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Tokenomics Explained

Tokenomics is a combination of the words “token” as in crypto token and “economics” and is about understanding the economics and fundamentals of a crypto token.

Economics is at the root of our lives and always has been. 

Whilst today’s economies are way more complex and sophisticated than from the days of our ancestors the basics still remain the same. 

There is always some form of demand and supply, some form of value measurement and some form of exchange like a currency or barter system to facilitate transactions.

Today’s economies are highly complex and fast-moving, economists, governments and businesses need to understand the trends and in the case of businesses navigate the economy for maximum benefit.

In much the same way, investors, traders and others interested in crypto need to be able to understand the fundamental economics behind the tokens they are interested in in order to be able to ascertain if they are wise investments. 

Tokenomics is the study of the economics and fundamentals of a crypto token.

 

What are tokens?

The first thing we need to look at and understand is what are tokens?

A crypto token can typically represent an asset or a utility that resides on a blockchain, allowing for the user to use it as an investment or for economic purposes. 

In the non-digital world, one could imagine a piece of gold as a token, as it could be used as a means of pure investment, i.e. hold onto it and let it appreciate in value, as a currency, pay for something with gold, not common nowadays but technically still possible or you could turn the gold into a piece of jewellery which can be considered a form of utility, a piece of jewellery to wear. 

If we looked instead at a $1 banknote, it serves no other purpose other than as a way to hold and transfer value, there’s nothing else you can actually do with it. 

These two examples could be used to crudely illustrate the difference between a crypto coin such as Bitcoin or a token just to be able to understand what a crypto token in fact is. 

In more specific terms a coin is native to the blockchain, for example, ETH or Ether is the native coin for the Ethereum blockchain whereas a token is not native to a blockchain such as Ethereum but independently operates on the Ethereum blockchain and provides some form of utility or service.

 

Let’s examine some token types so as to see how this fits into tokenomics?

There are four principal types of crypto tokens, these are:

Payment tokens – payment tokens are generally coins and their primary purpose is to act as a medium of exchange, a way to hold value or as a unit of account. In economic terms, the price of the payment token is highly influenced by supply and demand, just as in fiat currencies like the EURO, GBP or USD.

Security tokens – security tokens are similar to securities in the world of stocks and shares. If one owns shares in a company they can use their shares to vote for actions, hold onto the shares as investments in the hope the price will rise and also be able to enjoy a share of profits in the form of dividends. In a similar way, security tokens come with certain rights, privileges and means to earn money beyond simply the appreciation of the price of the token

Utility tokens – utility tokens give the holder access to a blockchain-based product or service. Where security tokens have some form of money-making at their core, utility tokens provide some form of utility hence the name. Imagine a piece of software like WinZip, it compresses and decompresses files on a computer, you cannot make money with it. However, you could buy shares in the company behind WinZip which would be a security token in this case. WinZip itself would be a utility token.

Non-fungible tokens – all crypto coins and most tokens are interchangeable, my one bitcoin is exactly the same as your one bitcoin. Just like my €20 banknote is worth exactly the same as yours. Non-fungible tokens (NFTs) are different as these tokens can represent a unique item, property or asset such as the deeds of a particular house, a piece of artwork or a collectible, no two are the same. The NFT can be considered as the legal title or deed to that asset, much like the deeds to a property.

 

What is tokenomics in crypto?

Okay, so now we have an understanding of what tokens are and the common types of crypto tokens out there. 

How does tokenomics fit into the picture? 

As we determined at the very beginning of this article, demand and supply are at the root of all economic systems, they in most cases determine the supply and the price. 

If the demand for something is high and there is limited supply the price will go up, if demand is low and/or the market is flooded then we can expect the price to come down. 

In much the same way, in tokenomics, we need to study the demand and supply of a crypto amongst other things in order to get at the fundamentals and determine if it’s a good buy or simply goodbye!

 

Below are some of the fundamentals we would be looking at in tokenomics

Allocation and distribution of tokens – how are the tokens being distributed, there’s a fair launch in which case the token is mined, owned, earned and governed by the community at large without any pre-release. 

