What Separates Good Blockchain Projects from the Bad Ones? The Answer Is Tokenomics
It’s been over a decade since the mysterious Satoshi Nakamoto invented blockchain technology to power the cryptocurrency Bitcoin
20:06 22 July 2022
It’s been over a decade since the mysterious Satoshi Nakamoto invented blockchain technology to power the cryptocurrency Bitcoin. Designed to act as a virtual, decentralised ledger for Bitcoin transactions, the tech has since proved to have vast applications in industries outside the crypto realm. Many commentators believe blockchain could eventually have a similar impact to the internet itself, revolutionising sectors such as finance, banking, healthcare, real estate and many more.
Businesses the world over are racing to adopt the tech, and brand new blockchain projects are launching all the time. Yet, blockchain is in its infancy, with much that is unknown about its capabilities and eventual potential. A new concept has emerged which attempts to make sense of the tech - tokenomics. If you’re looking to develop or invest in a blockchain project, tokenomics will help you separate the good ones from the bad. Here’s the lowdown.
What Is Tokenomics?
The word is short for token economics and refers to the ecosystem within which blockchain operates. Tokens are simply digital assets – typically in the form of a cryptocurrency – that power a blockchain. When issued, they can be used in a multitude of ways, for example to access services held on a particular blockchain. They also be issued as a reward. Think of crypto miners getting Bitcoin payments for mining blocks on that system. Tokenomics covers everything an investor or developer would want to know about blockchain and the tokens that power it – how it is created, issued, managed, who owns the tokens and how many there are.
Put your investor’s hat on and think about the most important thing you’d need to know – how will the blockchain perform in the future? Tokenomics holds the key, and here’s why.
Better Incentive Structures
Incentives make the world go round. Whether it’s spending more in a shop, supersizing your burger take-out or putting in the hours to get a bonus at work, incentives will influence your behaviour. Incentive structures are part of any business you can think of, and it’s vital in attracting and keeping investment. Blockchain is no different – indeed, given the decentralised nature of the tech, incentives are even more important. There is no central controlling authority, so incentives are a way of getting users to “follow the rules.” The better the incentive structure, the longer investors hold onto their tokens and more stable the blockchain becomes. This in turn creates value, confidence and attracts new investors. Whether it’s financial rewards or voting rights within blockchain operations, blockchain built with tokenomics at its heart will always have better designed and implemented incentive structures than those without it.
Market volatility is still a distinct feature of the crypto coins and tokens that power blockchain transactions. Tokenomics is invaluable in telling you what to avoid as well as what to invest in. How tokens are distributed is a key aspect of this, and something all investors should consider. There are essentially two ways tokens are distributed – through a fair launch or they are pre-mined. With a pre-mined launch, a select group of individuals or organisations are given tokens before they are made publicly available. Conversely, fair launches permit no early access or private allocations, so they are bought, owned and regulated by the entire community. While most launches involve an element of pre-mining, the wider the distribution and the more participants, generally the more solid the project. Heavy amounts of pre-mining can often lead to investors with large amounts of tokens making a quick buck and selling up, which can crash the price.
These are a vital tool in creating healthy, long term blockchain projects. Again, the volatile nature of the market takes centre stage – there is a lot of investor interest, and a ton of speculation! This is not always a beneficial thing, especially considering blockchains need healthy and long-term communities behind them. This is where tokenomics comes in, in the form of vesting schedules. This is when early investors, partners and project team members are prevented from selling their tokens for a specific period. This ensures a long-term strategy for the project, incentivising people to hold their investment and continue contributing to the project’s development.
More Responsibility Towards Investors
Another area where successful blockchain projects are designed with token economics in mind is in terms of responsibility towards investors. In this context, governance is a key pillar of tokenomics. As we know, blockchain is decentralised. So, unlike public companies with boards and CEOs, decisions are made on a far more community-led basis. This is where governance tokens play a key role. Holders of these tokens are entitled to voting rights to decide how the platform is run. Many tokens in blockchains are governance tokens, making these platforms far more responsible to their investors than traditional organisations. It can be something of a double-edged sword though. As the emphasis is on the community, then the governance mechanism must be very sound to make it work. Hence the more “tokenomic” the blockchain design, the better the platform.
Whether you’re looking to launch a blockchain project or invest in one, then tokenomics should be at the centre of your thinking. Ultimately, it will help you build better platforms and make better decisions. It is a new and developing field, and for both developers and investors, modelling token economies can be extremely helpful. Agent based modelling is a brilliant tool for this.