Crypto Economy and Tokenomics 101

The crypto economy is more similar to the traditional one than we usually think: there are many currencies and ways to manage them, regulatory frameworks including those for KYC/AML, and different instruments to multiply wealth.

Although the crypto industry is just 13 years old, it incorporates a huge variety of assets and tools. There are safe-haven coins that serve as a store of value, altcoins, stablecoins, tokens for utility, security and governance. Methods such as ICO, IEO, and STO allow emerging crypto projects to fundraise. In this article, you will gain insight into this diversity and understand the basics of how the crypto world functions.

What Types of Tokens Are There?

The first cryptocurrencies started to emerge shortly after Bitcoin, and they were called altcoins, or alternative coins. As of 2022, there are many thousands of such assets. To understand the crypto world, it’s essential to see what cryptocurrencies there are and what motivation drives their users. The more frequently used types of digital assets include coins, utility tokens, stablecoins, security tokens, governance tokens, and stablecoins.

Coins are what most of us imagine when thinking about crypto. These assets run in their own dedicated blockchains and include such cryptocurrencies as Bitcoin, Ethereum, Binance Coin, and Solana. Their price is tied to the faith in the value of the protocol and is volatile for most coins, which is one of their most important criticisms. As for use cases, coins are most often a store of value and a means of investment and speculation.

Utility tokens are used to exchange value within a certain crypto ecosystem. Tokens power it and allow users to pay for services within this ecosystem. Like in stocks, the price of a utility token grows and plummets depending on the public sentiment towards the protocol. Ethereum and Solana can be considered utility coins, but they most often fall into the category of coins. Utility tokens usually represent dApps built on Ethereum and other platforms such as Polygon (MATIC) (the token is used to pay for gas fees) and Decentraland (MANA) (users pay for goods and services in the metaverse).

Stablecoins are meant to mitigate the issue inherent to most coins and utility tokens — their volatility. These assets are pegged to stable assets — US Dollar, gold, or other reliable fiat currencies. Most stablecoins are pegged to USD, so their price is always $1. Many stablecoins are backed by reserves stored in vaults (like USDT and USDC). The value of others (like Dai) is supported by a large collateral of other cryptocurrencies. Finally, there are stablecoins whose price is maintained by market algorithms (Ampleforth).

Security tokens are among those least known to the public. They serve mostly as an investment tool (the reason why they often get in the spotlight of the America’s Securities and Exchange Commission). Security tokens represent a digital proof of ownership of some real-world asset such as real estate or stock. Such a token does not have an inherent value and simply proves that you own the underlying asset.

Governance tokens give their holders the right to participate in managing the crypto project. The users have a say in voting for protocol updates, introduction of new features, hiring and firing team members, and implementing new governance schemes. These tokens power DAOs — decentralized autonomous organizations, communities where users have influence over the key decisions being made. The examples of such tokens are MKR (MakerDAO protocol) and UNI (Uniswap decentralized crypto exchange).

What Is Tokenomics?

One of the advantages of crypto is that developers have simple and flexible tools to distribute tokens in the community. The rules of doing so are set before the project’s launch, described in the whitepaper, and hard coded into the protocol — together, they shape the tokenomics of the project. It also includes the way the tokens are managed and burned.

As an example, the key feature of Bitcoin is that its max supply is limited by 21 million coins, which makes it scarce and positively affects its price. Mining is the only way to obtain the coins, and every 4 years the mining reward halves so that the coin slowly approaches that max supply and does not exceed it.

Different tokenomic models offer various ways to distribute the coins. Besides mining rewards, the token can be pre-mined and distributed during the ICO — the more a user has invested, the more they get.

Some cryptos like Algorand don’t have a hard coded distribution mechanism, so the team can issue and burn tokens manually based on their views of what would be beneficial for users. Some tokens are distributed through giveaways or as rewards for participants’ activity (making transactions or holding the asset).

How Do Crypto Projects Fundraise?

There are a few ways to attract capital to your platform to meet the development demands. One of them is simply finding the investors who believe in the team and offer money for their own profit.

Other ways of fundraising have become popular specifically in the crypto domain. One of them is ICO, or initial coin offering, that was on the rise in 2017–2018. It is like an IPO when a company releases stocks to the public: here, a crypto platform distributes tokens across investors who got captivated by the innovation of the project.

As ICOs were poorly regulated, many scams were making fake ICOs, and this fundraising method was replaced by IEO — initial exchange offering. In this case, a project is listed on a respected exchange, so investors can rest assured that it is not a scam.

Also, there is STO — security token offering. Here, an investor receives tokens representing some other asset or security like bonds or real estate. This is how investors can allocate money into more projects at a time while taking advantage of the blockchain technology and obtaining all legally required information from developers. This method is similar to how non-crypto fundraising goes.

How Is Cryptocurrency Regulated?

In the early days of crypto when legal frameworks were lacking, a few precedents took place that harmed the reputation of crypto (such as the Mt.Gox hack or the creation of the Silk Road black marketplace). Gradually, countries started to adopt crypto laws that would tackle criminal activity in the domain. Legal frameworks were created in the EU, North America and many Asian countries, but the laws are still being elaborated. In some countries, the crypto legislation bans digital assets or is not present at all.

One of the crucial aspects of crypto regulation is the KYC/AML compliance. Crypto businesses identify users to know who they are working with in order to prevent criminal activity and money laundering. Centralized exchanges like Binance ask all their users to undergo the KYC check, while other platforms such as ChangeNOW allow for anonymous crypto swaps. Nevertheless, we strictly comply with the KYC/AML legislation — our risk monitoring system detects potentially malicious transactions and if it sees the signs of money laundering, the sender must prove their identity and the origin of funds.

Bottom Line

The crypto industry is evolving at an unprecedented pace, and thousands of different assets have emerged — all with their own economic rules (dubbed as tokenomics) and ways to regulate them. The aim of this article was to outline the main characteristics of today’s crypto market, show what assets there are, how they attract capital, and what regulation there is. Now that you know these basics, you can do deeper research on the topics that looked the most interesting to you.