Token Design is not a Business Model

Crypto tokens are digital assets that power blockchain ecosystems and applications. As it has become easier and cheaper to spin up code, there has been an explosion in token number and diversity. But as an investor or observer, how should you compare these different tokens?

Tokens are highly bespoke digital assets. They can have various rights embedded in them. In the first part of this article we look at the ways tokens differ, including in how they are created and why they might be demanded. Our aim is to provide you insights into the key aspects of tokens – even if you’re not a blockchain expert.

Token designs can look fancy. But a complex token design is never a substitute for a solid business model. In the second part of the article we emphasise that tokens can enhance an underlying business strategy or hypothesis, but they cannot generate sustainable value in isolation. While tokens are tools for incentive alignment, focusing too much on them can distract founders and communities from producing actual value.

Token Diversity

Crypto tokens are the fundamental unit of account in blockchain ecosystems. They are a building block of blockchain networks and many applications built on top of them.

Many people, motivated by the diversity of token designs, have identified categories such as stablecoins, utility tokens and governance tokens. What all tokens have in common is that they are digitally verifiable assets with some rights attached to them.

Tokens are interesting because they can be used to influence the way people in an ecosystem behave. They can bootstrap new networks. They can provide community ownership. They can empower bottom-up decision making.

Using tokens as incentive mechanisms matters because of the wide range of stakeholders in blockchain ecosystems. For a blockchain-enabled business to work it must effectively coordinate stakeholders including consumers, producers, investors and validators. Tokens, through the rights embedded in them, are tools to help all of these stakeholders to move in the same direction.

The Space of Token Design

The practice of designing tokens is often called “token economics” or “cryptoeconomic design”. It draws on fields such as economics, game theory and mechanism design. Ultimately the attempt is to effectively align incentives of stakeholders.

A useful way to think of the potential levers that can be changed are to look at demand (who wants the token?) and supply (where do tokens come from?). Let’s begin with supply.

Token supply

To understand the supply of a token, one must consider how tokens are created and allocated over time. All tokens must come from somewhere. But where tokens come from, and at what rate, and who to, can be (often unnecessarily) complicated. Let us consider just three ways the supply of tokens differs.

First, how many tokens will exist? Some projects have a fixed supply of tokens at launch, such as the famous 21,000,000 cap on Bitcoin. Other projects opt for variable token supply, where the token supply changes based on other parameters.

Second, how are tokens released over time? It is extremely rare for a project to release all tokens at launch. Tokens are typically released over time through processes such as:

• validating (creating new blocks in the blockchain)
• rewards for desirable behaviours (e.g. providing liquidity, staking for security)
• airdropping to various existing and future uses (e.g. for marketing or decentralisation).

When analysing token release (often referred to as issuance) it is important to look at the rate of token release. Will all tokens be released in a short period of time, or is there a slow release over many years or even decades? Many projects also have mechanisms to remove tokens from circulation, such as through “slashing” or “burning” tokens.

Third, who receives tokens? It matters who tokens are allocated to. Tokens can be allocated to different stakeholders including users, private investors, public investors, founders and to a collective treasury or foundation. Which groups hold tokens matters because each of those stakeholders have different incentives, including the time horizons and their incentive to hold the token.

Token demand

Tokens also differ widely in terms of demand. Why would different people, such as investors or users, buy or hold the token?

Predicting token demand is more speculative and uncertain than token supply. It relies more on trying to guess the uncertain wants of future stakeholders.

A useful approach is to view tokens as having different rights attached to them:

• Voting or governance rights embed the right to vote in decisions (e.g. to spend a shared treasury).
• Utility rights might grant access to use a product including to pay fees for services in the ecosystem
• Cash flow rights might include receiving a portion of the fees from an underlying business process.

Each of these rights change the incentive for different users to hold a token. An investor might value cash flow rights to receive a return. Other users might value governance rights in how a treasury is allocated, such as through grants programs.

Tokens are not a substitute for a business model

The bespoke nature of token economic designs leads to a common mistake of many blockchain-based businesses: thinking that their token design is their business model. They get caught up on complex mechanism design and fancy supply schedules. They focus on token price rather than value being provided by the underlying project.

Be cautious when projects have overly complex tokens while failing to demonstrate some value in their underlying project. Effective blockchain-based businesses leverage their token design but do not lead with it.

Leveraging the power of tokens means incentivising desirable behaviours (e.g. providing security or liquidity) while punishing undesirable behaviours (e.g. through slashing) and driving stakeholders towards a common goal. Investors, users and attackers all want different things. A good token design harnesses them and pushes them towards value-generating trade and coordination.

Conclusion

The field of token design will continue to evolve rapidly. As the cryptoeconomy evolves, understanding token design is critical. Whether you are an investor, developer, or simply an observer, the ability to analyse and compare different token models will be a valuable skill in understanding the emerging cryptoeconomy.

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Dr Darcy Allen and Dr Aaron Lane are with the RMIT Blockchain Innovation Hub, RMIT University