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Principles of Token Economics: Part 1

Token economics, put simply, is the study of the design of the ecosystem in a blockchain environment. The exercise of analyzing token economics is to answer questions such as:

  • How is the project looking to build a sustainable and stable ecosystem in the long-term?
  • How are tokens being injected into the ecosystem? How are tokens leaving the ecosystem?
  • Who are the ecosystem participants and how are the individual participants being incentivized to perform to the best of their abilities?

These questions and others are key to consider in launching a successful project. In this post we will discuss the key considerations of everything from token flow, ecosystem participants, utilization cases, rewards and incentives, value, and typical ecosystem controls that we look to model and test to help our clients launch.

Token Flow & Ecosystem Participants

Token flow is the first element to consider. Value from any token derives from how the ecosystem creates value, and part of what creates that value is the circulation of the token, how it is consumed and how the token is supplied to the ecosystem. Let us use a case study to illustrate some of these points.

ABC Token is a token used to get access to a platform, ABCnet.

The participants in this ecosystem might include ut is not limited to the following:

  • Players who participate in the ecosystem
  • The Company and team building the platform
  • Token Holders whether players who hold the token in order to gain access to the ecosystem or speculators
  • Adopters who are Players who grow the ABCnet ecosystem by inviting friends, developing additional utility, creating pools or other bespoke betting activity, etc.

It is important, in studying the economics of your proposed token, to consider the ecosystem and how the token might flow between these parties. It is also important factor in determining appropriate ecosystem parameters and controls.

Use Cases, Rewards and Incentives

Use cases, rewards and incentives are also factors to consider that drive adoption of the token and its use within the ecosystem.

Use cases describe what the token is used for in the ecosystem, and rewards and incentives describe how the token is designed to incentivize use of the token and the benefits of the token to the token holders and players. Using our case study from earlier, the use case of the token is to access functionality on the ABCnet platform. In this case, the reward might be a discount on each transaction made, say 2% for transactions of $10-$100, 3% on transactions of $100-$1000, and 4% on transactions greater than $1,000. Incentives in this case may be a discount of 1% for each player referred or for every $5,000 of ABC tokens held.

The overriding thing to consider will be how the controls set on the ecosystem will permit the token to be used as intended and to drive adoption. In this case, because the token will be usedas a primary funding tool of the betting platform, to ensure there is enough circulating supply to allow a widely held pool of users to use the platform. Additionally, what will the ecosystem do to reward or incentive token holders and users? Will staking incentives limit circulating supply? These are trade-offs that must be considered. Notably, the rewards and/or discounts to adoptersand holders may be tiered based on number of tokens held, number of users referred or any other parameter of choice to incentivize users to build the ecosystem.

Another consideration is that for an ecosystem to be successful, tokens need to be widely distributed to ecosystem participants. The question for new projects is how to carry out the ICO responsibly, while also ensuring early adopters are rewarded appropriately for action that createengagement and value for the ecosystem.

Token Value

Token value is derived from generating utility in the ecosystem, intrinsic value, but also from speculation.

The intrinsic value of the token is directly tied to the size, credibility and utility of the project and ecosystem. Speculation may also impact the value as speculators buy or sell the token based on expectations of future value. Speculators can be valuable or detrimental to an ecosystem, depending on the level of speculation occurring and the discrepancy between intrinsic value andspeculative value.

Ecosystem Controls

There are various ecosystem controls that can be built into a token’s architecture to help align incentives and create value including burning, staking and release schedules.

Burning is a tool used to increase scarcity of the token (and correspondingly the price of the token) over time as tokens are “burned” or removed from circulation by the network.

Another control, staking, involves locking up a percentage of tokens and releasing them over a period of time or based on a predetermined schedule. It can be a useful tool to incentivize largerholders, early community adopters, and other positive activity. Staking schedules may be changed significantly over time and are worth considering as a means of distributing tokens are not sold.

Lastly, release schedules or unlocking schedules dictate the lock up of founder, large investors or other insider token holdings. They are meant to align interests over time and ensure the founding team remain vested in the project, similar to a traditional start up or project.

Another control, staking, involves locking up a percentage of tokens and releasing them over a period of time or based on a predetermined schedule. It can be a useful tool to incentivize largerholders, early community adopters, and other positive activity. Staking schedules may be changed significantly over time and are worth considering as a means of distributing tokens are not sold.