Tokenomics Is the Study of Token Prospects
Tokenomics is the utopian study of a successful project economic model that originated before one-pagers and terms and conditions. It determines the principles of the pricing of the token and the fundamental reasons for the growth and loss of the token’s value. Unfortunately, most projects do not pay enough attention to these principles and subsequently make many questionable market investments, incurring significant losses.
Token functions
How can tokens be used within a project?
Tokens are used to certify the holder’s rights within the platform: for example, the Filecoin token allows the holder to store data on the hard drives of thousands of high-security computers. The STEEM coin gives its holder priority in voting on content on the Steemit platform. The BNB token allows holders to pay commissions on the Binance Exchange with a discount. XEM, in the blockchain Nem, fulfills the role of “block generation.”
However, this model also has disadvantages: with the increase of the token value, the price of the holder’s rights on the platform also rises, which may lead to a decrease in demand and the emergence of competitors with more favorable price tags.
Another model suggests that tokens be backed by material values or assets in the real world — precious stones and metals, art objects, etc. Tether (USDT) and dozens of other projects that tokenize various assets (Orebits, Sandcoin, and so on) are built on this model. Singular DTV, for example, tokenizes the ownership and licensing of content.
Some tokens give holders the right to receive services from issuers. Such tokens are used as securities that provide their holders, for example, the right to vote or the right to receive dividends. The DigixDAO token gives holders the right to vote and earn commissions from transactions with another Digix token pegged to the value of gold. The Primalbase token gives holders the right to use office space in business centers that the company plans to build using the funds it raises.
In addition, there are tokens that do not give any rights to their holders and are really just colorful candy wrappers.
Also, the potential holder of a token should understand that the declared intentions of the project creators (e.g., that the token is backed by some asset or obligation) can differ from the reality, as dictated by legal or technical restrictions.
Examples: good and bad tokens
Obviously, in an ideal world, the token would be an integral part of the project. A good example is a gas in the Ethereum blockchain. The idea is that Ether is a platform for the creation and functioning of dapps on the blockchain using smart contracts. The Ethereum virtual machine performs tasks using Ether or gas as a means of payment, and the ETH token is an integrated part of the entire platform. It’s a good token.
Let’s step aside of hundreds useless tokens which no one knows about and talk about world-known sort of a unique “bad example” — Ripple. When we talk about Ripple, we think of the XRP token. However, XRP has no direct relationship to Ripple, which contradicts the generally accepted trend (i.e., an inextricable link between the token and the platform). Its technology is used by a wide range of different banks around the world, but those banks don’t use the XRP token.
Let’s analyze Ripple and its products:
xCurrent is the main product that allows banks to make cross-border transfers more efficiently without making any fundamental changes to their standard system. xCurrent uses RippleNet and blockchain Ripple but not XRP tokens.
xVia is a kind of xCurrent extension that provides non-bank corporations, such as payment systems, access to efficient banking. It doesn’t use XRP tokens either.
xRapid is the only Ripple product that uses XRP. Its purpose is to increase liquidity when trading in emerging markets. However, banks are wary of this product because of the volatility of the XRP.
In fact, all the above large banks use only xCurrent, and xRapid, which uses XPR, is used by only one small non-banking organization: Cuallix from Mexico. Funny, isn’t it? So, while Ripple is growing and getting richer, XRP investors are left to kick themselves. It’s a bad token. And this is an example of declared intentions differing from reality.
We explored the understanding of token nature, but that wasn’t enough to understand the investment prospects of the token; furthermore, we need to know the token distribution model, the period of holding, and the scenarios of its behavior under different conditions.
Token distribution model
This model describes the shares of holders. The design and validity of a model can influence the rotation of holders (e.g., cheap or free tokens have low value for their owners and they usually get rid of it quickly). The following are some of the several token distribution categories:
● For sale
The higher the percentage of tokens the project initially sells on the market, the more decentralized the project is (in an ideal world, at least; in the real world, these tokens should be well distributed among the different independent buyers).
● Team
A portion of the tokens is distributed among team members as a reward.
● Bounties, airdrops, etc
Users get tokens for free for completing some actions or according to some criteria (e.g., airdrop tokens are transferred to users when a certain number of tokens is reached in the Ethereum or EOS blockchain system if the new project token is released on these platforms). Usually, the fewer cheap tokens that are distributed, the higher their final price. In general, bounty schemes run out of steam and are used less and less frequently. On the other hand, experiments with airdrops — freely distributing project tokens to a wide range of participants — are just beginning. There are some cases when all tokens are distributed by airdrop and for free — that’s a separate tokenomics model and a very interesting one.
