Alex Fatuliaj
August 8, 2023
Tokenomics Tuesday

TLDR: Cryptocurrency tokens are vehicles for transacting value and should be created on top of existing companies / communities / protocols. Tokens should have a clear purpose and inherent reason for their existence, and their utilities should enhance the user experience. By carefully considering the purpose and utilities of a token, projects can create a successful, decentralised ecosystem that aligns incentives, facilitates governance, establishes ownership, enhances sovereignty, redistributes wealth, and more.

Token Purpose and Utilities


Cryptocurrencies and tokens have revolutionised the way we transact value, from traditional monetary exchange to social and political interaction.

This means creating a token for your ecosystem is not about hopping on the bandwagon but about creating a clear mechanism that provides value to the users and ecosystem.


What is a token?

It is important to distinguish between cryptocurrencies and tokens.

  • Cryptocurrencies: the native digital asset of DLT networks, and a core part of how they function.
  • Tokens: secondary assets built on top of existing DLTs.

Whilst cryptocurrencies are used to fundamentally align incentives in a DLT, tokens are created as a layer above companies, communities, or protocols, that serve as a feature that improves user experience and/or company performance.

What is the purpose of tokens?

Token utilities are the practical applications of the token's purpose, and they should be designed to enhance the user experience and create additional demand. But what is the purpose of a token? There are three - decentralisation, control, and data transfer.

Decentralization

The mantra of Web3 is about giving users ownership of their own data, assets, activities, and everything in-between. To its extreme, this implies creating completely decentralised ecosystems that don’t need any middle-men, including the founders or team. Without a central authority however, these ecosystems need something to align incentives (1) and continue the idea of decentralisation beyond a localised system (2).

  1. Tokens are ideal for aligning incentives by giving everyone a stake in the ecosystem, as well as being often used more directly to reward good or desired behaviour, and penalise bad or undesired behaviour.
  2. If you’re decentralising the local system (i.e. the project itself), then you may as well decentralise the local system from the global system - in essence, you may as well remove any reliance on the currencies/assets of other entities, and create a self-sustaining machine.


Sovereignty

By utilising an independent token, it's possible to create ecosystems that are not associated or reliant in any way on anything or anyone else; this grants autonomy (1) and much greater safety from counterparty risk (2).

  1. Having control over your currency’s fiscal and monetary policies (inflation, taxes, interest rates, etc.) allows for more effective control over the overall economy and facilitates stability. This is particularly useful when a token is more than a mere medium of exchange, but is also a tool for incentive alignment, political sovereignty, data transfer, and more.
  2. Using a separate vehicle as a medium of exchange separates the value of your project from the value of things represented by other currencies (e.g. USD represents the value of the United States, so if the latter drops, so will the former.

Data

Utilising tokens to transfer data cuts the length & cost, increasing liquidity, and adds immutability and security, increasing trust. This is fantastic when tokenizing assets (1), for sensitive data transferring (2), and for data storage (3).

  1. Tokenizing any asset via a token that can trade 24/7 with much less restrictions creates much greater liquidity of the underlying asset in the exact same way that fiat created much greater liquidity for gold back in the 1600s when merchants started using Notes instead of gold itself. This is why Real World Asset tokenization is such a big craze right now.
  2. Using zero-knowledge proofs it is possible to acquire and use data without the actual data being revealed. This would prove incredibly useful for medical and scientific research.
  3. The fact that data on blockchains is immutable, and that blockchains are costly to attack, creates a secure ledger that adds significant trustlessness when it comes to data storage.

These purposes overlap in loads of different ways, and a token can have the purpose be any combination of the three at the same time.

What are token utilities?

Utilities are the direct actions that define what a token can be used for, and all fall under one or more of the token purposes above. We have outlined some of the most popular utilities below.

  1. Medium of exchange
  2. Staking (for yield)
  3. Access to certain features
  4. Discounted fees
  5. Governance
  6. Rewards (for doing something)
  7. Collateral (for whatever reason)
  8. Tokenized assets
  9. Data storage
  10. Data transfer

The crucial thing that most projects get wrong is they look at other tokens and think, “What utilities should we add to our token?” This is the top-down approach and the problem with it is that the utilities don’t stem from the product, which causes a disparity in the ecosystem.

In reality, you should create your product first, then think about whether you need a token and where it could be implemented, and then from there you can derive the necessary utilities.

Conclusion

It is crucial to understand that creating a token for your ecosystem should not be taken lightly. The reason behind the token needs to be carefully thought about and understood, so that the economy and tokenomics can reflect it.

Tokens are not a quick fix to a bad product or a trendy gimmick, but a serious commitment that requires careful consideration of the token's purpose and utilities.

Creating a successful token requires expertise in economics and finance, as well as understanding of politics and sociology, and a deep understanding of the underlying technology.


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