Introduction
Blockchain takes a leaf out of the field of economics to ensure viable patron engagement for all relevant parties. This article is all about cryptoeconomics and why investors should include it as part of their fundamental analysis of a crypto coin.
What is Economics?
Economics is the study of impact of financial instruments, trades, and commercial activity in a given region. It is also defined as the social science of manufacturing, utility, and wealth transfer. It deals with the individual choices concerning trade and livelihood.
At the same time, it also examines the motivations or hurdles that influence the individual choices and its micro and macro impact on the overall social unit. Marco Economics is one of its two major branches that take note of economic activities at an aggregate or government scale.
On the other hand, Microeconomics is the branch that focuses on retail economic contributors.
What is Cryptoeconomics?
Cryptoeconomics studies the impact of token currencies and virtual assets on economic activities. At the same time, it also attempts to find the real use case of cryptocurrencies to resolve real world problems using blockchain as a branch of computer science.
When developers are creating a new crypto project, they need to ingrain utility and incentive for stakeholders using economic principles.
Applications of Cryptoeconomics
The creation of Bitcoin is heralded as a disruptive technology since it realized decentralized peer-to-peer trading network based on democratic consensus.
Bitcoin solved the Byzantine General’s Dilemma, a theory that postulates that in a distributed network it is impossible to achieve consensus due to the inevitable presence of unreliable parties.
However, Bitcoin resolved this issue by introducing nodes distribution and consensus mechanism. In simple words, miners have real world incentive to put in work or computational power for verifying the transactions on Bitcoin network while the users on the blockchain gain practical utility for using the platform.
Basic Model of Cryptoeconomics
The foundational model of cryptoeconomics was created by Joel Monegro based on Bitcoin network. He has shared a holistic version of cryptoeconomics in his paper based on value flow model.
There are three main pillars of association or value transfer channels between stakeholders on Bitcoin namely miners, users, and investors. Each party transfers value in the form of native cryptocurrency i.e. BTC.
Users get to perform cheaper and faster transactions on the Bitcoin network in the form of BTC peer-to-peer transfers. Miners offer computational power to verify the transactions made by users to solve the cryptographic puzzle.
In return, they earn compensation in the form of fraction of BTC transaction made by the users. On the other hand, traders add liquidity for BTC token that allow miners to sell their BTC mining rewards to cover costs and generate additional profits.
At the same time, miners collect newly minted Bitcoins as part of their compensation based on Proof-of-work consensus model. They can maintain the BTC supply that directly impacts the Bitcoin traders.
Short-term investors or traders harbour direct value flow link with minor while long-term investors maintain indirect value flow channel as per Monegro model.
This model represents the basic dynamics of practical utility for each participant in a cryptoeconomy such as Bitcoin. Almost all decentralized blockchain networks follow the same cryptoeconomics model with slight variation.
At the same time, it resolves the dilemma of the trusted digital payment networks without the presence of a centralized verification authority such as banks.
What is Tokenomics?
Tokenomics is the combination of token and economics. It represents the economic dynamics for a given cryptocurrency based on its total supply, price, and market demand, etc.
Here are the key features of tokenomics that can help investors improve their fundamental study of a given cryptocurrency before investing in it:
- The type of mining model the blockchain uses and the ratio of mining rewards in addition to transaction fees percentage.
- Staking is an alternative for mining which means that investors have to consider the TVL or Total Value Locked in smart contracts by the validators.
- Yield earning is another incentive for staking. It means that investors should divide the TVL for validators and yield earners. At the same time, they should consider the APY (Annual Percentage Yield) offered by a given crypto project to its stakers.
- LPs or AMMs that offer new tokens for staking cryptocurrencies.
- The frequency of token burns and governance rules regarding it.
- The total supply of a given cryptocurrency to ascertain if a given virtual asset is deflationary or inflationary.
- Token allocation to different stakeholders such as initial investors, co-founders, developers, trust, foundation for a given duration.
Conclusion
Cryptoeconomics is a very important aspect of blockchain sector. It allows investors to ascertain practical utility for a given cryptocurrency and helps developers add more incentives for the network participants.
