Tokenomics: The Crypto Shift of Blockchains, ICOs, and Tokens

Markets have existed for as long as humans have engaged in trade and markets have emerged as a natural process of social coordination. The evolution of markets is constant, through a series of technological discoveries that help these markets to become more efficient.

Money has helped to facilitate trade and make markets much more efficient than bartering. In fact, it was around 5,000 BC that scripts first appeared and then around 2,500 BC when the first coinage appeared. With the onset of the agricultural revolution, and the rise of cities and kingdoms, an economy of favor and obligation didn't work. Therefore, money was invented as a much-needed solution.

Money allows participants within a community to compare quickly and easily the value of different commodities, and to easily exchange one thing for another. Cowry shells were a very popular representation of money used for thousands of years in Africa, South Asia, East Asia, and Oceania (Sapiens: A Brief History of Humankind, Yuval Noah Harari). Fast-forward a few thousand years and computers have made updating stock prices much more efficient than using chalk and blackboards, but how have networks and markets developed?

Naval Ravikant, the CEO and founder of AngelList, a website for startups, angel investors, and job-seekers, wrote a very insightful 36-tweet tweetstorm in June 2017 about a network of markets. Here is a summary of Naval's key points:

Blockchains will replace networks with markets. Humans are the networked species. The first to network across genetic boundaries and thus seize the world. Networks allow humans to co-operate and to allocate the fruits of our co-operation. It is this overlapping network that helps to create and organize society. Physical, digital, and mental roads connected us all together. Money is a network, religion is a network, a corporation is a network, roads are networks, electricity is a network, and all these networks must be organized according to rules. They require rulers to enforce these rules against cheaters. (https://twitter.com/naval/status/877467629308395521).

Ravikant further explained the different types of networks, such as social networks, the search network, the telecommunications network, and networks run by the elite, such as the university network, the medical network, and the banking network. The most exciting network mentioned was the blockchain network:

"Blockchains are a new invention that allows meritorious participants in an open network to govern without a ruler and without money. They are a merit-based, tamper-proof, open voting system where the meritorious are those who work to advance the network. As society gives you money for giving society what it wants, blockchains give you coins for giving the network what it wants".

The tweetstorm contained some very deep concepts (you may want to refer back to this when you reach the end of this book) that can be encapsulated by the very first tweet:

Blockchains will replace networks with markets.

Without having to understand what a blockchain is, but accepting that it is some technology that can enable the transfer of value without involving an intermediary, this statement conveys the idea that there is a technology that has come along and, for the very first time, allowed the creation of a network of markets, which is profoundly more powerful than the network of information.

These networks are essentially Open, Random, and Supportive (ORS)®, which is a concept expanded on in Chapter 9, Social Media and Influencers. Open and random mean permissionless because anyone can join the network at any time. Supportive means that these networks are neutral, censorship-resistant, and democratized.

This network of networks will also have to be interconnected because, as we've seen time and time again, the world will never agree on a single ledger or a single platform, as long as each provider wants to own the network.

Consider this: the largest taxi company in the world (Uber) owns no cars, the largest media company (Facebook) creates no content, the largest accommodation provider (Airbnb) owns no hotels, the largest e-commerce companies (such as Alibaba) own no inventory, and a $130 billion USD currency (bitcoin) has no CEO, no bank branches, and no customer support. What do they all have in common? They all have a network, be it of cars, rooms, suppliers, or trust (https://techcrunch.com/2015/03/03/in-theage-of-disintermediation-the-battle-is-all-for-thecustomer-interface/).

The word "tokenomics" is a portmanteau, or combination, of the words "token" and "economics" and it is a relatively new term that rose to popularity in the middle of 2017. As with anything new, the meaning has yet to be standardized, with many industry leaders attempting to provide their own definition. This is similar to attempting to define blockchains or the internet in the early days, as there are a range of ideas that are encapsulated within the idea of tokenomics.

Tokenomics, however, encompasses the concept of the study, design, and implementation of an economic system to incentivize specific behaviors in a community, using tokens to create a self-sustaining ad hoc mini economy. It includes game theory, mechanism design, and monetary economics.

If we think back to the loyalty points we get from our local supermarket or an airline, when we collect or redeem them some of us analyze the economics. For example, I need to purchase another $50 worth of groceries in order to receive a $15 gift voucher because it only gets paid out after 200 points have been collected, and I'm on 195 points ($10 of spending for one point). Another example is asking how many flights do I need this year to achieve gold status and how many flights do I need to maintain gold status? Anyone who has gone through these scenarios could argue that they were analyzing the tokenomics of the loyalty points system.

