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If General Economics is so cumbersome, how much more
All aspects pertaining to the cryptocurrency asset, its rewards, its supply, its inflation rules, fines and so on need to be considered and examined in as much detail as necessary. Token metrics can be considered a hybrid between a set of programmed rules that will be implemented on a blockchain. These rules will also guide the human interactions that are already on the network.
Some people refer to Token economics as Tokenomics, some as Coin Economics or Token metrics, but regardless of what it is called, it is a term sure to be heard whenever ICOs are discussed. It deals with real economic models.
It deals with new models created when new cryptocurrencies were created. Some of the new models are different from prior utility-focused models because they were created solely for fundraising purposes. Since these models do not play any role in stabilizing or incentivizing use upon the platform, they present a significant challenge to investors. Once a project has its ICO, it is unable to change the underlying model of the blockchain. Those tokens are solely useful for fundraising and utterly useless afterwards.
“In the blockchain industry, the term ‘security’ and all of the dynamics associated with that term, are nothing new. How property ownership is handled and how assets are transferred between individuals are two major factors that have been affecting the nature of commercial transactions since the beginning of time.
In fact, the blockchain enables these functions to be performed better than any other traditional institution. But one thing the blockchain industry as a whole has not been able to do, is gain legal recognition for a proposed change to the ‘normal’ dynamics of securities. That is to say, we have not yet been able to get legal regulations that recognize tokens for what they actually are, and not simply force every new development to comply with one or another category of traditional securities laws.
Furthermore, if regulations are not properly adapted to changing conditions and technological developments, then securities that are tokenized or blockchain-based will look extremely similar to the securities already in the current system. This would be an egregious example of missed opportunity for society at large.”
“In the same way that cryptocurrencies and the blockchain industry will radically change the world around us, tokenomics will radically change many processes that we have grown accustomed to under the present system.
We will discuss this in more detail soon, but first, let’s look at the mechanisms behind ICOs and see there is more involved than simply raising funds. Cryptocurrency models allow for the design and implementation of new business models. They also allow for a fundamental change in how governance is approached at all levels of the corporate structure. Token economics is all about the blockchain models in which the associated cryptocurrency tokens function in the framework of a particular business enterprise.
There are many token economic models, all of which share one underlying principle; People always act on incentives. These incentives are the tokens themselves. The tokens are used as a reward to move and motivate people. They encourage people already on the network to contribute to the security of the network or platform. This is based on incentive theory, a human behavioral theory that assumes behavior is motivated by a desire for reinforcement or incentives
It might seem that we have already presented you with a lot of information. We have tried to establish a base upon which you can build a thorough understanding of the importance of the tokenomics model underlying an ICO or cryptocurrency, and also its application as a utility and fundraising tool.
The root models for token metrics or token economics are structured and implemented right from the very beginning. The basic model is considered even before a new cryptocurrency is launched. Before launching a new token, the start-up firm must decide what role the token will have on the blockchain platform.
As easy as it seems, this is one of the most difficult and strategically challenging moments of an ICO project. Now this might sound hyperbolic, but in fact there have been many amazing projects with fantastic teams that have let down their investors and themselves by choosing one particular tokenomics model rather than another.
Before models are actually designed, the consensus model must already be in place. Although in a literal sense, tokens can be created over time, the consensus algorithm will be revised several times to innovate upon the initial solution.
The proof of stake algorithm is used by cryptocurrencies like DASH and NAV. This model is different in that holders of this token stake their cryptocurrency assets in a wallet in order to solve new blocks. For staking their own coins like this to solve blocks on the chain, they are awarded new cryptocurrencies for their effort. A proof of stake model is different from a proof of work model in that miners are not rewarded for solving complex mathematical problems but rather in a deterministic manner based upon each holders’ wealth.
There is one big and obvious similarity between the two models. Newly mined cryptocurrencies serve as an encouragement for active participation in the network. Through this process, the members will agree on the means of verifying transactions, securing the overall network, and boosting the blockchain.
The only way inflation will occur is if more coins are created. Once there is an incremental increase in the supply, each existing token drops in value. This will occur of course if the demand remains constant. Just as we have different underlying models for Proof of Stake and Proof of Work, we also have different rules for Inflation.
For example, consider bitcoin. When a miner solves a block, he currently gets about 12.5 units of the coin. In four or five years from now, this reward for solving a block will be halved to about 6.25, in the same number of years, the reward will be halved again and so on and on, until all of the 21 million BTC that are not currently mined come into circulation.
