My Strategy to create and evaluate Tokenomics
Web3 and decentralization are bringing Tokenomics to the next step.
What I take into consideration when designing a Tokenomics from scratch or when I am asked to evaluate one?
Tokenomics is a neologism merging Token & Economics.
Token is not any more a simple line of code, getting some features. Token becomes a new metric for arising projects in the Web3 / Cryptocurrency space acting as a form of crowdfunding and a tool to incentivize users in using a platform.
The first mistake I see people making is giving to Tokenomics too much responsibility. At first a proper Product Design has to be made and a clear (and numerically designed) Business Model has to be evaluated and re-evaluated.
Product Design, Business Model and Business Plan are usually carried out consequently while in my opinion the correct approach to be taken is an iterative mode. Like computers and computational softwares try to guess randomly the solution of a problem (with convergence algorithm), entrepreneurs too often trust too much that their product is worthy, it will be bought from people and it will create an adequate cashflow for co-founders to live by that business.
A lot of variables arise when setting up a start-up through different stages and the biggest mistake is thinking that Tokenomics will fix and optimize them all. Tokenomics is going to be another gear that can both power up or power down the engine.
But let’s see what Tokenomics should look like.
At first we must define some differences among different tokens that can get a role into the Tokenomics.
Utility Tokens: these are the most exploited. After the 2017 jungle-bubble of ICOs, Utility tokens are starting another rush in several different business fields. They are not representing financial instruments, they should not give passive incomes/yields AND they allow the user to perform action into the ecosystem.
Security Tokens: they represent financial instruments and they often have to be regulated from the national (or international) financial authorities. They can represent portions of Real Estates and other assets used for financial purposes, Company shares and more. Their regulation is far stricter than Utility tokens.
NFT: Non Fungible Tokens. They represent something specific, non dividable and not always interchangeable among them since they usually represent different functions, different tools, rights or Game characters.
Tokenomics as I am going to talk about will be mainly intended for Utility Tokens (and ancillary NFTs), while for Security Tokens, the dynamics are mostly connected to the traditional financial model they will represent.
Here are the main questions I ask to “wannabe-Tokenomics” projects or questions I often receive from the,
Is a Token really needed?
At first, we must understand if a token is really required into the project. There are several ways to adopt an internal token:
— initial crowdfunding
— scale-up of an existing project
— incentive
— privatization of transactions and/or data
Tokenomics is meant to cover all of these aspects but its design will lay upon different layers of design, from the macro-tokenomics to the internal token flows.
What is the Token utility?
When designing a tokenomics the answer to the question “Is the token really needed?” was YES, then features/utilities/applications of the token must be found and designed. The risk otherwise for people pre-funding the project (Pre-Sale, Seed Sale, Private Sale) is that after the listing the token will be worthless, creating a huge and long-lasting dump of the price.
So what is this token going to be used for?
- Internal purchases of Services, Products, assets, rights
- Voting power in a DAO (or equivalent)
- Tool for the exchange of services or digital products
- Access to exclusive services
What token behaviour? Inflationary or Deflationary?
I read people that defines Inflationary a token that simply increases it’s Circulating Supply. Anyway, if the supply of an Inflationary token is capped, it should be called “Capped Inflationary token” and the inflation rate will likely decrease over time, due to an increasing circulating supply (making the inflation rate to decrease over time).
Here is a numerical example.
Let’s say that a Token has a capped Supply at 1000 tokens. 100 tokens are initially released into the market and 10 tokens every month are released as Users Rewards.
The first month, inflation will be 10 released tokens on a total circulating of 100 tokens, so the inflation rate would be 10%.
The second month, inflation will be 10 released tokens on a total circulating of 110 tokens, so the inflation rate would be 9.09%.
Still Inflationary, but with a decreasing Inflation Rate.
Furthermore the token can be locally inflationary (meaning that the Circulating Supply is increasing over time) but Deflationary overall, due to some burn mechanisms.
Burn mechanisms usually reside into some transactions fees and other usages mechanisms but there are several ways to make a token deflationary.
What brings value to a project?
In a Cryptocurrency project including a Tokenomics, the massive sell has to be prevented and this can be achieved in several ways. The common ground for all the strategies to prevent the Massive Sell is to give benefits to Token Holders, in the form of access to exclusive areas, contents, services and more.
The huge difference from an Equity Crowdfunding, is that the company can still make profit out of the business while the token price drowns so token holders would find themselves with something worthless in their Wallets. That is why, from the very beginning, the Advisors and the Project Founders must have a clear idea in mind of the future uses of the token in an ethic and intellectual honesty attitude.
What different layers of Tokenomics?
The Macro-tokenomics is the division of tokens among different fields:
— Team
— Reserves
— Marketing
— Liquidity Pool
— Seed Round
— Private Round
— ICO/IDO…
— Staking (eventual)
— Rewards (eventual)
This is simply the token allocation that is just the Layer1 (Macro-Tokenomics) of the Token Economics.
Layer2 is not the Fund Allocation (from pre-funding and crowdfunding) since that is definitely a business decision. Layer2 is the so called Token Metrics.
Token Metrics is literally the measurement of the Token:
— How many tokens will be issued in total?
— Capped Supply or No-Cap Supply?
— How many decimals (if any)?
— What Blockchain will be the token issued on and/or bridged to?
— What is the vesting schedule?
— What will be the Initial Market Cap?
In the Layer3 of the Tokenomics, Token Flows have to be defined and designed, to make sure that all the tokens know in each moment where they are supposed to go or stay.
The tool that I am using at the moment to design a safe Tokenomics is the “Zero-Sum Game”, that I learnt during University with Chemical Reactors, that makes full sense also when applied to Token Flows. I am already using it in projects I am collaborating with and it’s bringing some interesting insights.
What characteristics should be pursued for a fast and scalable ecosystem?
Fast and cheap transactions. For this, some networks like Binance, Polygon, Algorand and many more are better indicated than others.
Layer2 solutions: some part of the ecosystem can be managed off-chain, to reduce on-chain transactions and synchronize with a specific frequency (seconds/minutes).
Easy to use platform: the user should be easily get access to the platform features, and understanding what advantage he/she can get with the native token.
Keep in mind that a lot of projects are evaluating the issuance of a single token, but instead, they should be advised to create a double token, one for the listing and another (a similar stable-coin) for internal uses and to avoid price fluctuation of the services. The internal-only stable-coin can be used just as an accountancy tool/unit of measure for the prices to avoid them to become too expensive (if the native token pumps) or too cheap (if the native token price dumps).
Governance can be another “second token” use case. A utility token to perform internal activities and a Governance Token to measure and distribute Voting Power. Governance Tokens are often represented by NFTs, like in The Land Safe and other ecosystems.
By the way, Tokenomics requires a lot of thoughts to be carried out and the worst thing you can ask a specialist in this area is “to give a feedback” about the Tokenomics, based on the Whitepaper or the Litepaper.
There are several aspects to be considered and usually, the only visible Layer of Tokenomics are “Layer1” and sometimes “Layer2”, meaning that all the internal distribution of Tokens are not visible.
I hope that this article could help you understand what Tokenomics really is and why a lot of attention has to be paid to create a good Token — Ecosystem.
Feel free to reach out for any questions and share this article with whom you may think can get benefit from it!
Mike
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