On the other hand, some tokens can be pre-mined and issued to developers and early investors in an ICO for example. Imagine there’s a wallet with a huge amount of tokens sitting there, the owner of this huge amount of tokens could dump them on the market and cash in causing the price to plummet, this would represent a significant risk to the other token holders. 

Token supply – the supply is probably one of the biggest factors when it comes to the ongoing price of the token, there’s circulating supply, the amount of the token currently in circulation potentially available to buy and sell, there’s the max supply which is the maximum amount of the token that will ever be produced and there’s total supply which is the total amount of tokens out there excluding any that may have been burned.

Market capitalisation – the market capitalisation of a token is similar to that of a company, it’s basically the price of a share multiplied by the number of issued shares. In the same way, it’s the price of the token multiplied by the number of tokens in circulation. The higher the market capitalisation the more solid the token, or in theory at least.

Inflationary or deflationary token type – a token is deemed to be deflationary if there is a limit to the total supply, for example, there will only ever be 21 million bitcoin, no more can be produced and this should lead to an increase in value in the long run due to the ultimate scarcity, just as with oil or gold, there’s only so much out there and this keeps the price up. An inflationary coin is the opposite, there is no upper limit to the amount that can be created, very much like fiat currencies like the EUR or USD, in these cases, oversupply can force the price down and this means that each token has less buying power or inflation as it is known in economic terms.

 

Conclusion

In summary, tokenomics is about understanding the fundamentals of a token in order to be able to determine if it is a potentially good investment. 

Just as government and business economists study economic fundamentals and patterns the same is true with tokenomics when it comes to crypto.

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Gold Backed Crypto

Gold-backed crypto is a derivative-based digital asset and type of stablecoin whose value is matched to and should be backed by an equal value of gold measured in grams or troy ounces.

We are to this day undoubtedly experiencing a gold rush in the world of crypto, no pun intended! It’s still extremely wild! Huge fluctuations are the norm and well almost anything goes at this point in time.

This is quite a contrast to the traditional financial world where sure there is of course fluctuation but it’s generally nowhere near as volatile. This volatility and extreme unpredictability gave rise to stablecoins which are as you would guess, stablecoins. Typically stable coins are linked to and/or backed by fiat currencies or indeed valuable commodities such as gold or silver.

 

So why gold?

Gold as a value of exchange and valuable commodity goes back way more than the fiat currencies that we use every day.

Gold really has stood the test of time in terms of value and universal acceptance. Our fiat currencies such as the USD or the GBP were even historically backed by physical gold until not that long ago. Actual gold bullion sitting in vaults matching every pound or dollar.

As a very crude measure, it has been said that historically 1 ounce of gold would purchase 10 loaves of bread and throughout time this has been more or less the case to this day.

We can trust gold as a reliable holder of value and also as a commodity that sees respectable long-term growth and stability.

With some of these things in mind, it made sense to create gold-backed crypto tokens to hedge against the extreme volatility of crypto coins such as Bitcoin for example.

 

How do gold-backed crypto coins work?

A crypto backed by gold should generally be supported by actual gold sitting in a physical vault somewhere. So, one gold-backed crypto coin could be equivalent to say 1 gram or troy ounce of gold.

As mentioned above, a gold-backed crypto coin will typically be pegged to the price of say 1 gram or troy ounce of gold.

As the price of gold rises or falls the gold-backed crypto coin will fluctuate with it. As gold is generally pretty stable the volatility is not extreme.

Typically the issuer of the gold-backed crypto coin will be holding actual reserves of gold to back up the coin just as was the case with our paper money in the past. On some of these coin issuers’ websites, you can even get a live view of the safe vault and the physical gold at any time.

 

The benefits of gold-backed cryptocurrencies

If we think in terms of investing in companies, the gold-backed crypto could be the equivalent of buying shares in a very well-established and stable blue-chip organisation such as a bank or maybe a corporation like IBM, Apple or Microsoft.

They will have decent levels of liquidity, will be considered well-established, not be very risky and will tend to go up in value over time.

