Table of contents
Image by erfouris studio from Pixabay
Recap
Last week we divided tokens into :
Physical Tokens &
Crypto Tokens
Physical tokens are mostly issued for a specific purpose(s) or to access specific service(s) & we used casino tokens as an analogy.
We then explained crypto tokens which are nothing but an entry in the blockchain ledger which is mapped to the address of the token holder.
We also saw that crypto tokens can be issued with a few lines of code & deployed on the Blockchain & tokens can represent the right to an underlying asset with some economic value.
Let us move forward
Economics
Before understanding the economics behind crypto tokens, let us start with economics in real life.
What is Economics?
As per Wikipedia,
Economics is defined as a social science that studies the production, distribution & consumption of goods & services.
Economics focuses on the interactions between economic agents & how economies work.
Microeconomics analyzes what is viewed as basic elements in the economy, including individual agents & markets, their interactions & the outcomes of those interactions. Individual agents may include, for example, households, firms, buyers & sellers.
Macroeconomics analyzes the economy as a system where production, consumption, saving & investment interact, & factors affecting it; labor, capital, land, currency inflation, economic growth & other public policies that have an impact on these elements.
From the above definition, we can infer that
There are actions involved, viz., production, distribution, consumption etc.
There are outputs - goods & services
There are agents or actors involved - markets, households, buyers, firms etc
The interaction of all the above creates an economic ecosystem of a country
The actors in a country's economic system are incentivized to interact with the ecosystem in certain ways depending on the economic environment. For example, in an inflationary environment, Central Banks raise interest rates to reduce inflation causing people to behave a certain way or lower interest rates in a recession causing people to behave in another way.
Similarly, there are economic interactions between users, miners, developers & other stakeholders in a Blockchain ecosystem. There are incentives to maintain & keep the infrastructure working & for the actors involved in that ecosystem to behave in certain ways. These incentives are implemented through tokens.
Trust Factor
Centralized entities like Finance Ministry or Central Banks are entrusted with the responsibility to run a country's economy. However, in a crypto ecosystem, none of the actors know each other & in the Blockchain ecosystem, the algorithms coupled with cryptography take care of that "Trust".
Next, let us understand what is crypto-economics.
Crypto-Economics
As per MIT Cryptoeconomics lab,
Cryptoeconomics brings together the field of economics & computer science to study the decentralized marketplace & applications that can be built by combining cryptography with economic incentives.
We can infer again from the above definition that
There are actions involved, viz., using decentralized infrastructure, building applications, etc.
There are outputs - transaction blocks, decentralized applications using cryptography etc
There are agents or actors involved - application developers, users, infrastructure developers, nodes etc
All the above stakeholders interact to create a decentralized ecosystem.
Protocols
Just like Governments & Central Banks have monetary & fiscal policies to manage the economies of nations, in a Blockchain, protocols are developed to ensure effective governance over applications & the Blockchain infrastructure. These protocols define how the stakeholders & participants in a Blockchain network interact with each other.
The most popular use-case of tokens is digital currencies like Bitcoin or Ether. These tokens are issued to miner nodes to compensate them for CPU & power usage to support the infrastructure. These act as incentives. However, this is not the only use case of tokens.
More on this next week