● Advisors
The ideal advisors are opinion leaders technically savvy in a certain field and experts who promote the project, participate in its development or attract investments and receive rewards for their effort. In most cases, advisors are not interested in storing tokens, and therefore, their shares are also often frozen.
When designing a token distribution model, it is crucial to establish a motive for the holders of the token to store and use it. According to one of the laws of tokenomics by Stanford University’s Fred Kruger, Ph.D. in the field of mathematical methods of research operations and statistics, promoting reasons to hold the token (both among end users and among team members) positively affects the behavior of the token in the market. This fact is likely obvious not only for Ph.D. holders but also for most users.
It’s also important to consider the differences between the freezing periods for different groups of holding companies, including the team and investment funds. All these parameters should be agreed upon in advance for the reliable and sustainable growth of the project.
Analysis of the token’s numerical characteristics
Fred Kruger conducted a detailed analysis of the cryptocurrencies market and introduced laws that allow one to determine price trends using characteristics of the token. The laws are applicable to projects that have already been released to the market, but there are also some points that should be taken into account when developing a tokenocomic model for a new startup.
Let’s analyze the variables:
● TS (Total Supply) — Total number of available tokens
● P (Price) — Current token price
● HT (Hold Time) — The period participants hold the token before selling (in terms of parts of a year).
● TV (Transaction Volume) — annual volume of transactions in US dollars.
● GTV (Growth in Transaction Volume) — Increase in the volume of transactions for one year. Increasing the value of TV means that there is a growing demand for the token (this is really good). Accordingly, GTV should be > 0%.
● TT (Transaction Time) — Transaction time.
● TMCAP (Token Market Cap) — Token market cap = TS х P.
● R (Ratio of Transaction Volume to Transaction Market Cap) — TV / TMCAP. The rate of the transaction volume per year against the market capitalization of the transaction.
● R1 (R adjusted for Transaction Time) — R / TT. R-value adjusted for Transaction Time
● R2 (R adjusted for Hold Time) — R / HT. The second R-value represents the token hold time.
All the laws can be found in Kruger’s blog, so let’s look at a few particular cases to understand all the features of tokens.
According to Kruger’s fourth law, the ratio of transaction volume per year against the market capitalization of transactions after the market release of the token should be much less than 10. This value indicates the coin’s potential for further growth. Let’s take a token with an average daily transaction volume of 500K dollars. In one year, we have 182.5M. If the market capitalization is, for example, 20M, the R-value will be 9,125 — not so good. But if the cap were, for example, 200M — R = 0.9125, this token would be very good for investment.
If the annual capitalization is several times higher than the volume of transactions, the company earns a profit, and there are prerequisites for the further growth of the token.
For example, let’s analyze Stellar: the capitalization is 4500M, the average daily transaction volume is 780M, TV = 284700M, and R = 284700M / 4500M = 63. Not that great, right? So, this is a good example of the effectiveness of this simple analysis.
The fifth law says there must be a reason to buy tokens, and not just to collect them. Some projects offer insufficient motivation to buy tokens (e.g., Steem or its Russian counterpart, Golos). Such tokens are immediately sold once earned. As a result, the token begins to depreciate in value. For example, the motivation for buying the Steem token is the increased voting power, but if you want to earn money instead of voting, like 98 percent of the user base, you will immediately sell this token.
According to the eighth law, sellers should become buyers. It is necessary that sellers themselves find buyers in the marketplace instead of exchanging tokens for fiat or other cryptocurrencies. This law correlates with the first law: Participants should want to hold the token, thereby increasing the value of HT.
Summary
A good tokenomics model must follow these universal recommendations:
1) the token is actively used in the work of the project and is an essential element;
2) increases in the token value does not affect the demand for the service;
3) the holder of the token is encouraged by the system;
4) there are several behavior scenarios for the token (for projects not yet released to the market) and a good ratio of the annual volume of transactions against the market capitalization of the company.
You should not underestimate the importance of tokenomics because it largely determines the development of a project in the initial years. So, establish interesting, worthwhile projects with a token that has a clear value. If you’re not sure whether your system needs tokens, don’t use blockchain. If the market is bearish now, you’ll be fine. But only startups with good tokenomics will survive the current and the future pitfalls and downtrends.
This story is published in The Startup, Medium’s largest entrepreneurship publication followed by + 382,862 people.
Subscribe to receive our top stories here.
