October 30, 2018

The development of token economy models

The development of token economy models

What seems to be a very simple and an easy to grasp subject, in the first place, is actually, one of the most complicated subjects within the blockchain sphere (the blockchain economics of course). If you are asking “why”, then you are making the right questions.

A technological progress, by all means, is a difficult and a complicated thing to grasp. Often, unless you are a coder, or at least have some basic skills of reading (and understanding) code, you are lost when it comes to fully understanding what a new crypto project has to offer.

But of course, most projects (the good ones for sure) have a great way of explaining and exploring (communicating) their tech to the public. Even if you aren’t a member of a big company or a team, it isn’t that hard to actually “dive in” into understanding the technological aspects of any project. If all means fail, you can always call up your second cousin, who has a masters degree in IT to help you out with the code (the latter is kind of an epic fail really, but sometimes the lack of means calls a rather weird end).

The second “hole” of the crypto field is - economics. And here, just as mentioned above, it seems all easy… But, it isn’t. In fact, a lot of researches point out that “the blockchain showed us that we don’t know (anything - authors note) about the economics of the world”. And this is partially true.

For one, a lot of economic research was done by “ink and paper”, many years ago, and we have already noticed that sometimes crypto just “doesn’t follow the rules”. For two, most projects (even those with an amazing technological base), simply do not have a clue about economics. They either completely ignore this in their documentation, or write something along the lines: “this token will work, because it’s great”.

During the past 2 years, a huge amount of research work was released by professors, scientists and crypto enthusiasts, regarding the development of blockchain economics.

In fact, since the beginning of 2018, more and more projects try to write and make a fully thought out financial models. Of course, this has to be taken with a pinch of salt (see point “one”, two paragraphs above as to why). But, in reality, this is a huge progress for crypto. Projects begin to understand, that simply having great technological base - isn’t enough. People want to make sure that the money they invest is put to use. By those, they have to understand the economical perspectives of a token (please note, that the word “token”, is used for the ease of understanding the subject at hand here, and in the whole of this article, and not, as a description).

There are so many ways to subdivide token economy, that it is hard to find a place where to begin. One might say, that most tokens are divided as per by function, and as per by economic activity (the latter, implying that the token has programmable abilities and has growth phases, the first, implies that it has a specific function - end of story). Once again… there is so much research on the topic, it is rather difficult to come to a consensus of definitions.

To our luck, the subject of this article is to see the development in the economic models, rather than trying to argue for the “correct” one.

It is worth noting, that over the past year projects have tried to avoid such simple token descriptions as: “amount of tokens, distribution, starting price etc”, and came to a more developed description on “what is a well designed token” - according to the project of course.

One may argue that a good model will include (some of the) things, such as the following:

  • the token has utility functions, it can be used within the ecosystem to purchase \ exchange and so on
  • it has an incentive to use it. This might sound obvious, but to my surprise mose tokens simply lack this ability. They cover it with: “we will rise in price” - which by all means is not an incentive to use it. This is a speculative argument, no more.
  • the token has an inflationary or a deflationary model (this is important to note, as the token must suit the purpose of the project. Not all models need to resist inflation, at least not at all times of its lifespan)
  • its a store of value, a rail of value and a unit of account… well ok, at least it’s one of these
  • it’s scalable and divisible - no need to explain this
  • its acceptable by consensus within the project its used
  • it has a strong mathematical base to prove how it will achieve some (or all) of the above statements

And here, we come to the last point of the above statement. This is exactly the progress I believe that we will see over the next year (2019), we will see more and more projects try to develop new and interesting financial models within their economy. Based on experience of past mistakes made by others (I hope), and based on the new available research published (links to some interesting works are below).

All this, will lead to a more “thought out” economical models, that will help the crypto community to choose, not only the best technological project, but also one, that has a strong economic base layer and a use (regardless of whether it is used in the real world, space, VR or any other dimensions out there).

Here are links to some crypto economical works I strongly recommend to read (please note that you can find a bibliography at the end of each work with links to others):

  • Blockchain economics by J. Abadi and M. Brunnermeir https://scholar.princeton.edu/sites/default/files/markus/files/blockchain_paper_v3g.pdf
  • The blockchain folk theorem by Bruno Biais, Christophe Bivi`ere, Matthieu Bouvard, and Catherine Casamatta https://www.tse-fr.eu/sites/default/files/TSE/documents/doc/wp/2017/wp_tse_817.pdf
  • An (Institutional) Investor’s Take on Crypto Assets by J.Pfeffer https://s3.eu-west-2.amazonaws.com/john-pfeffer/An+Investor%27s+Take+on+Cryptoassets+v6.pdf
  • The economics of cryptocurrencies– bitcoin and beyond by Jonathan Chiu and Thorsten Koeppl https://www.chapman.edu/research/institutes-and-centers/economic-science-institute/_files/ifree-papers-and-photos/koeppel-april2017.pdf
  • Some Simple Economics of the Blockchain by Catalini, C. and J. Gans https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2874598