Crypto Economy & Tokenomics Explained

The crypto economy is much like the rest of the global economy. It has various types of currencies, unique methods for managing those currencies, a budding regulatory environment that includes KYC and AML, and different options for raising capital, to name just a few.

However, the crypto economy is far more multifaceted and flexible than the global economy. There are different kinds of coins, like Bitcoin, altcoins, stablecoins, security, governance, and utility tokens, and unique ways of raising capital, like ICOs and STOs. That is a lot of technical terms for one paragraph, but by the end of this article, you should have a basic handle on what these terms mean, as well as how they impact the crypto economy. All of these terms are important because they are fundamental to understanding why the flexibility and unique nature of the crypto economy is rife with exciting possibilities.

Crypto Economy & Tokenomics Explained

Token Types

Bitcoin is the crypto that started it all, but as Satoshi Nakamoto’s revolution took hold, myriad other digital tokens began to pop up everywhere. These tokens were labeled “altcoins” by the crypto community, short for alternative coins. Having a basic grasp of the different types of crypto tokens is key to understanding what motivates actors in the crypto economy. Some of these different types of tokens are utility tokens, stablecoins, security tokens, and governance tokens. What follows is an overview of each of these classes of tokens.

A utility token is what is most commonly thought of when people think of crypto. It is a token whose value rises and falls like a stock based on the market’s interest in a project. Utility tokens are therefore directly tied to the value of a project. Bitcoins are utility tokens, which rise in value when the market values Bitcoin more, and fall in value when the market values Bitcoin less. The volatility of Bitcoin has laid the groundwork for some of the strongest criticisms of utility tokens as a replacement for fiat currency. Imagine if when you left your house to go to the store, a thousand dollars could buy you a brand new laptop, but by the time you got there, the value of the dollar had plummeted, and a laptop now costs five thousand dollars. As of 2020, if Bitcoin were used as a replacement for fiat currency, this sort of thing would occur frequently.

A stablecoin is a digital token designed to minimize price volatility, and solve the major issue with utility tokens. Stablecoins solve this problem by pegging their tokens to some stable asset or combination of assets, whether fiat currency, gold, or even another less volatile cryptocurrency. Pegging a token to an asset essentially just means that the group managing the token holds the stable asset or assets in reserve (like a large pile of dollars). Holders of the token can always trade in their tokens in exchange for the asset. In this way, investors are assured of their tokens’ value and do not have to worry much about inflation or volatility.

Security and governance tokens are probably the two types of tokens that beginners have not yet heard of. A security token acts more like a vehicle for investment (and as such, they are always subject to the SEC’s KYC and AML regulations). Security tokens are digital proof of ownership for any asset that already has value like real estate or stock. This basically just means that a security token does not have any inherent value, instead representing an ownership stake in some other valuable asset.

Governance tokens are simply administrative tokens that allow holders access and rights to participate in governing crypto projects. Such governance implies hiring and firing, including new features, and even changing governance schemes or protocols. These tokens are essential in the seamless administration of crypto projects, and will become precious commodities when crypto eventually goes mainstream. The power of a company CEO, CFO, manager, and board of directors will all be wielded via governance tokens.

Tokenomics

One of the most exciting aspects of crypto is the flexibility developers have in distributing and managing the tokens they create. This so-called science of the token economy has been coined tokemonics, the discipline of coin creation, management, distribution, and removal from a blockchain. The variety of methods available in tokenomics enables vastly different functionality. For example, arguably Bitcoin’s most valuable feature is the absolute cap of 21 million tokens that can ever be produced or distributed. Not only that, but there is only one way to receive Bitcoin directly from the blockchain — mining. This feature is why investors like Paul Tudor Jones and others have called Bitcoin a modern gold in the sense that it is fully protected from the dangers of inflation. Other cryptos, like Ethereum, do not have any cap on supply, instead continuously doling out tokens to encourage transactions on its network.

Another example of tokenomics at work is the flexibility in how tokens are distributed. Tokens can be distributed like Bitcoin, with miners receiving tokens for every verified block up until the total supply dries up. They can also be distributed on a fixed schedule in a string of ICOs, with buyers bidding on the price of new tokens. And crypto tokens can of course be distributed like fiat currency, with a centralized company issuing new tokens based on whatever they think is most beneficial to the currency (see Algorand, for example). Perhaps the most fun distribution scheme is through lotteries and giveaways. Tokens like Banano and NOW token often employ this method of supply distribution.

Raising Capital For Crypto

There are a few primary methods for raising capital in crypto. One tried and true method is simply seeking investors, those who believe in a project and are willing to inject it with their own capital. The other methods (which are unique to crypto) are called an initial coin offering, or ICO, and a security token offering, or STO. These options are similar to initial public offerings (IPOs) where a company issues shares of stock to the public. In an ICO, the company or individual behind a crypto issues tokens to the public in exchange for capital. Usually, the developer will put out a white paper describing the technology and utility of the token to attract investors. Unlike IPOs, ICOs are almost entirely unregulated, so investors have to be very careful which ICOs they participate in to avoid getting duped or defrauded. This also means that ICOs have more flexibility than IPOs in terms of the value of each token that they offer.

STOs are more of a hybrid between ICOs and IPOs. In an STO, the investor receives a token just as in an ICO, but the token represents some asset or security, whether stocks, bonds, or even a real estate asset. The three primary benefits of an STO over a traditional IPO are that (1) investors have access to a wider variety of assets through offerings (real estate investments, for example, are generally not available through an IPO), (2) a token holder gains all the benefits of blockchain technology including security, anonymity, transparency, smart contracts, near-instantaneous transactions, and more, and (3) investors have access to a plethora of information that the developer is legally required to provide. At the end of the day, raising capital for crypto is not all that different from raising capital for non-crypto ventures.

Crypto Regulations

Crypto has experienced some major scandals that are inevitable without proper government regulation (Silk Road and Mt. Gox cases are good examples). As crypto expanded its user base, governments have taken notice and have begun to pass into law and enforce some important regulations. An overview of the crypto economy would not be complete without a discussion of regulation, but this topic is expansive enough to warrant its own article, as regulation will likely shape the direction of the crypto revolution in numerous ways. Thus, what follows is just a brief introduction to the most important issue you will encounter in this area, know-your-customer, or KYC, and anti-money laundering, or AML regulations.

KYC and AML compliance require that crypto companies gather certain information about their clients to enable easier identification and tracking. These requirements serve to prevent criminal activity through the use of crypto, or, at the very least, make it more difficult not to get caught. One major benefit of crypto is that users can stay completely anonymous, showing the world only their wallet address in the form of a string of letters and numbers. This is great for legal actors who want to mask their transactions for benign reasons like privacy. However, criminals, especially money-laundering criminals like mobs and hackers, benefit in a major way from this anonymity. Requiring KYC information limits the risk of illegal activity through crypto.

Bottom Line

The crypto economy is a dynamic and fast-paced system with groundbreaking innovation, the speed of which has never been seen in any economy in history. This innovation breeds flexibility, opportunity, and exciting new ways to solve old problems. This article hopefully provided the basic contours of the crypto economy, and equipped you with the knowledge necessary to do focused research on the areas of crypto that interest you most.

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