One of the most common phrases being bandied around in the crypto world these days is “tokenomics”. A portmanteau of “token” and “economics”, tokenomics of course refers to the economic model of different cryptocurrencies.
Tokenomics is a word that covers almost every aspect of a token’s creation, management and sometimes even its removal from the network. The idea behind tokenomics is to create a sustainable ecosystem model where people are incentivized to use the tokens day-to-day, ensuring that its value remains stable so the project can grow in the long-term.
Most blockchain projects today design their tokenomics rules as a way of encouraging or discouraging certain actions. In that way, tokenomics is seen as similar to the modern economy, where central banks print money and implement monetary policies that aim to encourage, or discourage spending, lending, borrowing, saving and the transfer of money.
Unlike with fiat currencies however, tokenomics are implemented via code in a way that’s transparent and predictable. Most importantly, tokenomics are designed to be almost impossible to change.
Good Tokenomics
The earliest example of tokenomics, and also one of the simplest models, is Bitcoin. The inventor of Bitcoin, Satoshi Nakamoto, programmed Bitcoin to ensure that there will only ever be 21 million coins. New Bitcoins are brought into circulation through mining, where so-called miners are incentivized to process transactions with rewards. For every new block of transactions that recorded onto the Bitcoin blockchain, the miner earns a specified amount of BTC in exchange for providing the resources required to process that block.
This rewards is halved every time that 210,000 blocks have been processed by the network. According to this schedule then, the “halving event” takes place roughly every four years. Since Bitcoin was first created in January 2009, there have been three halving events, which saw the reward to miners fall from 50 BTC to 25 BTC, then to 12.5 BTC, and now 6.25 BTC presently.
Going by these rules, we can predict how many new Bitcoins will be mined each year. For instance, we can calculate that 328,500 new Bitcoins will be mined in 2022. New Bitcoins will continue to be mined until 2140, when the final coins will be minted. After that time, it’s hoped that Bitcoin will be so valuable that the transaction fees alone – which also go to miners – will be enough to incentivize people to keep on mining. The transaction fee, by the way, is itself designed to increase the busier the network is. In this way, it helps to prevent spam transactions and ensure miners will continue processing transactions even as the block rewards diminish.
Bad Tokenomics
The tokenomics of Bitcoin is simple and ingenious and it has proven to be very successful for over a decade now. With the advent of newer, more complex cryptocurrencies we have seen many more complex tokenomics structures arise that are designed to incentivize users to process more complex transactions and economics.
One of the most infamous tokenomics structures to arise was that of the Terra Luna ecosystem. Terra was a blockchain that was primarily designed to support decentralized finance, an alternative financial system that anyone can access. DeFi supports many kinds of financial services, including lending and borrowing and more complex activities like yield farming.
One of the novel ingredients of Terra was that it had its very own stablecoin, which was designed to always have the same value as the U.S. dollar. Rather than stablecoins like USD Tether, which banks each of the tokens it issues 1:1 with fiat assets held in a physical bank, Terra USD was designed as an algorithmic stablecoin that used complex mathematics and incentives to retain its 1:1 peg with the USD.
A simplified explanation is that, in order to mint new UST, users had to burn an equivalent amount of LUNA, which was Terra’s native token. Whenever the utility of UST expanded, increasing demand for it and causing it to unpeg from its USD value, the process worked in reverse. Holders of UST would be incentivized to burn their tokens for a slightly higher amount of LUNA, which could then be sold to profit from the arbitrage. It was supposed to be a self-sustaining tokenomics system where demand and supply remained balanced, keeping UST pegged with the USD.
As is well known, there was something amiss with Terra’s tokenomics structure and earlier this year the two currencies entered into a death spiral. As the value of UST decreased due to selling pressure, more and more LUNA tokens were minted in an effort to stabilize its price. Unfortunately, the value of UST too fast for the protocol to keep up, resulting in billions of LUNA being minted, making the token practically worthless.
Following the sudden, but ultimately not very shocking collapse of Terra LUNA and UST, one of the key lessons learned from that episode is that tokenomics must be based more on utility and less on speculation.
With Terra, the only thing that was creating demand for LUNA was the ecosystem’s DeFi protocol Anchor, which offered an incredibly high APY of 20% on staked LUNA tokens. However, that protocol ultimately proved to be unsustainable – as many had warned it was – and it rapidly fell apart as the value of LUNA nosedived.
Going forward, we can expect to see tokenomics focus more on fostering growth of the ecosystem that surrounds new projects, as opposed to models that simply encourage speculative demand. At least, that should be the case for genuine projects that don’t want to be labeled as a “Ponzi scheme”.
