Tokenomics

Tokenomics, also known as token economics, is the study of parameters that determine the characteristics of cryptocurrencies (cryptos) or cryptographic tokens to create economic value.[1][2] Both cryptocurrency and tokens are the subclasses of digital assets that use the technology of cryptography.[2] Crypto is the native currency of a blockchain, and it is developed directly by the blockchain protocol.[2] Tokens are created through a blockchain-based organization or application.[3][2] For example, Ether (ETH) is the native crypto of Ethereum, while Axie Infinity Shards (AXS), the governance tokens of the game Axie Infinity, lives on Ethereum, and users can use them to play games.[2][3] In both cases, tokenomics acts as an incentive mechanism and monetary policy of the supply and demand of certain crypto or token.[4] Tokenomics rules how and when a new crypto or token should be generated or removed from the system. Once the tokenomics is written into a smart contract, the system is automated.[4]

In the real-world economics system, the economy is subject to fluctuations like inflation and deflation.[4] Central banks intervene through monetary policies.[4] Tokenonomics can be thought of as an approach to implementing monetary policies and economic rules via automated smart contracts.[4] On the blockchain, different projects may issue their own tokens with different tokenomics to complete their ecosystem for various purposes, such as fundraising and governance. Some common tokenomics models include the deflationary model[5], inflationary model, and dual-token model.[6] For instance, before the very last Bitcoin is added to the Bitcoin pool, it is inflationary because as miners (people who find Bitcoin by using algorithms to solve mathematical puzzles) keep mining Bitcoins, the amount of Bitcoins increases and the purchasing power of each Bitcoin decrease.[6] However, the tokenomics of Bitcoin has multiple mechanisms to lower the rate of inflation, such as making mathematical puzzles harder and harder to solve and allowing fewer and fewer miners to receive the coin.[6]

Creation of tokens and token types

Companies may create their own tokens for economic and structural reasons. Tokens are created to encourage the holder to interact and empower the product by automatically distributing the rewards to their stakeholders.[7] Projects may use tokens to raise funds from the public and for proof of internal operation (e.g. game tokens and governance tokens for the right to vote). To achieve the purposes and function of the tokens created, a fine tokenomics structure is needed.[4]

Security tokens for fundraising

In traditional capital markets, if a company wants to raise funds from the public, it must go through an initial public offering (IPO), which may take years, costing anywhere from $4 to $28 million in fees, depending on its size.[8] In the early stages, only accredited investors are allowed to enter an investment, such as a venture capital.[1] In the decentralized, automated world, with lower cost, tokens can be created by anyone, with fundamental parameters and functions described by tokenomics.[1] Instead of equities, blockchain companies raise funds through the issuing of tokens in the process of initial coin offerings.[1] The security tokens can be thought of as equity shares of the blockchain companies.[1] After issuing the tokens, individual investors are allowed to buy tokens and own shares.[1] For investors, they can become early contributors to gain returns along with the growth of the company.[1] Web 3.0 investors can sell their holdings of tokens after the vesting period.[1]

Utility tokens for internal use

Utility tokens are used as proof to access a company's service or product.[9] Unlike security tokens, utility tokens are for exchange and securing the liquidity and value of the company. Utility tokens are an in-ecosystem currency.[10] For example, with a token named Smooth Love Potion (SLP) in the game Axie Infinity, players can use it to breed desired spirits. In this case, SLP acts as the internal currency within the game.[11] Users earn SLP from tasks, and spend SLP to defeat opponents.[12]

Risk

Investors risk being "rugged," meaning that the token issuer may "raise money and disappear," resulting in a value loss in those tokens and a capital loss for investors.[13][14] Hackers may hack into the system and steal the tokens.[13] Each tokenomics model has its disadvantages and advantages.[10]

See also

References
  1. Wandmacher, Ralf (2019), Goutte, Stéphane; Guesmi, Khaled; Saadi, Samir (eds.), "Tokenomics", Cryptofinance and Mechanisms of Exchange, Contributions to Management Science, Cham: Springer International Publishing, pp. 113–123, doi:10.1007/978-3-030-30738-7_7, ISBN 978-3-030-30737-0, S2CID 239396338, retrieved 2022-11-07
  2. Nahar, Pawan. "Crypto class: Difference between crypto coin & token". The Economic Times. Retrieved 2022-11-08.
  3. Lo, Yuen C.; Medda, Francesca (December 2020). "Assets on the blockchain: An empirical study of Tokenomics". Information Economics and Policy. 53: 2. doi:10.1016/j.infoecopol.2020.100881.
  4. Kampakis, Stylianos (2018-05-02). "Why do we need Tokenomics?". The Journal of the British Blockchain Association. 1 (1): 2. doi:10.31585/jbba-1-1-(8)2018. S2CID 169216722.
  5. "Understanding Deflationary Tokens and Their Benefits". antiersolutions.com. Retrieved 2022-01-12.
  6. Chiu, Jonathan; Koeppl, Thorsten V. (2017-09-01). "The Economics of Cryptocurrencies – Bitcoin and Beyond". Rochester, NY. SSRN 3048124. {{cite journal}}: Cite journal requires |journal= (help)
  7. Lamberty, R.; Waard, Danny de; Poddey, A. (2020). "Leading Digital Socio-Economy to Efficiency - A Primer on Tokenomics". S2CID 221006174. {{cite journal}}: Cite journal requires |journal= (help)
  8. Jay Preston, Initial Coin Offerings: Innovation, Democratization and the SEC, 16 Duke Law & Technology Review pp.328 (2018)
  9. FINMA, Eidgenössische Finanzmarktaufsicht. "FINMA publishes ICO guidelines". Eidgenössische Finanzmarktaufsicht FINMA. Retrieved 2022-11-07.
  10. Freni, Pierluigi; Ferro, Enrico; Moncada, Roberto (2022). "Tokenomics and blockchain tokens: A design-oriented morphological framework". Blockchain: Research and Applications. 3: 100069. doi:10.1016/j.bcra.2022.100069. S2CID 247126100.
  11. Brucker, Anders C. (2022). De-Fi Protocol Token Valuation by Projecting Token Flows and Estimating an Appropriate Risk Premium (Thesis).
  12. "What is Axie Infinity? | Everything You Need to Know About AXS". capital.com. Retrieved 2022-11-08.
  13. "Statement on DeFi Risks, Regulations, and Opportunities". www.sec.gov. Retrieved 2022-11-08.
  14. "Watch out for the 'rug pull' crypto scam that's tricking investors out of millions". Fortune. Retrieved 2022-11-08.
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