Crypto Economics Crash Course

By December 10, 2018Crypto
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What Is Crypto? 

Crypto is a form of digital currency that’s built on the desire to have individual sovereignty over your money. It’s one of the many use cases of blockchain technology and acts as a unit of measure, medium of exchange, and a store of wealth. This means that crypto acts in all the same ways as “traditional” currency but without many of its flaws. Crypto doesn’t need to be stored in a bank, it gives people a higher sense of privacy from the government, and it’s relatively easy to use for the technically minded. But most importantly, the individuals pushing the use of crypto want to improve the world through transparency and voluntary democratic participation.

While there are many people that compare crypto to failed units of trade, the difference is that crypto is built on blockchain technology, which has the potential to change the way we fundamentally trust each other. Blockchain is a hard system to hack, it has a complete record of transactions, and can last longer than other currencies due to its decentralized nature. These reasons make crypto a prime candidate for a revolutionary currency system.

Though there’ are great use cases for crypto, it’s also received a lot of backlash. Crypto can be stolen, they have been used for illegal purchases, and have been very volatile in the past. For these reasons, many people give cryptos zero tolerance and want them banned. However, if we extended the same zero tolerance to current systems, we’d have to get rid of many things despite their net benefits. We’d have to get rid of ports because that’s where drugs come in, cash because of fake currency currently in circulation, and hotels because sex work happens there. Though it has some flaws, crypto is gaining a lot of attention and is on its way to broad market adoption.

 

What goes into a Crypto and What is Tokenomics?

Currently, there are more than 2,000 cryptocurrencies listed on coinmarketcap. With so many cryptos, and new ones entering the market every week to compete for market dominance, it’s hard to see why one fails and another succeeds. It may seem random, but there are three key aspects to a crypto’s success: how it’s being governed in the market, its economic model incentives, and the humans and machines working to make it function. While there may be other factors that are important, by developing these three key aspects cryptos gain value through stability.

Most cryptos are governed by the idea of consensus, from how the crypto is allocated to how funds are protected. This is all done through blockchain technology. Each person has a ledger with transactions made up of blocks. Blocks are trusted based on how much computing power has been put into the chain of blocks. If the ledger matches the other distributed versions, it will be considered accurate. Governance can cover how many blocks have to match in order to be considered accurate. Or does the majority of ledgers need to match (say 51%)? Or is a supermajority or more than 60% needed for some changes to the crypto? Differences in these rules can make a big difference in how secure the crypto is and how fast transfers are made. Often, these governance rules are explained in the code and whitepaper for the crypto.

The second key to a crypto’s success is its economic model incentives. An economic model outlines how the crypto has value to those who use it. This plays a key role in whether or not users buy into the idea of using the crypto. Incentivizing users through ideas such as supply and demand is not enough to get people to engage with a crypto. There has to be some reason why people use, mine, hold, talk about, and advocate for the product that’s tied to the crypto. While these incentives may include differing things such as stability or profitability, virtually all include the promise of a positive return on investment. Cryptos are subject to all the same economic forces as traditional currency, the difference is that crypto has more transparency due to its use of blockchain technology.

The third part of a successful crypto is the people and machines that make it function. While people are the key source to making a project work, cryptos use a lot of computer power in order to operate and rely heavily on the use and growth of technology. The more computers working to complete the block, the faster cryptocurrencies can be transferred to different wallets. And overall, the more people involved, the more secure the crypto will become. Understanding these needs and limitations of each individual project is key to improving the quality of cryptos in the market.

With this basic understanding of the anatomy of a crypto, it’s possible to start looking at more powerful economic approaches. The most important of these are tokenomics and crypto economics. Tokenomics is the first attempt at a theory to explain the macroeconomics of a crypto, and assesses crypto as either a currency or an investment. This includes making sure the crypto has a system for distribution and utilization as well as ensuring the crypto remains stable and retains value. While tokenomics is about understanding the macro value, crypto economics is an approach to understanding a crypto at the micro level as its own little economy. This includes evaluating the transfers of cryptos between wallets, understanding the distribution of wealth, how many tokens are currently in circulation and how this mini economy will respond to shocks like changes in regulation, the entry of a competitor, and/or sudden shifts in user preferences. Although crypto economics is a more complete method for analyzing cryptos compared to tokenomics, there’s an even better solution that no crypto project is currently using.

 

What is The Next Frontier For Crypto?

There has been a lot of work done to better understand cryptos, but there’s still a long way to go. The next frontier for crypto includes a new economic model that better explains the anatomy of a crypto, simulates its future market, and accurately predicts a crypto’s value over time under changing market conditions. Being successful means having real data and market intelligence. This includes forecasts of your crypto, competitive intelligence (other cryptos and FIAT), understanding of global market trends, what user personas the crypto is going to attract, and the costs associated with operating the crypto.

This is a lot of data that requires a unique mix of skills in agile market research, data science, and economics. In order to be successful, no data can go unnoticed or unchecked. All this data needs to be captured, analyzed, forecasted and validated through rigorous experimental testing. With such rigorous data, it’s possible to use one of the most advanced methods in microeconomic analysis: agent-based simulation. This method uses mathematical equations to describe agents in an environment operating under specific rules. Like a mini Matrix world, this computer-generated reality allows us to run an infinite number of simulations to find the outer limits, and optimal outcomes, for any crypto project within the market.   

Because of their unique advantages over current currency systems, cryptos have the potential to change the world. They add more security and trust to our money supply, they require no centralized bank to be stored in, they can be transferred directly to one another in any quantity at low fees across the globe, and don’t need government involvement to function. While cryptos are a fantastic invention, the next generation has to be better to drive broader market adoption. Ultimately, crypto economics based on the market simulation of extensive data sets will be the foundation of success for the next generation of cryptos.