Economy-Based Tokenomics
In other words, there’s going to be a lot more interest in tokenomics structures that can help to foster a thriving economic ecosystem, where the coins that revolve around them have actual use cases. It’s a development that is likely to unfold by necessity, as crypto investors and users, especially those who were burned by Terra, are likely to be much more cautious about the projects they invest in.
In recent months we’ve already seen a number of novel tokenomics systems arise that focus on providing genuine utility and increasing demand by incentivizing usage of their tokens. A good example is the new play-to-earn game Apeiron, which is a metaverse game that sees players take on the role of “Godlings” and control the ecosystem of entire planets and attempt to foster their development into an advanced culture.
Unlike other play-to-earn games, Apeiron has created a unique tri-token economy that aims to promote a much more fluid system of in-game commerce. The platform’s main token is Anima, a P2E token with an unlimited supply that’s paid out to players as rewards for completing in-game tasks and challenges. The second token, Apeiros, is a governance token with a fixed supply that provides voting rights. It has a staggered release and can only be won by participating in special tournaments that take place on a regular schedule. Finally, the game introduces a special token called Ringularity, which is only distributed in special events and will provide access to special benefits, including high-interest yield farming opportunities and access to exclusive shops. This token is designed to support the game’s long-term growth by encouraging players to join gaming guilds and create alliances. After all, alliance gameplay has proven itself key to promoting longevity in video games.
The idea is that Apeiron’s tri-tokens will operate in tandem to create a functioning economy, providing incentives for different players at different stages to interact with the numerous economic aspects of the game.
Utility-Based Tokenomics
Many projects are likely to boost their existing tokenomics structures by introducing new use cases and utility for existing tokens and NFTs. The hugely popular Decentral Games has recently done this through the launch of its new ICE Poker “Sit-n-Go” tournaments, which are fast-paced, single-elimination tournaments that see poker players compete for ICE NFT wearables and ICE and xDG token rewards.
Sit-n-Go games will involve six players with mandatory 10/20 chips blinds, which double every four minutes. The blinds are a mandatory bet for all players that help to ensure the action remains fast-paced, just as in real poker. The winner will be rewarded with a Tournament Badge that can be redeemed for ICE NFTs, ICE and xDG tokens, while the runner-up will receive a refund for their Shine entry fee.
To participate, players will be required to purchase either a Tournament, Flex or All Access wearable NFT. Players will have to stake a certain amount of Shine on their wearable, which can only be refilled using ICE. The exact amount will depend on the requirements of the specific event or tournament they wish to enter.
The Sit-n-Go tournaments create an additional use case and are expected to increase demand for ICE tokens. A portion of the ICE spent on Shine will be burnt, creating a sustainable token sink to stabilize the game’s economy. Most importantly though, the entry requirements for Sit-n-Go are much lower than on the standard Challenge mode, which means more players with less capital available can start playing with Tournament Wearables, prove their worth, and later graduate to a more expensive Flex or All Access wearable.
Demand-Based Tokenomics
New crypto projects may also want to benefit from the unique demand mechanism that has been created through Lena Instruments’ and Flare Network’s novel CloudFunding launchpad. Announced this month, CloudFunding is an entirely novel funding platform that requires investors to stake FLR/SGB tokens to support upcoming projects. Rather than fund those projects directly though, CloudFunded projects only receive the earnings from investor’s staked capital, with the principle remaining in the hands of the investors themselves. Once the CloudFunding period is up, the investor will be returned their entire principle amount. So not only do they get to support their favorite projects and receive its native tokens, but it doesn’t cost them anything to do so, apart from whatever interest they may have earned.
It’s a unique model that will not only ensure long-term demand for FLR/SGB, thereby stabilizing its value. It also promises to help stabilize the tokens of the projects that rely on CloudFunding. That’s because investors will be able to receive an IOU of each project’s token before it officially launches. This IOU will be tradeable even before the token launches, which should help to establish a stable supply and demand ahead of the token generation event.
The latest trends in tokenomics suggests that projects will, going forward, put a lot more focus on making their tokens truly useful and therefore boosting demand for them. Any tokenomics structure that can help to foster demand and create a thriving ecosystem that incentivizes users to spend those tokens, rather than just hold them as a speculative asset, is likely to gain solid traction. The goal should be to encourage stable and persistent demand for the project’s assets.
At the same time, projects need to be more careful about how they promote their tokenomics, explaining how the economy works in a way that’s simple for users to understand. After all, many of their users are still relatively new to the whole idea of crypto and still in the process of educating themselves about what things such as NFTs, DeFi and so on actually mean. The key is to help users understand the value of whatever it is they’re getting into. If users believe in a tokens value, the sustainability of its tokenomics should be a natural consequence.
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