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What is Tokenomics?

Brian Tinsman, Head of Analytics, He3Labs

Tokenomics. Cryptoeconomics. I See Words... What Do They Mean?

The fields of cryptoeconomics and tokenomics are so new that there’s not much consensus on the definitions of terms, or best practices for designing tokens. As a full-time cryptocurrency economist, I’ll help define these terms and outline token design in line with my work at He3Labs, where we bring the benefits of blockchain to real-world businesses.

Cryptocurrency economics or cryptonomics is the economics of cryptography-based currency and networks. Yes, cryptonomics can help investors make better investing decisions, but it’s more important than that.

Cryptocurrency economics focuses on creating economic incentives to direct the behavior of buyers, sellers, service providers, and other parties in the network. It also attempts to measure and predict metrics such as user adoption, coin price, transaction volume, and services provided. Drawing on economics and game theory, it helps developers choose the best currency system parameters to generate the results they want.

Tokenomics is similar but broader. It includes all of the above, but adds other kinds of tokens beyond just currency. It includes all economic study and design of distributed ledger technology (DLT) tokens.

What tokens live on distributed ledgers besides cryptocurrencies? All kinds of data, such as:

  • Identity documents
  • Voting records
  • Contracts
  • Game characters
  • Stock ownership usage rights (such as a software license or computing services)

A digital asset could also be an account that contains several of these other asset types. All these are often represented by virtual tokens or data containers. If you can assign value to any of these virtual assets you can perform economic analysis on them.

Branches of Tokenomics

Let's look at a comparison to traditional economics first. Economics has two main branches:

Microeconomics focuses on the economy within a single entity such as a business or product. It studies specific individual decisions. “How will Intel change prices of their processors?”

Macroeconomics studies the interaction between many entities in a marketplace. It’s about aggregate decisions in competitive ecosystems. “How will worldwide chip prices change?”

Similarly, tokenomics has two branches:

Microtokenomics focuses on the forces coming from within a single ledger system. It’s about the parameters and individual built-in properties of a blockchain. (previously referred to by some as “crypto economics.”)

Macrotokenomics looks at the entire ecosystem of a DLT network. It depends on the aggregate actions of third parties such as exchanges, regulators, governance teams, and business partners.

Mic vs Mac.png

Berg, Davidson, and Potts at the RMIT have defined an even broader category, called Institutional Cryptoeconomics, which encompasses the systems of ledgers, their rules, and how other companies and societies interact with them.

“Cryptoeconomics” describes currency-based ledgers and “tokenomics” describes token-based ledgers so I’ll build on their term and add Institutional Tokenomics as the broadest system of all DLT economic interactions between all token-based ledgers, organizations, and societies.

Traditional Economics Vs. Tokenomics

One important difference between economics and tokenomics is that economics most often starts with predictive goals, and tokenomics mainly starts with design goals.

EvT.png

Designing Successful Tokens

What specific aspects of token design does tokenomics inform? Let’s use our two branches of Tokenomics to organize them.

Microtokenomics Design

These are features that drive the functions and participants within a single ledger platform. Results depend directly on the token features and parameters.

  • Mining difficulty or similar consensus algorithm settings
  • Mining rewards. (How much should a miner get?)
    • Change in rewards over time
  • Supernodes or other privileges for special status holders
  • Mechanics to adjust supply, demand, velocity
    • Inflation rate
    • Lockups
    • Vesting
    • Utility of the token
  • Utility as a currency (transaction speed, transaction fees, privacy features)
  • Utility as a claim to rights or services
  • DLT Security
    • Hashing, sybil resistance, consensus algorithm
    • Distributed vs centralized network
    • Understood and proven or obscure and experimenta l?

Macrotokenomics Design

These are features that depend on parties external to the ledger system. They are mainly centered on governance and stakeholder behavior. Coin prices and adoption are especially important to businesses seeking to raise funds.

  • Initial distribution plan - ICO or variant
    • Fundraising goals (valuation and market cap, issue price)
    • Securities compliance
    • ICO road map
    • Permissions on who can buy or use
  • External factors in coin price growth and volatility
    • Value drivers
    • Liquidity on exchanges
    • Conversion to another asset or future airdrops
  • Ecosystem Growth
    • Corporate or individual usage/adoption (demand for goods/services, how to exchange for goods/services, and cost savings or other advantages over current tech)
    • Network effect of retail acceptance or other ecosystem growth
    • Wallets and apps needed
  • Governance and voting (how are decisions about all the above made?)
    • Centralized or decentralized control of development and tuning
    • Road map ownership - who decides what features happen next?

Stay Tuned

The goal of this post was to address problems with how cryptoeconomics-related terms have been used inconsistently and share a framework that helps solve this confusion. Another goal was to introduce some of the differences between traditional economics and this new field, and how it’s relevant to design. Check back later for more posts on these and other topics related to tokenomics and crypto-token design.

I’m not sure what to call a tokenomics specialist. Tokenomist? That doesn’t sound right. Any ideas?

About Brian Tinsman

Brian is an economist with 15 years of experience creating and balancing digital economic systems, including massively multiplayer online games, rewards points systems, and real-money gambling economies. Brian is Head of Analytics at He3Labs, a development company specializing in blockchain and DLT.