Token Economics in ICOs
An Initial Coin Offering (ICO) is the process of raising funds for a new cryptocurrency project. It is different from the traditional IPO or other difficult fundraising processes encouraged by banks etc. when a project needs to raise funds.
The idea is that the tokens are given to investors as their stake in the project. In turn, the investors support the launch financially by also buying some of tokens offered for sale.
“Token Economics in ICOs §2
As an Investor, how can tokenomics help me?
Simply stated, Token economics and metrics will help an investor understand if the token will rise in value after the ICO. From this analysis, the investor can make money by later selling the tokens on an exchange for a nice profit over the token price at the ICO.
In the early days of ICOs, investors made their decision based solely on the quality of the team. They would look for the requisite talent, history of execution, or even the ability to network with people enough to actually create a viable product. These days, tokenomics is the first thing to investigate because it can reveal everything you need to know about the project before you even read about what they say they are going to do.
Did You Know?
Between 2014 and 2017, there has not been one successful ICO
that has raised less than $100,000 USD.
Across the world, over $6,400,590,440 USD total has been raised via ICOs.
“The Price of ICOs’ Tokens
From an investors’ point of view, determining whether the price of tokens is fixed or fluid is very important. This will help the investor envisage and quantify how many tokens will be received per BTC or fiat value as a proportion of the principal of your investment. In a situation where the price is not fixed, but is priced in an auction format of sorts, you may be encouraged to dedicate more funds toward the ICO than the actual stake you desire to take, because you know the offer will be oversubscribed.
So, cryptocurrency investors function between two possible pricing states for an ICO. If the ICO token priced is fixed, then you will receive a certain number of tokens, assuming there are enough left by the time you receive your allocation. If the price is fluid, you will have to compete in terms of price and the value of your bid price to win an allocation.
In both situations there are disadvantages for the investors. A fixed ICO could potentially lead to the undervaluation of an ICO token. This might be by design to encourage investors to purchase stock at the ICO or pre-sale, aiming for gains when it gets listed on an exchange. If the price is fluid, a token might become overvalued during the ICO process and crash at the exchange listing. This would greatly damage the investors as well as create negative expectations in the market for that token in the future.
“The Price of ICOs’ Tokens
Some teams have designed an alternative pricing mechanism. Under this pricing mechanism there is a proportional relationship between the value of tokens bid for at a certain price and the relative purchase price to other bids. In this system, the final price of purchase changes with the progress in the sale of tokens.
We have covered many different factors and various mechanisms involved in an ICO. We strongly recommend investors carefully consider the manner and terms under which an ICO will occur.
Depth of Investors
As in any auction, or even any transaction, the depth or number of people willing to purchase something is a major influence over the final price of the goods. ICOs are no exception to this rule of supply and demand.
If there are more investors, and they have a substantial amount of capital, the ICO will be able to raise funds much easier because the project has a significant depth of capital wishing to invest in the ICO.
A team setting a fixed hard cap before an ICO that is both reasonable and likely to be hit is a positive sign to an investor. There is nothing worse than a hard cap not being reached because you can almost guarantee the token will later crash on the exchange listing. Investors purchase tokens with the express belief there is enough demand and scarcity so that the tokens will go up in value.
“Depth of Investors §2
What if there is no set hard cap?
It can save the team embarrassment if a specific target is not achieved. It can also be a signpost of a poor ICO. By not setting the hardcap the team is not placing a limit on the amount of money that can be raised. This means either the team does not know how much money they need to raise for the project and are simply holding out their hat for free money, or it demonstrates that they are simply greedy and are looking to pull in as much money as possible without regard to what they will do with it. Some incredibly popular ICOs in the past have done this. Although they haven’t been greedy or fraudulent actors, still, history strongly demonstrates an ICO without a hardcap is a tremendous warning sign. By not setting a hardcap there is no defined amount of money which can be contributed to an ICO. This doesn’t allow for the creation of price tension in the market, which would help a token increase in value after it lists on an exchange.
Although when ICOs set a hardcap, it can possibly result in the over-concentration of tokens in the hands of the biggest few investors. And in fact, history has shown this to be true. This does contradict the entire idea of the blockchain network which prides itself on decentralization. There are advantages and disadvantages to both pricing models of ICOs, as well as the relative role of the depth of investors.
“Judging the Size of the Market from the top
Most ICOs show the entire availability of tokens to the market. From this they value their tokens based upon the top-down market size. To illustrate how this works, let’s say you want to design a blockchain network for the production of Michael Jordan Sneakers. In your whitepaper, you could write down that the entire market size for this type of sneakers is expected to be a certain amount, say $500 billion by the year 2030.