Now compare this to investing in a hot new startup company with no track record and little to no liquidity. The risk parameters are completely different.

Investors come in all shapes and sizes and invest in all sorts of things, some have high appetites for risk and may well back that startup, while others are more conservative and would prefer to put their money into Apple or Microsoft stock, or perhaps an index fund like the S&P 500 that tracks the performance of 500 large listed companies in the USA. 

In much the same way in crypto land, those with higher appetites for risk can put their money into higher-risk coins and tokens and those that may want to play it a bit safer and perhaps enjoy the best of both worlds can instead put their money into something like gold-backed crypto.

There is also, of course, a middle ground where a shrewd investor can put money into both and thus have the possibility to enjoy huge gains but at the same time hedge some of the risk.

Stablecoins such as gold-backed crypto can also be used for business transactions where a certain level of price stability is required.

For example in imports and exports, the common currency being used in the trade simply cannot fluctuate outside an acceptable range otherwise one of the parties will no doubt suffer.

The excitement and inherent volatility of the crypto market has undoubtedly made many people extremely rich. Still, by the same token, many have no doubt had their livelihoods destroyed or at least dented.

During this same time, gold has grown by around 25%, a very respectable level of growth and hence a relatively safe investment commodity for the masses. Gold has historically also beaten inflation by a fair margin so all in all, there is a pretty good case for a crypto that is backed by gold.

 

The downsides of crypto-backed by gold

What about the downsides? Gold-backed cryptocurrencies have historically struggled with certain issues such as:

Not really decentralised – gold-backed cryptocurrencies tend to be dependent on central parties for collateral safekeeping and auditing which kind of defeats their purpose as cryptocurrencies, with decentralisation generally being one of the core properties of cryptocurrencies

Irrefutable proof of actual gold reserves – it’s not easy to ascertain the proof of gold reserves as claimed by the coin provider. With crypto still being largely unregulated, there is no government body ready to step in if things go south. Investors are very much on their own with little to no recourse if the gold-backed crypto collapses for example.

Lower levels of liquidity – gold-backed cryptocurrencies tend to have lower levels of liquidity compared to other coins mainly due to not being traded across as many exchanges

 

A few examples of crypto-backed by gold

Below are a few examples of gold-backed cryptocurrencies:

Goldcoin (GLC)

Paxos Gold (PAXG)

Perth Mint Gold Token (PMGT)

Digix Global (DGX)

Tether Gold (XAUT)

Meld Gold by Algorand

 

Why buy a gold-backed cryptocurrency when you could simply buy and hold physical gold?

It’s true, very little can beat the security of holding physical gold. It doesn’t rely on technology, holds its value very well and is pretty liquid.

Even in urgent situations, there will always be people out there who will buy your gold and turn it into hard cash. What are then the benefits then of holding gold-backed crypto?

 

Below are some of the benefits of holding crypto backed by gold

A global market that can facilitate almost instant transactions – selling and transferring gold would be an expensive and time-consuming process.

As gold is valuable, insurance would no doubt be wise and would add extra costs on top of physical shipments. By contrast, gold-backed crypto coins can be transferred worldwide via blockchains relatively inexpensively, fast and securely.

Highly fractional – it’s way easier to purchase and transfer small amounts of gold using gold-backed crypto tokens.

A secure audit trail – transactions conducted on blockchains can be easily audited and traced. There is no risk of gold going missing in the post!

Backed by smart contracts – one of the inherent beauties of smart contracts is their absoluteness, there is no space for misunderstandings, mistakes or prejudice. A transaction does or does not take place based on very specific rules and once it’s done it’s done.

No need for banks – there is no need for banks or other intermediaries to carry out transactions due to the decentralisation of crypto and this should result in lower costs.

Conclusion

In summary, gold-backed crypto is very useful as a stable cryptocurrency, either to hedge against the volatility in the crypto market or trade in gold using the security and speed of blockchain technology or for use as a stablecoin for transactional purposes where volatility can be a problem.

Investors looking for alternative, stable long-term crypto investments can certainly consider digital assets such as gold-backed crypto as safer longer-term bets.

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