Token Economics: A Guidebook for Encryption Project Economic Model Design
Original Author: Renesis Tech
Original title: Tokenomics: Designing Economies for Crypto Games
As the core concept of cryptocurrency, token economics has always been an important topic in the structural design of a project. Yet it is complex and confusing. This article is a comprehensive introduction and reference guide for developers, publishers and investors. We'll introduce it in terms of cryptography, applications, and the motivation behind it.
Token economics is a combination of "tokens" (especially encrypted tokens or currencies) and "economics". The term represents the process and state of interaction of multiple blockchains and decentralized technologies.
Ideally, token economics should be aligned with the incentives of the parties involved. It is critical to grow from a simple model earning profits for developers to a decentralized project with millions of participants and a multi-billion dollar market cap.
We need to coordinate the distribution of interests among these contributors, participants, and investors in the cryptocurrency "game". They may obtain multiple different "types" of benefits from the operation of a certain project, and these roles become more and more complex and blurred: participants may become investors, investors may also participate in project construction, and so on.
Therefore, a correct and appropriate token economic model is the basis for the success of an encryption project. Especially once tokens and smart contracts have been deployed and rolled out around the world, it is difficult, if not impossible, to make changes.
A well-designed token economic model will lead to a pleasant experience, increase value, and improve profitability. Conversely, a bad token economic model will lead to rapid depreciation, poor experience, loss of users, and even the core financial collapse of the project.
There are several examples in gaming, gambling, business and finance. For example, P2E (Play-to-Earn), "gold-making" and "leveling" in MMORPG (represented by World of Warcraft) have existed for decades, in "Magic Online" and "Second Life" etc. Place has many similar concepts. We can even watch how large, complex in-game economic structures interact with real-world traditional banking in EVE Online. At the same time, the function of governance tokens is similar to that of stocks, and the token exchange is similar to the existing stock market.
On the other hand, key concepts in the crypto space: decentralization and autonomy, play an important role. When participants and contributors work together with a common goal, the economy and commodities (products) are developed and built. Although DAO (Decentralized Autonomous Organization) is not the focus of this article, various topics related to it will be covered.
We will also avoid discussing the technical and legal elements of token economics, as these are equally broad and complex areas. The mechanics covered in this article assume that the tokens involved are based on the Ethereum blockchain or derivatives thereof, have a similar feature set, and comply with your local country’s regulatory requirements.
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token mechanism
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Tokens and Currencies
Currency is the native store of value of the blockchain. For example, ETH is the native currency of the Ethereum blockchain, while BTC is the native currency of the Bitcoin blockchain. These currencies are often used as rewards for consensus methods such as mining in Proof of Work or staking in Proof of Stake.
Tokens, on the other hand, act like money in terms of how they are transferred between addresses. Unlike currencies, tokens are user-defined, meaning they are generated from a specified address through a programmable technique.
Within Ethereum, the ERC-20 standard is a widely used common token structure. This standard enables tokens to behave and act in predetermined ways. Thanks to this standard, ERC-20 tokens can interact, such as trade, in a predictable way, even if the individual tokens are unknown.
Tokens have multiple utilities, including:
Securities (or governance): These tokens function like shares, allowing holders to vote on certain issues and share in profits.
Platform: Platform tokens, which can be exchanged for things like computing time.
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substitutability
Fungibility is a core concept in tokenomics that allows one token to behave differently by exchanging it for other tokens.
Fungibility means that anything can be exchanged similarly (such as a $1 bill) without losing its functionality or value. If an item is unique (like the Mona Lisa), it is considered irreplaceable because it cannot be replaced without losing its value.
As such, fungible tokens are ideal for in-project currencies as they can be freely awarded, traded and spent. NFTs, on the other hand, have their own set of information that differentiates them from other tokens. NFTs are ideal for in-item items such as characters and attributes because of their information and non-fungibility.
smart contract
smart contract
Smart contracts are pieces of code that automate interactions between currencies, tokens, and external inputs, and are generated on the blockchain.