Tokenomics was selected as the title of this book because with all the ICOs in the last few years, and this new tokenized economy that is emerging, token supply, inflation rate, and even the various incentive schemes can all be encapsulated into this word.

First occurrence of the word

One of the earliest occurrences of the word was in a tweet with the hashtag #TOKEnomics, in March 2012, from DJ Hustlenomics, an American rapper:

Figure 1: One of the earliest uses of the word "tokenomics" by an American rapper. (https://twitter.com/DjHustlenomics/status/185205191480582144)

'Hustlenomics' was the second studio album by American rapper Jasiel Amon Robinson, who is better known for his stage name 'Yung Joc.' Needless to say, this was probably nothing to do with blockchains or the new decentralized economy.

The next occurrence was from someone on Twitter with the handle @thewayoftheid. Again, we can probably safely assume that Jamie is not talking about blockchains to @Mami_LongLegz:

Figure 2: Another use of the word "tokenomics" on Twitter in December 2013. (https://twitter.com/thewayoftheid/status/416599434097463296)

Almost a year later, in August 2014, there was a more relevant tweet from Dave Feuling, or @GoodForOneDrink, who tweeted Enjoying Tokenomics at the good ol Hammond Hotel. Feuling explained where he heard the word from:

"A local bar (no longer in business) held Tokenomics on Wednesday nights for a certain length of time. It was called this bc (sic) every drink you bought awarded you a drink token that was good for one free drink of equal or lesser value. It was basically a special happy hour" (https://twitter.com/seandotau/status/1024041929158221824).

This tweet may not be directly referencing blockchains or ICOs, but we are getting closer because there is a token involved that can be redeemed for a drink at the Hammond hotel in Wisconsin, USA:

Figure 3: The earliest mention of the word "tokenomics" that has reference to an actual token (https://twitter.com/GoodForOneDrink/status/497159085721391104)

Fast forward to March 2015 and the word "tokenomics" was mentioned again in a tweet by @mmoblogosphere, who was actually referencing @casualnoob blog post titled Tokenomics. @casualnoob is a female blogger with the pseudonym "Da Cheng", who is a mage (a magician) character in the computer game World of Warcraft (WoW).

Figure 4: A blog post on tokenomics, analyzing the WoW token

The tokenomics blog was in reference to a WoW token released by Blizzard Entertainment and "Da Cheng" analyzed the economics of the token. Essentially, Blizzard created two in-game tokens. One token could be bought from Blizzard for an initial price of $20 per token and another could be sold to Blizzard to add 30 days of game time to your account. The final tokenomics recommendation from "Da Cheng" was:

"Recommendation: buy Gold WoW tokens on day 1. Buy all you can afford. There will never again be such a concentrated glut of sellers. The price will never drop to 40 000g again. Don't buy $teel WoW tokens before week 5, once the upward price momentum of gold tokens is obvious."

The final occurrence before the floodgates opened wasn't until June 2017 (https://twitter.com/search?l=&q=%22tokenomics%22%20since%3A2014-07-03%20until%3A2017-07-04&src=typd&lang=en) by William Mougayar, a thought leader in tokenomics, who wrote an article titled Tokenomics — A Business Guide to Token Usage, Utility and Value. (https://medium.com/@wmougayar/tokenomics-a-business-guide-to-token-usage-utility-and-value-b19242053416). Mougayar provided a detailed analysis, where he defined a "token" as just another term for a type of privately issued currency.

Figure 5: The tweet that opened the floodgates on the word "tokenomics." (https://twitter.com/wmougayar/status/873912937676779522)

Burrhus Frederic Skinner, or more commonly known as B.F. Skinner, was an American psychologist, behaviorist, and social philosopher who used the term "token economy" in 1972 in a video titled Token Economy: Behaviorism Applied" (https://www.youtube.com/watch?v=fyFzPgIy-0g). Skinner used this concept in the context of using physical tokens in a program of therapy for the treatment of criminals and the mentally ill. As a side note, the writer of the famous American animated sitcom The Simpsons, Jon Vitti, named the "Principal Skinner" character after B.F. Skinner (The Simpsons season 2 DVD commentary for the episode "Principal Charming" [DVD]. 20th Century Fox).

