When we talk about tokenomics…

1/4 // Tokenomics Focus // October 2022

Token networks have opened a completely new way for marketplaces and ecosystems to function, powered by blockchain technology. The design and structure of these token networks are broadly discussed as ‘tokenomics’, a relatively new term that is still finding its ground in the crypto lexicon.

We at Verum Capital have been concepting token models since 2019 and have delivered over 35 projects, many of which are enabled by various token incentive structures. Our team has dabbled in almost all possible token models and is obsessed with finding the right balance of incentives to create more sustainable, inclusive, and productive networks and protocols.

We, like the rest of the crypto space, are still discovering different ways to innovate. A starting point for this innovation has been cementing the terminology we use. There still exists a distinct lack of consensus on vocabulary when communities and projects are discussing tokenomic design. So, in this post, we wanted to share our own working definitions of these terms.

“Tokenomics”

Tokenomics describes the elements — such as the creation and distribution of a token, supply and demand, incentive systems, and token burn schedules — that affect a token’s use and value.

Tokenomics should not be confused with cryptonomics, which is concerned with the combination of cryptography, game-theory, and economics to create robust decentralised peer-to-peer networks. Although there is some overlap in what these two terms encompass, we tend to use the term tokenomics when designing, analysing, and building a token network. Meanwhile, we use cryptonomics when designing, analysing, and building a decentralised network.

We learned a lot from this Hacker Noon article that outlines the good, bad, and ugly (including use cases) when it comes to tokenomics.

“Network Utility”

Also known as incentive design, network utility refers to the underlying incentives of a network and how these incentives come together to create a virtuous cycle. We believe it is vital to understand all the token network’s participants, their motives, and how they respond to various incentives to develop a network utility scheme.

There are many many examples of poor network utility design, but those that support unsustainable growth are particularly worrisome. Schemes such as StepN, a move-to-earn dApp on the Solana protocol are an example. Despite having admirable ambitions, at its core, StepN relies on an unsustainable ecosystem that relies on a constant stream of new users buying in so slightly older users can earn and exit at a higher price.

We stand behind our principles of good network design, which includes sustainable growth, value, and security. However, there is a lot that goes into the network’s utility, including token allocation and non-token factors such as the network’s communication with users.

For more about good token network design and why a token network is even worth building, we highly recommend this early post by Chris Dixon on the subject.

“Token Model”

Token design is a very important part of a token economy. Essentially, the token model is how the token functions: what it is and how it can be used. Bankless published a great article recently discussing the history and future of token model design. They split token models into three types:

• Governance
• Staking/Cash Flow
• Vote Escrow (veTokens)

Vote escrow may be the current meta for token models. It offers a system where token holders can stake their tokens in return for VE (vote escrow) tokens, which can be used for voting while also giving rights to protocol revenues. It can be seen as a combination of governance and staking/cash flow tokens.

Regardless of the model leveraged in any given project, we at Verum try to focus on how a token can be catalytic to the network’s desired outcomes rather than just a driving force in its price movement.

“Token Allocation”

Token Allocation describes who gets what and when. It is decided pre-launch and is set using smart contracts.

Our friends at Borderless Capital have written a great article on tokenomics where they discuss their token distribution guide.

We agree that token distribution to the community must be at least 50% of the industry average. The amount of ownership that the team and investors can effectively keep is effectively reduced by at least 50% as a result. For instance, if a token is issued with 50% of the supply going to the community and the team holds 100% of the equity, the team will only hold 50% of the total supply.

According to Borderless: The token allocation should also outline the cliff and vesting schedule of a token. The vesting schedule is essentially a period of time from which the owners of tokens are unable to access their tokens and is a powerful way to inspire trust in a core team or investors. Private rounds typically have a longer vesting period because private investors like VCs would receive it. Rounds for public sales are shorter, typically lasting 3 to 5 months. Projects with little to no vesting period frequently result in a significant sell-off, which causes the price of the token to fall.

“Token Distribution”

Token distribution is the strategy the token network uses to distribute tokens to participants. There have been many innovations on this since the early ICO days, including the move to more novel ‘Fairdrop’ mechanisms.

Airdrops are essentially a network bootstrapping tactic by transferring tokens to wallet addresses. Small amounts of the new crypto are transferred for free or in exchange for a small service, like retweeting a post from the business issuing it, to the wallets of active members of the blockchain community. A crypto airdrop’s main objective is to raise interest in and use of a new token or coin.

The Optimism Foundation’s Airdrop #1 is a great example of a retroactive fairdrop. OP rewards those who have been instrumental as early adopters and active users of projects in the Optimism ecosystem.

Airdrops are very popular but have mixed success in actually bootstrapping the network to functionality. There have many many attempts at better airdrops that try to minimize the risk of dysfunction, such as bounty, holder, raffle, fairdrops, smartdrops, and retroactive airdrops.

We have found though that the more care the projects put into creating a sustainable, long-term token network by rewarding retroactively or proactively, users who will benefit the system as a whole are the most important priority when designing an airdrop.

“Token Issuance”

Token issuance is the process of creating new tokens that are then added to the total supply of the cryptocurrency. The issuance policy will also detail when, how much, how frequently, and why new tokens will be minted, along with where they will be sent. This is an important mechanism for ensuring the system runs smoothly by injecting more tokens to aid in the token network’s incentive mechanisms.

Certain cryptocurrencies also make use of a procedure known as token burning. In contrast to token issuance, tokens are effectively destroyed permanently in this scenario. In order to guarantee there is agreement among the network of nodes, several consensus algorithms depend on a combination of token issuance and token burning.

Token issuance is crucial in the world of cryptocurrencies. Investors can choose whether or not to invest in a project based on the rules governing token issuance on various projects. Additionally, the value of cryptocurrencies may be impacted by these regulations. When the blockchain is on the verge of surpassing this maximum supply restriction, prices of cryptocurrencies with a set maximum supply frequently increase.