Built on a foundation of human psychology, distributed ledger technology, and cryptography, tokenomics are digital systems of value and ownership attribution intended to replicate and quantify business models in cyberspace.
The arrival of cryptocurrency into the public domain has sparked the next chapter of economic evolution for mankind. Touted by the world's most prominent technologists and financiers as the frontier for global economic transformation, tokenomics has become the focal point of financial innovation.
Stemming from computer science and acting as vehicles that capture arbitrary, abstract forms of value, tokens are essentially tools that facilitate the accounting, storage, and exchange of information.
Economics are the physics of finance; models that quantify the behavioral and monetary relationships of human activity.
Bringing these two concepts together can supercharge society, however, when amplified by the open, decentralized nature of crypto/blockchain, the level of exploration achieves exponential proportions.
While it has been a blessing and truly given the concept of equal opportunity a radical new meaning, tokenomics have invited malicious and inexperienced market participants into the fray.
Delusioned by visions of extremist grandeur that will tear down governments and “decentralize everything” Memecoins, degens, and everything in between have imposed a distorted perception of value.
It is mindboggling how many downright stupid projects have been able to garner attention with shady, manipulative marketing tactics while having absolutely nonsensical vaporware token models with no purpose besides gambling.
Tokenomics alone do not define a quality project, there must be strong visions, a realistic sense of technological capabilities, adequate teams, and a problem that can be (should be) solved.
However, tokenomics do serve as a powerful proxy through which we can ascertain the depth of a project’s thinking and connection to reality.
With years under our belts and billions of dollars in scams and fraud destroying people's life savings, it is hard to believe how so many projects do not comprehend what real, good tokenomics implies.
To be fair, poor tokenomics does not only apply to scams. There are cases with phenomenal teams, great tech, and strong visions failing due to lackluster tokenomic designs.
There is no universal model for “correct” tokenomics, tokenomics must be designed to intimately serve a purpose for its specific application/use case.
There are three major elements that tokenomics addresses; all of them are equally important in their own way. The absence of any of these is a red flag for a crypto project:
How will the supply-side logic of the digital asset be implemented?
Where will the assets be held?
Who will get how much and when?
What blockchain will they deploy to?
What token standard will they use?
What is the supply?
What is the emission schedule plan?
Application to Environment
The degree of relationship between the digital asset and its application.
When people hear tokenomics they start looking for charts about the assets allocations and funding rounds. This alone is so shallow and nearly impossible to properly quantify.
If a project is “fully decentralized”, meaning deployed with no pre-mine or team to push for its development, then this portion doesn't even apply.
Allocation and distribution give insight into the potential centralization of economic power within a project. The beauty and elegance in this portion relates to a balanced understanding of where supply belongs.
Here we find so much misconception among novice market participants suffering to understand where tokens should be deployed to.
At the most basic level, there are 8 segments to which tokens can be allocated:
1) Market Making
2) Protocol Incentives
4) Sales (private public)
7) Community Bounties
*** These are rudimentary percentage allocations to just express a basic idea.
Market Making (20–30%)
A projects Exchange presence.
Market making must have a sizeable portion of the supply.
Listing across many different venues requires having tokens to provide them for opening markets. If the supply of tokens on exchanges is small then the price is subject to violent swings in price. However, even if a lot of supply is on exchanges, over the course of time as people enter a market they will be able to increase the decentralization of the token (how many holders) and still drive the price up.
Protocol Incentives (10–20%)
Some mechanisms to reward users and bootstrap the application.
Fundamental for getting some economic activity moving and bolstering adoption in the early phases of the project.
Layer 1 blockchains implement this as block rewards that ultimately add tokens into circulation through the network operator's contributions.
DEFI protocols for lending/DEX might provide bonus APY in the form of their token in order to attract some liquidity.
This only applies to capped supply projects! Some cryptos might even have perpetual inflation (Dogecoin) that cannot be quantified into this model. (FYI, there is no team/dev allocation in DOGE).
Incentives for the hard work and risk to build a project.
Skin in the game for the project creators is important to align their actions with the maximum potential qualitative development of the product.
Ideally, 5% is perfect; however, the larger the team the larger the allocation might be acceptable. I already consider 10% to be very generous, but there are cases with projects allocating >20% to their teams. I personally consider this a red flag and do not/will not invest in any such projects.
Token Sales (10–20%)
Bootstrap the token's development.
A high level of decentralization in distribution at an early stage of a project is a red flag. This results in masses of people that are hard to coordinate and will result in chaotic selloffs that can drive users/investors away from a project before it even has a chance to develop properly.