For example, a smart contract could allow players to pay with currency tokens and choose an NFT, then execute the contract to increase the properties of their NFT.
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coin
Minting is the process by which a contract with a specific address generates tokens (fungible or non-fungible) on the blockchain. At minting, tokens must meet a series of conditions, including:
The name of the token is what it is. For example "carrot" (a hypothetical token).
Abbreviations, such as "CRT", are used as symbols.
Decimals: Maximum decimals for a token. To declare a token to be an integer, it can be set to zero.
The total number of tokens that may be generated is called the total supply.
issued
issued
Issuance refers to the process of buying, trading or otherwise distributing new tokens. Tokens can be issued in various ways:
Presale: A method of selling fungible or non-fungible tokens before the tokens are available for use. This is often used in the same way as crowdfunding campaigns, with future holders purchasing tokens to support future development.
An Initial Coin Offering (ICO) is a form of pre-sale or launch of security tokens for public trading, similar to an IPO (Initial Public Offering) on a stock exchange.
Holder Purchases: Holders make purchases.
Holder Rewards: Rewards for participating in the project, such as winning a competition.
Developer Rewards: Rewards for proposals and delivered features, bug patches, or other software development, including bug bounties.
Pay third-party advisors, such as token economic model developers, to align their goals with the long-term sustainability of the token.
Faucet: A website where project participants can earn tokens for free or by completing tasks such as filling out surveys or joining mailing lists.
Airdrops: Free distribution of tokens to addresses promoting the token or its associated projects, these are typically distributed to those who have signed up for the airdrop or are active members of the community.
Note that this is not a complete list of all distribution mechanisms and some of these technologies may overlap. For example, a presale might include an airdropped token reserve to reward those who make random purchases.
combustion
combustion
The opposite of minting is burning, i.e. burning (or otherwise permanently removing from circulation) a token or group of tokens.
Burning tokens can be achieved in two ways: by programmatically lowering the total supply (via a smart contract); or, by sending tokens to an address with an unknown private key (i.e. an inaccessible wallet). The former is a hack that may go against the wishes of the original coin developers, but it would be great if coins were set up to interact in this way.
There may be some burning as part of the deal. For example, use the breeding token to breed two NFTs to mint (yield) one NFT. On this basis, tokens are burned and new tokens may be created at a later date.
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inflation
Inflation occurs when the total circulating supply (or cap) of tokens increases due to continued minting and issuance. Despite the increased circulation, these tokens may not become liquid, i.e. not tradeable on exchanges. Instead, beneficiaries may hold or stake new tokens (see section on staking).
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floating supply
When there is a burning process but an infinite (or extremely high ceiling) issuance, the supply is known as a floating supply. That said, tokens may be inflated or deflated at any time, depending on current market conditions.
pledge
pledge
Staking is the practice of locking up tokens for a predetermined period of time in exchange for payment. Usually the reward is more of the same token, but note that this does not necessarily represent a "positive return".
Through the PoS consensus mechanism, the blockchain is guaranteed to be verified by those who have economic interests in the chain. In operation, it is often used to distribute token yields, usually with the aid of treasury operations (see treasury section).
treasury
treasury
A vault is a collection of addresses that pool and distribute cash and tokens. These cash and tokens may have come from the sale of other tokens, or they may have been deposited as a result of specific events such as breeding.
A number of techniques or rules can be used to automatically diversify its holdings:
Staking: Staking tokens for a share held by the total treasury or a chance to win a share.
Development and Advice: Compensation for consultants, internal or external developers. External developers can contribute to an initiative and, upon acceptance and delivery, get paid.
Participant Rewards: These are rewards given to participants based on their performance, such as winning a competition.
vote
vote
Tokens can often be used to vote on issues related to participation in governance, the treasury, or the community. This is why tokens with voting rights are often referred to as governance tokens (or security tokens), the latter referring to their resemblance to corporate shares.
