An Easy Guide to Blockchain Incentive Structures
Incentives and Token Economics — Tokenomics
The incentive theory of motivation is a fundamental rationale for human behaviour. It argues that incentives or ‘rewards’, can encourage a specific, and/or desirable behaviour.
Is this a psychology essay? No.
But neither are you going to finish that last cookie because it tastes repulsive. You’re ‘motivated’ to eat it because it’s delicious, and that’s your incentive; your reward.
So how can we apply this theory to blockchain networks?
In decentralised systems with no controlling authority, incentive structures are especially important as it ensures that the network is functional and secure. This means that users are encouraged to follow the ‘rules’ and be on their “best behaviour” through incentives (i.e. financial rewards in the form of cryptocurrencies), therefore preserving the authenticity of transactions on that network.
More importantly, cryptocurrencies’ independence from a central authority (e.g. a central bank) means that it needs its own unique form of monetary policy — an incentive structure to ensure the currency’s relative stability and value.
This brings us to the subject of Token Economics, or Tokenomics
There is a subtle difference between the terms ‘coin’ and ‘token’. Coins are cryptocurrencies with their own blockchains (e.g. Bitcoin) while tokens are built on existing blockchains (e.g. ERC-20 tokens on the Ethereum blockchain).
Tokenomics, as its name suggests, is the economic design of a blockchain ecosystem. Think of it as the microeconomics of the decentralised world.
A good example of tokenomics would be Bitcoin’s supply cap at 21 million coins. By having a finite supply of coins, and reducing the amount of mining activities by half every 4 years, it results in the economic phenomenon we know as ‘scarcity’, which then causes a deflationary effect — or an upwards pressure on its value.
See the ‘economics’?
Check out this useful infographic by He3Labs:
As aforementioned, it’s imperative to have sound incentive structures in decentralised networks. It motivates users to act in accordance with the network’s rules, and encourages a healthy exchange of ‘value’ in the network, much like how the value of traditional currencies are derived.
Here’s a simple breakdown of the role of incentive structures in the token economy:
- Distribution — E.g. How are validators/miners incentivised or rewarded with cryptocurrencies therefore maintaining the authenticity of transfers and the overall trust in the blockchain.
- Price Stability — Ensuring that price and supply levels are kept in check so that users are incentivised to use a particular token.
- Governance — User decision-making rights. E.g. Incentivising users to put their cryptocurrencies at stake in the PoS (Proof of Stake) consensus mechanism.
Still confused about blockchain and cryptocurrencies? We get it! Check out our previous Tokenize Research articles:
Keep Tokenizing! Till next week.
Here at Tokenize, we strive to provide the best possible platform for cryptocurrency trading. More importantly, we believe in sharing our passion on all things blockchain, crypto, and DeFi.
Stay tuned for the next Tokenize Research articles!
Or let us know if you’re curious about a topic and we’ll try our best to explain it :)