This statement of fact in the whitepaper does not mean that by year 2030 that particular product will actually be worth $500 billion. It is just an estimate of total market size at that point in the future based on present market conditions and trends.
As part of your proposed blockchain solution for the production of sneakers you should expect some leakage of market share. Between now and the time horizon under consideration, there will be new competitors in the market and unpredictable evolution in fashion tastes and trends. You will also have to work hard to win consumers away from the big brands currently dominating the market. In addition, you still need to convince enough people that it is a good idea to invest in your own blockchain project, that buying your ‘token for sneakers’ will be a profitable decision.
“Judging the Size of the Market
So, from that example, a winning strategy would be to determine the total size of the market and potential market share you are likely to win. The value of your tokens and the implicit value seen by investors is not determined by the total market capitalization, or dollars spent in that industry overall, but rather the amount which you could credibly win from the competition by the creation of demand for your product.
In the traditional world this is called Market Opportunity. It is calculated by multiplying the total market size in dollar figures by the possible percentage penetration. So, let us assume that your ICO has 0.15% of penetration and the market is currently valued at $500 billion; then the market opportunity will be calculated:
0.15*$500,000,000,000 = $750,000,000
From this, you can determine how to price your token, assuming you believe your company can honestly capture this level of market size within your stated time horizon. You will also need to lower the valuation of your token further to give your investors a reason to invest. Otherwise they are purchasing the token already at its intrinsic value, yet taking on the risk of you being able to execute your strategy. This all comes from the perspective of how the ICO team might value their own token. As an investor, it is strongly recommended you check their calculations and do your own research to verify the team’s conclusions.
“Judging the Size of the Market From the Bottom
This is another way to judge the size of the market. It involves projecting the growth of your proposed ICO or product based on the current financial numbers. This process involves taking a transaction and extrapolating. In this case, the transaction means an investor buying tokens and the project awarding the tokens to the investor.
Let’s go back to the example of Michael Jordan sneakers. Let’s assume you plan to sell a dozen for about $400. Investors decide to purchase ‘sneaker tokens’ which can be exchanged using any exchange. You are also aware that in your local area you might be able to sell as many as thirty sneakers in a single month because demand is so high.
From this little token economics you can calculate the market size as follows:
Number of items * Price = Market Size
30 * $400 = $12,000 per month
In a year, that figures become $144,000. As time goes on, you are likely to sell more sneakers and earn more money. When you use the bottom up approach you can determine not only the possible revenue of the company based upon key assumptions, but also how sensitive the company’s future earnings will be to certain key assumptions. It is strongly recommended investors complete both forms of analysis before deciding on a token so as to avoid any unexpected surprises.
Judging the Size of the Market
Most ICO teams do not readily show their books and metrics if they already have a working product with paying customers. This is due to commercial sensitivity and protection of proprietary information. But the majority of ICOs do not have a working product. All they have are market plans and examples of possible outcomes. It is very easy to place numbers on a spreadsheet and compound them. It is much more difficult to actually deliver a tangible product or establish a working business that justifies a company’s valuation.
How do I judge if a token’s price will rise in value?
Investing will never be risk free, of course, there will always be risks associated with any investment decision. The least risky ICO you could find, is one with a working product and tangible proof the numbers they are providing are based on reality. From there you can grasp the fundamentals of the business and key assumptions in the business plan. You can also see if the company’s premise and purpose have been validated by the market.
Now we focus back onto the economics of the actual token itself. The least risky token would be one with a low hardcap, with a strong depth of investors, with an outsized demand for tokens relative to the cap available. In this situation, assuming everything remains sound between the ICO and the unlocking of the tokens on the exchange, the price is likely to go up thanks to the pent-up demand.
“Notable Examples of Key Token Economic Models
There are unique structures and models that different ICO campaigns have implemented over the past few years that have helped them succeed. The most popular structure, that has helped many successful and well-known campaigns, is one wherein the vast majority of tokens are sold in presale without a large bonus, and slightly longer than average lock-up or vesting period.
The underlying principle of this model is to lock in cornerstone investors before going to market. This generates further market hype and anticipation that the token has strong support even before it becomes available to the general public. Selling a good supply of tokens before the token is even listed further amplifies this anticipation and ensures that as long as there is liquidity on exchange listing, the token should be in hot demand. Investors will be looking to capitalize on the bullish market sentiment and positive outlook for that company.
