Tokenomics

The power of incentives.

What is Tokenomics?

Tokenomics is the study of how specific cryptocurrencies work and incentivize human behavior within their ecosystems. This includes things like token distribution, issuance, staking mechanisms, rewards and governance. A project with the right tokenomics can help tell their brand’s story, attract massive liquidity and recruit network participation overnight.

Bitcoin invented digital scarcity. This profound idea is playing out in real time across the crypto universe.

A digital token that represents a unit of real world value is a great incentive to drive human behavior. When a central bank wants to incentivize borrowing and spending; they change their monetary policy, lower interest rates and print reserves. Similar mechanics can be implemented in crypto, but it’s done in the open, so the network’s operations are predictable and immutable.

Token distribution

Projects need to distribute tokens to become a distributed network. The question is — how to do this and how to do this in the best way to bootstrap liquidity, increase the token’s value and drive network effects?

Projects can:

• Reward network validators or miners through new issuance.
• Host a private sale where users get early access to discounted tokens and which are then locked for a particular period of time post launch to help stabilize price.
• Reward users for specific behaviors. For example, Uniswap the largest DEX uses liquidity pools that allow traders to swap different tokens without a centralized party. The liquidity pools are created by users who stake their tokens in exchange for yield created by the cash flow from the exchange fees.

Governance

Since there’s no one authority, decentralized projects need a way to evolve and make decisions as a community. These decisions can impact the projects token issuance schedule, which can impact the token’s scarcity and ultimately it’s value. Therefore, the project’s core designers can create rules that help drive quality decision making for the long-term health of the network.

In our recent, MAJR Coin’s research piece on the Internet Computer Protocol, part of their tokenomics was to proportionally reward users with more tokens the longer they staked their tokens. The users with more tokens had more voting power when it came to different governance proposals. This mechanism creates a positive feedback loop. Users are incentivized to stake tokens longer which removes tokens from the liquid market, therefore driving scarcity and ultimately putting upwards pressure on price. The users who staked their tokens are now more loyal to the network. Their total holdings have increased in value as the token has become more scare and via the issuance of new tokens. When it comes time to vote, the users with more tokens and more voting power are now inclined to vote on decisions that should drive value for the network rather than harm the network.

A circular economic solution that pulls the network forward.

Deflationary Token Models

Like I said at the beginning, digital scarcity is a profound idea. Bitcoin uses a deflationary token model where the new issuance is cut in half every four years. There’s guaranteed to be less new bitcoin issued in the future then today. This simple incentive scheme has helped drive Bitcoin’s market cap from $0 to over $1 trillion.

A shrinking new issuance schedule isn’t the only way to create a deflationary effects. A deflationary currency, is one where your currency increases in value compared to the goods and services it can buy. This is the opposite of fiat’s inflationary effect where your currency decreases in value compared to it’s buying power…but I digress.

Projects can create deflationary effects through token burning.

When tokens are burned they are removed from circulation. This is done by sending tokens to a burn address, an address that can’t be accessed. Therefore, the tokens are gone forever. This incentive scheme can be implemented in a number of ways. If the project wanted to reduce selling pressure, the protocol can implement a sales tax. The users who sell are then taxed additional percentage of tokens which can either be distributed to the rest of the network or automatically sent to the burn address. This reduces the overall supply, therefore putting upwards pressure on price as the tokens are more scarce. This scheme does two things. It helps maintain the network’s value and creates a negative feedback loop for sellers. By selling, users miss out on the token’s upside appreciation in price.

Bullish on crypto

New and interesting tokenomics are being explored by all sorts of projects which is one of the main reasons for investing in tokens outside of bitcoin. This is also one of the main reasons why I believe investing in digital assets is the best place for investor dollars.

Incentivizing human behavior is built into these protocols. It is their business model. It’s very difficult for non-crypto businesses to implement such schemes at this scale and velocity.

Quality tokenomics put stock buy backs to shame.

Matt Verklin