Tokenomics 101: How to build a thriving financial community using blockchain

At Jia, one of our main value propositions is creating a financial community where entrepreneurs participate as owners, not just customers. This commitment is based on our core belief that ownership enhances the behavior of small business entrepreneurs within a community, encouraging loyalty.

In other words, Jia is building a system where everyone wins.

How will we do this? Jia will reward customers with tokens when they take certain value-added actions. For example, customers will earn rewards when they repay their loans on time, bring in new members, or provide a service to the Jia community.

Tokens are a vital element of many blockchain projects. Yet, implementing a successful token system requires careful thought: while game theory and incentive alignment in a well-designed system can provide an edge, a poorly designed system can destroy trust by creating unrealistic expectations from investors.

As part of our crypto education series, we performed a comprehensive review of “tokenomics,” the economic principles underpinning blockchain tokens. This article summarizes the key points from the session and explores how to ensure that token systems thrive.

Overview of Tokenomics

The word “tokenomics” is simply a portmanteau of “token” and “economics.” In building the economic foundations of a blockchain token, it is essential to consider the token’s supply, demand, and utility within a project’s ecosystem. Successful tokenomics align the incentives of ecosystem participants and safeguard value.

Tokenomics can be readily compared to the management of fiat currencies. For example, factors including total supply, domestic and international demand, and federal fiscal policies influence the value of the United States dollar. Additionally, the USD’s status as the global reserve currency upholds the currency’s value since international actors utilize the dollar as the primary unit to borrow and transact. This gives the dollar immense utility and incentivizes entities to hold USD. Supply also impacts the dollar’s value: in response to the financial shock created by the COVID-19 pandemic, the US government enacted loose monetary policy and deployed large amounts of fiscal stimulus, increasing the global supply of dollars by 40% within two years. These policies caused the dollar to depreciate and contributed to the high inflation rate recorded in 2022 and 2023.

Factors such as supply, demand, and utility similarly influence the value of cryptocurrencies, though typically with greater volatility. For example, innovations such as DeFi and NFTs have given increased utility to Ether since 2020, contributing to its value increase. Since “the Merge” in September of 2022, ETH has become deflationary, further influencing its value going forward.

The principles of managing a token economy are broadly similar to a government’s managing of fiat currencies through monetary policy, considering factors such as supply, demand, and utility.

Our research into tokenomics yielded the following insights on the structure underlying effective token systems.

Key Elements of Tokenomics

1. Total supply: The total number of tokens that will ever be created. An unlimited supply may negatively impact a token’s price, while a capped supply can contribute to price stability and potential value appreciation. For instance, Bitcoin’s limited supply of 21 million coins has significantly enhanced its price performance.
2. Circulating supply: The number of tokens available to the public at a given time. The circulating supply affects market dynamics and assists in calculating a token’s market cap. Shifts in circulating supply can influence short-term and long-term outlooks.
3. Token distribution: How, when, and to whom tokens are distributed. Token distribution significantly influences token behavior and market dynamics. Distributing tokens to users who have genuine incentives to hold them can augment stability and utility.
4. Utility: The range of applications and use cases for a token. A token’s value increases when it has various practical purposes within an ecosystem. Conversely, if a token lacks utility, its value diminishes.
5. Income: A token that gets to participate in a consistent stream of revenues can be rationally valued according to timeless investment principles rather than on speculation alone. Connecting a token to such a stream can help ensure it maintains its value indefinitely.

After understanding the mechanics of successful token systems, we outlined some key areas where implementing tokens can improve the functionality of blockchain projects.

The Importance of Tokenomics

1. Boosting network participation: Well-designed tokenomics can incentivize users to participate in a blockchain network. By distributing tokens as rewards, companies can attract more users and encourage engagement. This advantage distinguishes crypto companies from traditional businesses: the former can create and distribute an asset with value, effectively aligning incentives for network growth.
2. Aligning incentives: Because the creators of a crypto project can control all of the factors outlined previously, they can, in effect, enact their own monetary policies to drive desirable behaviors within their ecosystems. For example, just as the US government grants tax breaks to encourage electric vehicle purchases, a protocol like Jia can distribute extra tokens to clients who take actions that benefit the ecosystem, like repaying a loan on time.
3. Protecting token value: While we may seem overly focused on the value of a token itself, maintaining a token’s value is crucial to upholding its utility and sustainability. Tokens must have value to fulfill their intended purposes within an ecosystem. If, for example, the value of the US dollar was not relatively stable, participants in the global financial system would shift to more stable assets, and the dollar would lose its utility. Emerging markets with rapidly depreciating currencies, such as Turkey and Argentina, exemplify this phenomenon. Effective tokenomic policies involve managing supply, ensuring scarcity, addressing inflation concerns, and considering a token’s associated cash flows.

Maintaining a token’s value is crucial to upholding its utility and sustainability. Tokens must have value to fulfill their intended purposes within an ecosystem. Just ask Gru.

While it’s critical to understand the fundamentals of tokenomics and its significance in supporting blockchain-powered products, many token systems are adversely impacted by some common shortcomings. Our research yielded the following strategies to maximize the success of a token system’s performance.

Avoiding Common Pitfalls

1. Pay attention to fairness: Ensure that tokens are distributed to individuals who contribute to the community or the protocol. Mitigate the deployment of tokens to individuals lacking ecosystem-oriented objectives.
2. Don’t rely solely on governance: Since governance aligns with the ethos of decentralization underlying the crypto space, it’s a common use case for tokens; however, it should not be the only utility. Ensure that token ecosystems maintain utility outside of a completely governance-oriented structure.
3. Avoid centralization and manipulation: When implementing governance through token holders, prevent the concentration of tokens in a way that allows a few entities to unilaterally control the protocol. Distribute tokens carefully and allocate voting rights appropriately.
4. Emphasize security: Pay close attention to security measures, as smart contracts are exploitable by nature. Be cautious of vulnerabilities, 51% attacks, civil attacks, and social engineering. Since the crypto space often attracts unscrupulous individuals, maintaining security is crucial.
5. Avoid relying on hype: Building a successful project requires more than hype. Focus on creating a firm foundation of real-world utility for the token.
6. Don’t overlook regulations: Pay attention to regulatory aspects when launching tokens. In an unregulated or ambiguously regulated space, be transparent and comply with relevant restrictions in order to avoid potential shutdowns or legal issues.

The Road Ahead

Through understanding tokenomics, blockchain projects can supercharge their growth and drive more value to their users than traditional internet companies. But, in the nascent space of token design, where fundamental principles are still being established, it’s easy to stumble into mistakes that hold a project back.

At Jia, we’ve worked to understand this trade-off — we’ve integrated the considerations outlined above and more into our rewards token structure and will continue adapting our tokenomic strategies to keep pace with new developments in crypto.

This diagram shows how Jia’s rewards token system incentivizes pro-ecosystem behavior. Read more in the Jia Litepaper.

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