One of the major teaching techniques was using a token economy with the students. A token economy was very simply a structured learning situation, where tokens, or little plastic chips, were used so that students could earn tokens in a wide variety of ways. This always involved learning more appropriate behavior.

The meaning of a token economy or tokenized economy in 2018 contains the same concepts, but it is applied in a different context. Little plastic chips have now been digitized into tokens and instead of students earning tokens, anyone can earn them and the structured learning environment has now changed into a new digital world, where anyone can participate.

The underlying infrastructure that has allowed this new token economy to flourish is blockchains, which are the equivalent of an ad-hoc miniature economy. In this economy, you have a group of people, or entities, who are all interacting with each other, making decisions, co-operating, and even competing with each other. The driver is an underlying software that enforces the rules created by the original author(s) and it governs how the interactions will unfold.

What is interesting is that all these miniature economies are powered by their own specially created token. Why do these token projects do this? The answer is: because they can. The marginal cost of creating a new token on a platform designed for creating tokens is almost nothing; however, gaining adoption is a totally different challenge.

This leads to the concept of a minimum viable economy, where if traction or critical mass is achieved, the economy can self-sustain and self-govern. Otherwise, it collapses and new ones form very quickly, and it's the low barrier to entry that allows this to occur.

The token is interwoven throughout the business model, providing a way to reward and incentivize the network participants, customers, and stakeholders. This focuses innovation at the token level, as the blockchain infrastructure is already provided, along with other requirements, such as consensus algorithms and the creation of a network.

There are key questions to consider around the tokens with a token economy. For example, is the token tied exclusively to a product usage or a network? The current answer is almost always yes. Other key questions include: does the token provide the owner with special privileges or ownership? Is the token required to run a smart contract or is it used to pay for usage? The answers to these questions are all varied and unfortunately, they depend on the design and context.

The most important question, though, is whether having a token is an absolute necessity in solving the problem. In other words: if digital tokens and the blockchain technology had not been invented, could the problem still be solved?

A unique aspect of the token economy is around the distribution because the key is to get the tokens into the hands of as many users as possible, so they can be used. This is because in this miniature economy, your products or services can only be used or traded with that token, which means that if you provide a valued service or product, that token eventually comes back to you. This circulation between stakeholders is very important. The most successful token projects will be the ones that can solve this challenge or even gamify it.

Marc Andreessen, co-founder of Netscape and venture capitalist firm Andreessen Horowitz, famously stated, Software is eating the world. In his 2011 article, he outlined that the world's largest bookseller, Amazon, is a software company; the largest video service by subscriber, Netflix, is a software company; and music companies like iTunes, Spotify, and Pandora are also all software companies. The list keeps going, with the likes of Skype in telecommunications and Pixar for animated movie production and Andreessen added, Software is also eating much of the value chain of industries that are widely viewed as primarily existing in the physical world (https://a16z.com/2016/08/20/why-software-is-eating-the-world/).

Nearing a decade on, the manifestation of the physical world is slowly being recreated in the virtual world and the missing piece of the puzzle has been discovered: the ability to transfer value in this virtual world with trust. This is how and why the token economy will continue to grow and develop. The tokenized economy starts with the digitization of the physical world and ends with the realization of the virtual world.

What does the current tokenized economy look like?

A token economy may be hard to conceive because it is not really tangible, like physical assets or your local bazaar, but there are digital tokens being created every day for all sorts of uses. The following image shows only the top 10 out of the thousands available and these thousands will grow further in the coming years. The reason for the growth is because of the new network of markets that is being created.

Figure 6: A list of the top-10 tokens, out of thousands in a token economy, from CoinMarketCap.com

In this chapter, we introduced the concept of a network of markets and considered the fact that blockchains could replace networks with markets. We also looked at how the Internet of information has transformed society, but has fallen short of being able to transfer value because this wasn't possible, until now.

We discovered that solving the "double spend problem" in a decentralized manner has enabled the creation of the Internet of value, which is the missing piece of the puzzle for building internet 2.0. In this new world, tokens will represent this value and they will be created, transferred, and exchanged in new markets making up this new token economy. The digital token economy will continue to grow, causing assets in the physical world to have their digital counterpart in a virtual world.

Now that we have set the scene, let's turn our focus to the all-important theory, setting you up for the rest of the book. It is a light-touch approach for beginners, breaking down several concepts that have become very important in this new decentralized world.