Tokens and tokenomics
Organisations require incentives. Whereas traditional organisations use mainstream fiat currencies, many DAOs and other distributed organisations use their own digital tokens.
What is a token?
A token is just another word for a type of privately issued currency. Outside of the blockchain world, examples of tokens include air miles or store credit. However, in combination with smart contracts, digital tokens can be utilised for a wide range of purposes – including fundraising, enabling micropayments, encouraging early adopters and voting.
Fundraising is possible when tokens are created and sold for other cryptocurrency or fiat currency. This often takes place through a ‘crowdsale’ process akin to crowdfunding. This process was originally known as an initial coin offering (ICO); however, this term has fallen into disfavour in reaction to the large number of ICO scams and legal issues related to issuing securities. Where the token represents equity, many people now prefer the term security token offering (STO), removing any ambiguity that they must be issued in accordance with investor protection regulations.
Unlike traditional crowdfunding, however, the new tokens are typically available globally and tradeable via online secondary markets shortly after being issued; this greatly increases liquidity, encouraging investment. Whereas, as noted earlier, platform cooperatives sometimes struggle to raise investment, tokenised securities have been used to raise hundreds of millions of pounds.
Tokens can also serve as a micropayment system. For instance, Filecoin is a decentralised cloud data storage system in which people can earn tokens by contributing their storage capacity to the network, or use tokens to pay for storage of their own files. Tokens can be swapped for fiat currency at various exchanges.
However, thinking of digital tokens simply as a novel funding mechanism misses their transformative potential. For one thing, tokens can help solve the problem of how to encourage early adopters. Many platforms depend on network effects: the utility of sites like eBay and Twitter clearly increases with the number of users. However, the converse is also true: like an empty nightclub, the first person using a new auction site or social media platform will find it of little utility until others have joined. How, then, can early users be enticed?
Tokens can help resolve this chicken-and-egg problem. If tokens are required in order to use the system – for instance, if the Filecoin network only allows users to pay for storage with the Filecoin token – then demand for tokens will rise as the system gains users, and hence if the number of tokens is fixed, then the price of the tokens should also rise. Thus, knowing that tokens are likely to become more valuable, there is an incentive for potential users to buy or start earning them earlier on. This also ensures that users have ‘skin in the game’ and will therefore act in the best interest of the organisation.
Tokens may also discourage bad actors and unwanted behaviour by requiring a fee to be paid in tokens (‘gas’) to conduct a transaction or execute a contract; this is used to mitigate spam and help allocate resources across the network. In addition, tokens can be used to bestow a right (e.g. the right to vote on how a DAO is run or the right to access a service like file storage space).
These functions can be combined in clever ways to enable an almost infinite number of innovative business and governance models. The study of how tokens can be used in this way is sometimes called ‘tokenomics’. This overlaps with the term ‘cryptoeconomics’ – the study of ‘protocols that govern the production, distribution and consumption of goods and services in a decentralised digital economy’.
Nevertheless, despite the huge potential, questions remain around what the most valuable use cases are for DAOs and how the token systems they run on can be optimally designed to create and distribute the most value. The essays in this collection explore these issues, alongside broader questions related to the social and economic impacts of decentralisation, and whether blockchain really is the best technology for the job, from the viewpoint of both supporters and sceptics.