Token holders use their tokens to vote on proposals following a (usually web-based) system process where there is a link between the number of tokens owned and the number of votes cast—for example, 10 tokens Equal to 10 votes.
Voting allows token holders to make decisions on issues that directly affect them, which can provide investors with a sense of belonging.
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Anchored
The technique of linking the value of one token to the value of another is called a peg (or some other asset, like fiat currency).
When a token is pegged, it indicates that it can be traded for a certain amount of currency at any time. For example, casino chips are pegged to the value of a currency such as the pound sterling because they can be bought or sold at face value. To do this, the casino has a cash reserve equal to the number of chips in circulation. So a £10 casino chip will always have the same value.
Likewise, Tether is an Ethereum-based token (USDT) that can be bought and sold for $1 per token from its issuer (Bitfinex), which allegedly holds the equivalent of the entire USDT supply cash reserves. In other words, Tether is pegged to the US dollar and maintains a consistent price, thus earning the title of "stable currency".
Alternatively, stability can be achieved using algorithmic tweaks such as Dai's Target Rate Feedback Mechanism (TRFM), which can maintain stability at around $1 without margin, with DAI still worth $1.
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External: DeFi and exchanges
A characteristic of tokens is that they do not only exist in wallets and their associated applications. In other words, they can exist within the broader crypto ecosystem.
For example, if on a sidechain, the token can be bridged to a mainnet like Ethereum (a mainnet is a fully functional, operational blockchain network, as distinct from testnets and regtest networks, etc.).
Connecting tokens to the mainnet has two key advantages:
Practicality: Connect to the wider DeFI world, allowing your tokens to connect to decentralized exchanges (DEX). Additionally, other dapps (decentralized applications) allow tokens to be borrowed (such as NFTs), and there are other applications that create financial derivatives to enable further speculation on assets.
Portability: The public chain allows data to be used in multiple projects without permission. This means that the project can be expanded through open source, community building or other commercial means.
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designing process
If you are new to the world of designing crypto projects, you can read our blogs on building an economic system, retention framework, balancing, LTV, and monetization catalysis.
Detailing the entire tokenomics design process from start to finish is beyond the scope of this article. However, here are some questions you can ask yourself or your team to clarify the basic idea:
Who does your program serve?
How will you attract participants, investors and others from crypto and various industry ecosystems? How does it keep participants interested while providing a lasting experience and/or economics?
What motivations attract participants?
Why did your participants get and stay involved in the project? For example, do the incentives of participants and investors complement or interact with each other as part of a balanced token economic model?
What is the core mechanism of the project?
How is the project mechanism different, interesting, marketable and compatible with the token system? How can a project be maintained and adapted while maintaining its core appeal and community? How do you ensure a meaningful experience for new participants, while also serving existing participants who have invested significant effort and money?
What is centrally anchored value?
Anchoring values are resources from which a designer can connect to other resources through one or more transitions. For example, a project's "token" can serve as a core currency that can be exchanged for other in-project currencies, used to purchase in-project items, or provide liquidity. A well-conceived and integrated anchor value allows developers to model, structure, and refine the economic structure of a project — and its monetization potential. Carefully consider how your anchor value and in-project economic structure are tied to the project token. Check out our in-depth Axie Infinity breakdown for examples of successful cryptoeconomic models.
What model should be applied?
in conclusion
in conclusion
Cryptocurrency technologies are as complex and varied as the human motivations that drive them. It is time-consuming and difficult to fully grasp everything from mining, investment practices, economic theory, project design and web3, but in essence, there are only three areas to consider:
Mechanisms: Which mechanisms are supported by the technology. Meaning how tokens and currencies interact and flow on-chain and off-chain.
Incentives: The incentives for participants to participate, developers to build and improve, and investors to speculate and profit.
System: How the mechanism holds it together and aligns those motivations.
As with any project design, human needs need to be combined with technology to create an experience. Whether it is a project party, a participant or an investor, the new feature of an encryption project is the transparency and close connection between these participants. It creates a great experience for everyone and brings everyone together to make the product successful.