High levels of distribution to early investors shows laziness on behalf of the project’s founding team and attempts at just attracting fundraising, without too much care for being decentralized. (nothing wrong with this, there are very successful examples of VC-driven projects that are alive and well).
Key opinion leaders and external professionals to act as ambassadors.
Advisor allocations are important for attracting influential people to a project. These individuals help build brand recognition, promote the project, and help with a slew of problems.
Advisors are like external team members, therefore these allocations must have some kind of vesting schedule.
Partnerships with other projects.
Crypto is all about cooperative competition. Building partnerships is quintessential for accelerating the presence of a project, its technological capabilities, and cross-pollinating communities.
Community Bounties (1–5%)
Supporting community involvement.
Engagement from a crypto project’s community of retail investors or just believers is priceless. There should be a least some portion of the supply allocated to reward them for supporting the social activities necessary to push the project forward.
(ex. having a social media campaign for Tweeting or making memes)
The Decentralized Autonomous Organizations Treasury.
Not required if a project will be centralized, but if there is a DAO in its roadmap then it should have some portion of tokens allocated to its treasury. By doing so, the community will be incentivized to work together and coordinate how to utilize these funds at a later date.
Technical fundamentals about the asset itself.
This is so basic and fundamental that not being able to find this in a tokenomic section of a project should be an immediate tell of a lack of attention to detail and a sign to stay away.
Token Name: XYZ token
Token Ticker: XYZt
Token Standard: (ERC20, SPL)
Token Network: (ETH BNB SOL)
Decimals: (9 18)
Archetype: (utility security reward)
Supply Model: (inflationary deflationary fixed)
Application to Environment
This is the factor that distinguishes true crypto-projects from wannabes.
A token should capture the delta of value between the service it provides and the solution it solves.
The trick art the art of good tokenomics exists at the intersection of the application and how the token relates to it.
Generally speaking, there are three grades of a tokens relationship to its network project:
-) none (no effort)
-) weak (minimal effort)
-) strong (maximal effort)
None means that there is no tie between a platform and the asset they are issuing. This is lazy construction that has no respect for its end users. Tokens are just waste emitted in order to satisfy the founder's desire to be important in some way.
For example, if a token is only used to reward people for participating (such as every time you post on our social media you earn token XYZ), there is no actual utility for the token and users have no incentive to hold it. Their only objective would be to accumulate the tokens with the intention of selling them. This builds no connection to the platform and promotes the mercenary behavior of spamming.
Weak means a very low level of interconnectedness between a token and its issuing platform. If a token is necessary in order to access some functionality, such as membership to a DAO, there is a small vector for users to desire ownership of the asset; namely, gaining more governance power. However, this is still considered “weak” because monetary/intrinsic value cannot have a hard formula ascribed to its demand side. Odds are, in the case of a purely governance/access-based model users that acquire tokens just to sell will continually outnumber true holders.
The highest/purest form of tokenomic design that qualifies as strong are those that demand the asset in order to utilize the network itself. Case and point here being something like Ethereum. Every time an action takes place on the chain ETH must be spent. Now it becomes somewhat more possible to model the potential demand side of the equation based on how much activity the network will warrant over a given timeframe.
Besides base layer coins, another example of such strong ties to the network can be found in a project such as Chainlink. Here, there is a wholesome, multi-sided demand from operators that must stake LINK in order to become nodes and users need to pay operators in LINK tokens to make requests/provide data to applications. There is real utility for the token and the project understands that its value comes from the business-related functions, therefore it wastes no time catering to retail end-users, instead, they allocate their efforts towards building out their partnerships with companies that need on-chain data.
Ultimately, regardless of how fancy a use case or how futuristic a concept may sound, the most important factor to consider in a tokenomic model is supply vs. demand.
No matter how large an economy was, how mature its financial systems were, or how old a civilization is, economies never stood the eternal test of time.
From the dawn of man, when trade took place as barter, through to seashells, metal coins, paper bills, and credit cards, economics have always been experimental.
The very premise of economics is, by virtue of its own nature, transient.
Tokenomics are giving society a chance to design their economies anew.
This turned out to be more of a rant,
But I hope that you can find some valuable insights for your journey through the wild world of crypto, blockchain, and Web3.
Anybody who is looking to get involved in the space or is building something and would like to chat, I propose to you, my friend:
“Lets Find each other and do something great together”
Live long and Prosper 🥂