What is Tokenomics and how does it work?
- The so-called tokenization of the economy and finance brings with it a revolutionary movement that could take shape in a few years.
- The clearest examples of tokenomics are to be found in the ecosystems of decentralized finance or DeFi.
Each cryptocurrency that exists has a foundational base, a specific functioning, a purpose, and specific ways of distributing potential benefits or giving rewards to its users… All these mechanisms that shape and define the cryptocurrency itself are its tokenomics.
Tokenomics, which are generally detailed in the white papers of each project, are implemented, in whole or in part, through smart contracts. Thanks to smart contracts, greater transparency and security are achieved. In addition, smart contracts make it possible to automate and reduce the cost of certain processes such as interest payments, token distributions…
Decentralized finance (DeFi), as the name implies, is articulated through smart contracts without the need for a trusted third party. This means that common human errors are generally absent from the token economy mechanisms.
The universe surrounding tokenomics
As can be intuited, tokenomics have the task of making the mechanisms by which investors’ money “works”. In that sense, they are no different with respect to the mechanisms used by other services to accomplish similar tasks. The big difference is that the latter operates human teams and the former operates algorithms, as we will detail later. The topics to be studied in this article are listed below:
- What is tokenomics?
- Why are tokenomics important?
- The varied nature of tokens
- The emergence of DAOs and their tokenomics
- Why investors should know about tokenomics?
It is worth noting that this new concept is set to fundamentally change the world of investments and many facets of the economy. In other words, the universe of cryptocurrencies, decentralized finance, and all its derivatives are firmly established thanks to tokenomics.
Although this is a process that is in its infancy, the impact it is already having is considerable. For example, sports clubs, the real estate market and many other businesses are venturing into the world of tokenization and thereby offering various opportunities and methods to take advantage of these proposals. The latter is what is known as internal tokenomics.
What is tokenomics?
Tokenomics are all the mechanisms, agreements and functionalities that define a cryptocurrency and allow it to function as expected. As a whole, tokenomics, seek the establishment of a new type of economy. It is based on the revolutionary blockchain and its sustainability depends on the movement of tokens. In such a way, tokens are the backbone on which all business processes coupled to this technology revolve. Users interact with the tokens through some kind of interface. At the same time, those tokens can be linked to real assets, which represent the wealth of the project and investors. A simple example can be found with mobile car racing game applications. The user can participate in racing tournaments and according to the score is assigned tokens, nothing new.
However, in most of those games the tokens have no market value. This is where the revolutionary aspect of tokenomics comes into play. These, when linked to the blockchain, give the ability to add real financial value to those tokens. With this, games go from being hobby apps to become apps that combine hobby with revenue generation or GameFi. Among the most popular games are Axie Infinity, Defi Kingdom and others.
It should not be lost sight of the fact that the concept of tokenomics applies to virtually anything tokenized. As already mentioned, tokenization of the real estate market is one of the most promising for the financial world. Along with this, there are lending, staking, etc. options.
Why is tokenomics important?
The key aspect that determines the importance of tokenomics is that it was born as an alternative to the centralized system. Consequently, one of the core tasks is to preserve wealth in the face of inflation. The control of traditional currencies such as the USD or EUR is tightly monopolized by central banks.
The latter have the ability to issue money at will, which generates inflation, which is one of the most damaging phenomena for people’s economy. At this stage, the importance of tokenization comes to life as an alternative to the inflationary phenomenon of centralized entities. Tokenomics are as varied as the number of applications with tokenized services or options. In general, DeFi applications have a White Paper.
In this document, the mechanisms of the token economy of a given project or financial application are explained in detail. This ranges from issuance and distribution to exchange rates and rewards. All these elements make it possible to enter the services of a decentralized application, for which one must proceed to acquire its native tokens. In the end these will set in motion all the internal mechanisms established by its developers. Hence, it is crucial to know the whole process of the movement of these tokens in all its facets in their respective white papers.
The varied nature of tokens
The basis of the token economy is, and could be none other than the token. To have a clear context, it should be said that the token is for the tokenomics and the commodity is for the classical political economy, that is, the nucleus from which a whole big bang and its universes explode. But tokens are not a single entity; rather, an important variety of models can be distinguished. The following are the most outstanding ones:
- Inflationary token model
- Double-token Model
- Deflationary Token Model
- Backed Token Model
Although at first glance these concepts may seem complex, the reality is quite different. In that sense, anyone who has used cryptocurrencies, even at a basic level, will quickly understand what these different natures of tokens are all about.
Within the crypto market world, there are all these models and usability depends on users’ tastes. Some people prefer to bet on tokens that are deflationary for short and long-term profitability. Although these tokens usually offer large amounts in a short time, their volatility makes them high-risk assets.
Other more conservative users opt for backed tokens, which offer moderate and steady returns. If these two cases sound familiar with those who opt for Bitcoin, on the one hand, and those who prefer to invest in stable coins like USDT on the other, that’s what it’s all about.
The emergence of DAOs and their tokenomics
Governance is one of the newest players in the investment arena in the digital currencies and DeFi market. Many projects create governance tokens to successfully roll internal tokenomics. An example of this is the already named case of the double-token model.
As such, many of the protocols are turning to the decentralized model of DAOs (Decentralized Autonomous Organization). This is a system based on governance tokens. The hodlers of these tokens become part of the decision-making in the projects through voting. The holders of these tokens occupy a position similar to the holders of shares in a company, with the difference that the company does not have a CEO or a central board of directors.
The place of the board is taken by the functionality programmed into a smart contract. Simply put, a DAO is a computer program that works automatically. At the same time, it needs participation to operate, since it does not perform all its tasks by itself. Such user participation is realized by means of governance tokens.
As already noted, there are projects that work with a dual token model, one to raise funds and the other to keep the protocol operational.
Why investors should know about tokenomics?
As explained in this article, knowing the token economy of a certain cryptocurrency is of fundamental importance for investors. Taking for granted that supply and demand conditions are determinants for the present and future value of any asset, from stocks to cryptocurrencies, it becomes vital to know the mechanisms of token-based financial service offerings.
Read the full article: https://investortimes.com/what-is-tokenomics/
