Token Economics: In The Long Run, Decentralization Will Survive

Money exists to serve a fundamental purpose as a medium of exchange for goods and services. A central authority designates a certain currency as ‘legal tender’ and people can proceed to trade with it, trusting in its function as a unit of account and a store of value. Simply put, the traditional system of money thus far has revolved around four main participants: governments, central banks, intermediary banks, and users of money. It’s a system that has been built over centuries—one not easily dismantled or replaced, as significant cost and physical infrastructure has been put into supporting its integrity and performance.

Changing the game

Neeraj Khandelwal, CoinDCX

Relatively speaking, traditional money and the financial system it runs on have weathered much of the digital revolution unscathed. Rather than changing to fit the times, digital technology has been integrated around the usual way banks and financial institutions function, leaving the underlying fundamentals of the system untouched, along with its inherent inefficiencies and costliness. To say that legacy finance is now under threat, however, might be to jump the gun; nevertheless, we can see some challengers to the status quo emerging, as technology advances and becomes a more pervasive part of human life.

Cryptocurrencies have been lauded as one of the biggest game-changers within the centralized system of banking and finance. With the distributed ledger that underpins cryptocurrency, decentralization and disintermediation is made possible, and instead of a centralized entity validating transactions, the process is distributed across a network of validators. In a truly decentralized financial system, the middlemen and their fees are cut out, while the speed and efficiency of transactions are greatly improved. Clearly, such a system would be able to directly challenge the function and use of the traditional financial order.

Good governance and incentivization

While the technical aspects of cryptocurrency and distributed ledger technology have moved beyond theoretical whitepapers and into real-world applications, relatively little attention has been paid to the economic relevance of cryptocurrencies and the forces that govern the price and value of digital assets. Called cryptonomics, tokenomics, or just token economics, this field of study focuses on how incentivization and validation is used to encourage token adoption and subsequent ecosystem building around that token. While the utility of fiat currencies is largely limited to exchange and trade, crypto tokens can be put into service in a myriad of ways, and token economics explores the use cases of digital assets beyond their utility as currency.

There is so much to unpack when trying to understand the forces that govern functioning crypto ecosystems. Crucial issues, such as the incentives for blockchain participants to cheat or the endogenous value of a token in exchange, are still poorly understood and yet are pivotal to understanding the optimal design for a mainstream blockchain-based form of payment. How should a system be built to reinforce desirable behaviors amongst users, while discouraging cheating and market manipulation? Any platform looking for longevity and sustainability in a fast-changing industry must ask this question first and foremost. Currently, most cryptocurrency platforms incentivize users to perform governance decisions by awarding them newly-mined cryptocurrencies. They manage the rate at which new units are created to keep the supply of available tokens in check; therefore, the total amount of currency in the system is limited by the protocols written by the creator of the blockchain. Having these limits in place creates an impression of scarcity amongst users that allows the system to maintain the value of the crypto token.

Breaking the rules

It is this quality of scarcity that breaks the rules of inflation that already govern legacy money standards. Under the forces of inflation, the power of money to buy the same basket of goods is expected to be less in the future compared to today. These same forces do not have to apply to cryptocurrencies; not when they offer an opportunity for monetary experimentation and the potential for new ways of managing monetary supplies. Major platforms like Ethereum place community governance of token supply at a higher priority to maintain the ethics of a decentralized system, while privatized foundations of cryptocurrencies like Binance and VeChain use coin burning techniques to limit supply and temporarily increase the value of tokens. Essentially, the supply and value of a given digital asset is dependent upon the participants of the network and the algorithm it is built on, which places cryptocurrencies largely outside of the influence of geopolitical flux that otherwise affects traditional markets. For this reason, people from Venezuela and Argentina—both countries experiencing hyperinflation—are putting their money into bitcoin and other digital assets to hedge against the risk of inflation in the traditional market. 

As the industry moves on from the crypto hype and market correction of the past, it has become clear that decentralized finance holds incredible potential for the global financial and economic system. The technology is constantly evolving, but sound principles of business and a strong token-flow model are more necessary than ever to keep the industry sustainable in the long-run, particularly in the face of tightening global regulations on crypto tokens and exchanges. Governance, incentivization, revenue sharing, and accessibility are all crucial metrics to consider before building an economic model for digital tokens and cryptocurrencies. 

In the coming years, we can anticipate a future where both tangible and intangible assets are tokenized and easily used in real-time transactions on decentralized platforms and exchanges. We are on the precipice of a new global economy, one that is undergoing massive transformation. The steady development of decentralized finance, regulatory clarity, crypto-specific taxation policies, and central bank digital currencies are all positive steps towards shaping the new financial ecosystem—a decentralized token economy characterized by greater accessibility to financial services, safer transactions, and lower transaction costs. With full decentralization on the horizon, it’s becoming apparent that the face of global finance will never be the same again.

Neeraj Khandelwal is Co-founder of CoinDCX, India’s largest cryptocurrency exchange