For example, if a team or advisor(s) is allocated a certain number of tokens for the work they have done, the real worth of those tokens is actually $0. The tokens did not cost the advisors or team members any money, they simply used some of their time and skill. Upon listing, the tokens are suddenly attached a value by the market whereby the individuals are able to sell them to a willing buyer at an agreed upon price. An investor should keep this in mind, how many tokens have been allocated to the team or the advisors, and at what price? This will greatly influence the value of the token on the exchange or any time during the ICO.
“Notable Examples of Key Token Economic Models
-Fully Mined Structure
Bitcoin is an example of a token that utilized a fully mined structure. Unlike other campaigns where the team holds most of the tokens, there was no pre-mined amount given to any team member or group of advisers.
Participants were rewarded for their efforts in mining new tokens and verifying transactions on the blockchain. The structure was a tremendous success because not only was there an active incentive for anyone to participate but there was also a finite and easily calculable supply of BTC in the market.
The Ripple ICO is another well-known example from a few years ago. They used a structure that allows for percentage sharing. A certain percentage of tokens were reserved for the team, some were reserved for early investors during the presale, and the remaining percentage was available to the public during the ICO. This was a tremendous success and is currently very much the bedrock structure of all ICOs. Many people are somewhat concerned about extra-generous allocations to team members and pre-sale investors, but the structure itself is sound and strong enough to encourage investors to participate.
-Majority of Tokens kept
Ethereum used something of a hybrid structure combining both the shared and fully mined systems we just talked about. The foundation team (Ethereum foundation) and other members, held the majority of the tokens as part of the sale. This was a success due to the mission statement of the team and ultimate goal of their project (Dapps upon their blockchain). And then later, ETH also eventually swapped to a mining structure similar to BTC.
“Preferred ICO Structures
After you have evaluated the tokenomics of a project it is important to consider the flow-through market in which the tokens will be marketed. The ICO presents the first real-world challenge for the final structure, and a one-time opportunity to demonstrate if the correct tokenomics and structure were chosen.
Capped Sale (First Come-First Served)
In this structure, a set number of tokens are offered for sale to investors and the general public on a first-come first-serve basis. As a result, there is also a set amount of funds that can be raised. A portion of tokens are typically allocated to the team, advisors or friends during the pre-sale (Ripple for example).
Of all the ICO campaigns conducted to date, this structure is the most commonly used structure for an ICO. Some ICOs give the incentive of a discount or bonus to motivate early participation before the public ICO. But recently, the majority of campaigns have removed any incentives or discounts. There was a massive disparity between the investment register in terms of buy-in price, and the discounts were attracting short term speculative investors who just want to buy tokens and flip them for a quick profit.
Preferred ICO Structures
Under an Uncapped structure, tokens are offered to investors for sale over a considerable period of time. The tokens that are offered for sale are not just a percentage of the maximum supply, but an unlimited number of tokens. Any number of investors who wish to purchase the tokens may do so. The price per unit is the only thing that is fixed from the start. No target price or ceiling price is set. Insiders still receive allocations of tokens.
Just as the name suggests, investors place individual bids capped in terms of price and total investment value. The number of tokens sold is set at a variable wherein the final price is decided by the proportion of funds allocated at and above certain price points that meet the projects’ defined threshold. It could be a Dutch auction or a Blind auction. As usual, the insiders receive their allocation of tokens, a variable percentage of the total supply of tokens. The percentage allocated to insiders will depend very much on the number of tokens sold in the auction. There are sometimes limits on the number of tokens each buyer is able to purchase.
Preferred ICO Structures
Reverse Dutch Auction
In this token metric structure, Investors place their bids based on the price they want to pay and number of tokens they want to buy. The ICO has a fixed quantity of tokens it wants to sell to the bidders in a descending price order till all tokens that are up for sale are finally sold. There is no cap on the eventual amount that is raised. Insiders are allocated a certain percentage of the total tokens that will be supplied.
Capped with Re-Distribution
In this structure, investors will bid the full potential amount of their desired total spend. A fixed quantity of tokens is then offered for sale and sold to them at a fixed price. The portion of tokens sold to each investor is in proportion to what he or she is spending as a proportion of the total pool of funds tendered. If an investor misses out on a portion of their funds bid, the unused portion of their funds pledged will be returned to them. Just as the name indicates, there is a cap placed upon the total number of tokens that are sold. Insiders will still get their allocation of the total tokens offered for sale too.
A special advantage of this structure is that anyone who is interested can participate, everyone who bids will get some tokens. But of course, if the sale is oversubscribed, each buyer will get fewer tokens than they wanted to buy.
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