How to design the tokenomics for your ICO?

Blockchain and ICOs have been going through an amazing phase over the last couple of years. Today, ICOs are one of the most sought-after ways for Blockchain startups to raise capital for their businesses. Until the first quarter of 2018, the total funds raised through ICOs sums to $6.3 billion, which is 118 percent of total funds raised in 2017. The growth of ICOs is mind-blowing, attracting many more entrepreneurs and companies towards it every day.

The most critical element for any blockchain based project or an ICO is its token economies or otherwise called “tokenomics”. In this article, I’ll explain how to design a tokenomics model for your project.

What are tokens and tokenomics?

Decentralization is one of the inherent properties of a blockchain based project and there will be different types of participants in it. The transfer of value happens between the participants and the factor of ‘trust’ is established in the system via the crypto tokens and their transactions. Participants can take full advantage of the project only when they take part in the turnover of tokens. For example, STORJ is a utility token which is used by the users of Storj platform for using the different functionalities in it.

Let’s say if you want to tokenize your project, you have to define the total number of tokens you will create (unless you want to launch an uncapped ICO). The total number of tokens should be defined based on the following rules,

• The total count should not be too high such that the high supply results in a low value for the token
• There should be enough tokens available for your potential customers to purchase it from you
• The value of the token should be optimal based on the utility it serves.

By evaluating the different aspects of your projects like the business plan, potential market, projected market penetration, token utility etc you can decide on the numbers in your token model. That’s what tokenomics is all about — How the token is going to create value through the token movements inside the project. Let’s see in detail about tokenomics,

Token functionality

If you want to tokenize your project, you have to define answers to the following three questions.

1. Who uses the tokens in your project?
2. Why should they use the tokens?
3. How can they use it in the project?

The answers to the above three questions sum up your token functionality. As an example, binance raised their funds via ICO by selling the binance tokens. The traders in the binance exchange use the binance tokens because they can pay the transaction fees using it. Once you have a clear idea of the token functionality, you can define the token distribution.

Token distribution

Token distribution accounts for every ‘in and out’ flow of tokens in the system. Think about what are the different ways the token can be pushed to the market for circulation and how all it returns back to the system. The goal is to hold the in/out flow in optimal volume so that the token can hold the token model in long term. For example, a token model where users are forced to cash out (the process of exchanging tokens for fiat currency) the tokens will not sustain in a long run. The utility of the token should persuade the holders to keep the tokens and not to cash out immediately.

Token workflow

Once you have defined the token functionalities and token distribution, you can put it together to build a lower level token workflow model. It essentially depicts the possible flow of tokens between different participants of your system and the potential velocity of the token flow. The utility of tokens for each of the participants determines how long they are going to keep it or pass it to other participants or cash it out. Once you define the complete token workflow model, you can identify potential dead ends for the token flow. When you have the token workflow defined, you can start working on the ‘numbers’ for your ICO.

Let’s get familiarised with a few terms to appreciate the basic rules in defining tokenomics;

TS: Total circulating token supply – total count of token you create and circulate in the market.
P: Current price per token
HT: Hold time of a token in Ecosystem- average time a participant is holding a token
TV: transaction volume per year
TT: transaction time- the time required for completing a transaction
TMCAP: token market cap = TS * P

R= TV / TMCAP = ratio of transaction volume to transaction market cap.
R1 = R / TT
R2 = R / HT

Following are the rules you should focus on while designing the tokenomics.

The value of HT should be as high as possible

As stated before, immediate cash out of the token will result in collapsing the value of the token. Identify the type of participants who are most probable in cashing out the tokens. Build more utilities for them so as to encourage the hold time. In overall, the high value of hold time can increase the token demand and token value in the market.

The value of R should be as low as possible

Suppose your system has an annual turnover of 100 million and there are 1000 million dollars in tokens, then there will be an upward pressure in tokens. The lower is the value of R means there is an upward pressure in the token value. Or we can say R is inversely proportional to token’s value. However, R is not taking account of TT or TH which are also factors affecting the token value.

The value of R1 and R2 should be as low as possible

Transaction time should be optimal and hold time should be as high as possible so that the token value will have an upward pressure to increase in the value. Higher the hold time means the lower the value of R2. Likewise, the higher the transaction time means lower the value of R1. Lower values of R1, R2 brings transaction volume to transaction market cap ratio lower and this results in an increase in token value.

Understanding and defining tokenomics of your project can be quite overwhelming. But the good thing is that you don’t have to perfect it in the whitepaper stage of your ICO. Once you have the initial tokenomics, you can perfect it over time by close analysis of how your token is performing in the market, how people are accepting it. Then you can strategize your operations to optimize token utilities and value. In the upcoming article, we’ll see the methods for defining the numbers for the hard cap and token value for a token model.