digital values purely peer-to-peer (P2P) in the form of tokens, eliminating the double-spend problem. In this way, sending digital assets over the web has become as cheap and easy as sending an e-mail. As of April 2022, close to 10,000 public tokens are listed on CoinMarketCap. Having peaked at 2.5 million contracts deployed in June, Ethereum has seen more than 900k contracts deployed from September, which is when Cardano smart contracts were first introduced. This equates to an almost 1,000 times increase in the number of smart contracts being deployed on Ethereum. In June 2019, the social media giant Facebook announced that it is working on its own token Facebook Diem (formerly Libra token) and Web3 infrastructure the Diem Network (formerly Libra network). In addition, Diem will have no fixed token supply. Rather, its single currency stablecoins will be minted and burned by Diem as needed in response to market demand, and each token will be backed by a reserve of liquid assets.
To understand the token economy, we should first look at the economic models of the top 100 paying Tokens. In this context, we need to take a look at 4 different token economic models.
These models are:
1. Deflationary Model (Currency)
In a deflationary token economic model, although there is an increase in demand, the incremental increase in demand is not accompanied by an increase in supply. Thus, there is a hard upper limit on the number of tokens created as a deflationary mechanism. We can give BTC, LTC, and BCH as an example of the Deflationary Model (Currency).
2. Inflationary Model (Utility)
There is no limit to the number of tokens created in an inflationary token economic model. There are several iterations of the inflationary token model, where some token issuers limit token generation on an annual basis, others exit a specific schedule, and some prefer to determine supply based on demand-driven data. As an example of the Inflationary Model (Utility), we can give ETH, DOT, and SOL.
3. Dual-Token Model (Other) -
In a dual token economic model, two different tokens are used in combination on a single blockchain. This usually includes a value store icon as well as a utility icon. This model aims to encourage users to retain the store of value tokens to receive returns in the form of utility tokens that can be used for transactions on the chain. Examples of the Dual-Token models are (Other) VET & VTHO, NEO & GAS, and ONT & ONG.
4. Asset-backed Model (Stablecoins)
In an asset-backed token economic model, an issuer pegs the value of an asset to the token’s underlying assets, similar to an Asset-Backed Securities in traditional financial markets. Asset-based models may rely on assets with fluctuating valuations such as gold or fixed assets such as the US dollar. Examples of Asset-backed Models (Stablecoins) are PAXG, USDT, and USDC.
Token Returns in the Context of the Economic Model
When we examine the token returns in the context of the four models we mentioned above, we see that the model that brings the most returns is the inflationary model. The rate of return of the inflationary model was 2392%. On the other hand, the high rate of return of the inflationary model is not much different when compared to the deflationary model (2067%) and the dual-token model (2084%). Asset-Backed Models’ return rate was 116%.
Three Major Consensus Mechanisms
There are three basic mechanisms that blockchain networks implement. These mechanisms are:
1. Proof of Work (PoW)
2. Proof of Stake (PoS)
3. Delegated Proof of Stake (DPoS)
Networks like Bitcoin, Ethereum, and Litecoin have PoW, and NXT PoS, and both EOS and Telos are in the newest mechanism, DPoS.
In PoW consensus, the network consists of nodes, or in this case miners, who verify and record transactions on the chain. They must have high computational resources to create blocks and deal with complex computations. The miner who generates the last hash values receives a reward. The difficulty of the hash decoding algorithm increases due to the increasing number of miners. As a result, miners need a higher level of computation to solve them. This of course means more expensive equipment and higher energy consumption. The negative effects of this on the environment and climate change are the subject of another article.
There are no miners in the PoS consensus. However, the more tokens the block producers selected according to their token share have, the more blocks they can work on. This method was developed as an alternative to PoW, which offers lower costs and energy consumption. High stakes users, on the other hand, are selected for verification, giving them much more power than most other users. In response to this problem, DPoS was implemented. Block producers are selected by all token holders through a voting system. Therefore, BPs must demonstrate to the community that they are worthy of their grant by excelling in transaction verification, block generation, and overall maintenance of both the mainnet and testnets. The voting system for Telos is counter-weighted; this means that the weight of a vote depends on the number of votes cast. Token holders have a maximum number of BP candidates to choose from. If they vote for that number of candidates, their vote will have full effect, while if they vote for fewer candidates, the votes will be devalued. This procedure avoids voting and encourages the higher performance of BPs.
Among the top 100 cryptocurrencies, the most common consensus mechanism is PoS. More than 55% of token projects use this method. Looking at the returns earned by the consensus mechanism over the past 1 year, we can see that Pow tokens outperformed other categories followed by DPoS.
On the other hand, coins with the most returns with the consensus mechanism can be further fragmented by the economic model and consensus mechanism.
Deflationary PoS has had its best performance in the past year. On average, it saw growth of over 6000%, while Inflationary PoW tokens saw growth of over 4000% over the past year, the second-best performing. In the case of Deflationary PoS tokens, investors have a fixed cap on the total supply. Thus, they are attracted to token models where they can earn returns on their holdings. In the case of Inflationary PoW tokens, investors are once again incentivized by cash flow, but this time by mining rather than staking. For mining rewards to be high on new platforms, token issuers must use an inflationary model that allows them to offer high returns for early miners.
Token Distribution Channels
There are multiple ways of token distribution. There are options, such as an ICO (or IDO) or a Private Sale, that are funded by allowing the token issuer to sell the tokens directly at a fixed price. There are also unfunded options such as distributing tokens to existing holders of another crypto or allowing users to sign up to receive tokens via an airdrop. Tokens can also be released only through PoW or PoS, where the tokens act as a reward to miners or token holders who choose to have stakes in the network. These distribution methods have varying effects on the performance of the token.
However, deflationary currencies like Bitcoin often have a distribution method. This method is also mining. On the other hand, inflationary currencies like Luna have more than one distribution method. These distribution methods are:
- Inflationary Rewards: Staking or Mining
- Fundraising Events: ICO (Initial coin/currency offering) or Pre-Sales
- Airdrops
Many of the protocols that distribute rewards based onplatform usage are deflationary. Therefore, it has a fixed upper bound. This means it’s always early users who get the rewards. Thus, it promotes Token discovery.
References:
https://www.oreilly.com/library/view/what-is-the/9781492072973/ch01.html
https://research.thetie.io/token-economics/
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