How to make your utility token economy work: proven practices for future growth.
The explosive growth of a token is a golden grail for crypto founders. Some believe that if the project is disruptive and creates genuine value, it automatically ensures token success.
The explosive growth of a token is a golden grail for crypto founders. Some believe that if the project is disruptive and creates genuine value, it automatically ensures token success. In reality, proper token management coherent with a business model is as vital as the quality of the project itself. Given that projects are often financed with the token sale, it's a question of survival.
What is tokenomics?
In a basic understanding, tokenomics boils down to dividing token supply. For example, apportioning 5% to the pre-sale, 15% to the main sale, 20% to the team, and so on. A more robust understanding includes modeling the organic and speculative demand for tokens, proactively managing token supply, and adjusting liquidity. The end goal of tokenomics is to maintain a stable and, ideally, growing token price and market capitalization.
This article applies to the global economy of utility tokens. Utility tokens enable usage of a particular service, serve as an internal currency in the tokenized ecosystem, or represent a tokenized loyalty point. For other types of tokens, the tokenomics principles will be somewhat different.
For example, security tokens are described by conventional corporate finance as they represent traditional securities on the blockchain. The main areas of concern are the type of the financial instrument and the company's valuation.
Related: Equity, debt or a hybrid instrument — what should you offer investors?
There are also other types of tokens with their unique challenges and various approaches to their tokenomics. For stablecoins, the main concern is balancing the profitability of reserves and the risk. For governance tokens, it's the protection from the concentration of power. The global economy of native blockchain tokens is about keeping low transaction fees, maintaining cybersecurity, and properly rewarding validators.
Related: The future of cash: Stablecoins vs. CBDC
Why do the token's market cap and market price matter?
The key factors for any token are its price and market cap. There are four reasons why they matter.
- If the token’s price is too volatile and changes abruptly, it becomes impossible to plan token-related expenses. Some users may spend their deposit too fast and lose access to a critical service. In the case of a tokenized loyalty program, the token's volatility may destroy the bonuses of companies' most loyal customers. Tokenholder confidence strongly impacts the retention rate and the percentage of users ready to hold the token for the long term.
- Token determines the project's revenue potential. Selling tokens from the reserve is often the primary revenue source for the project in question. The ability to capture this revenue depends on token price stability and deep liquidity.
- The tokens often represent a decent share of the team's compensation package. A solid utility token’s economy facilitates the attraction and retention of top talent. Moreover, companies often pay with tokens to contractors and partners, so a strong token can further reduce operating costs.
- The project's image is linked with token performance. Companies with a history of growth, resilience against bear markets, and a higher market cap have a better reputation. Positive perception makes it easier to get partnerships, media attention, great candidates, and tokenholder interest.
How to increase the price of the token?
The token value can be affected by two key factors - supply and demand.
Demand can be divided into two subtypes: organic and speculative.
Organic demand comes from people who wish to buy the token in question to actually get the utility behind the token, be it using your platform or enjoying other bonuses. Organic demand is the key driver of long-term token appreciation and an increase in the market cap. Strong organic demand is a necessary basis for healthy tokenomics.
Hacking the organic demand is impossible. The only way to master it is to create a genuine token utility, for which there are two requirements:
- Firstly, the product should offer a compelling value proposition customers love — there is no strong token without a product-market fit.
- Secondly, the token design should encourage people to use it to get the total value of your product or service.
The token may be a supplementary element of your business model, representing a loyalty bonus. This provides a limited foundation for its growth but also makes it less critical for your revenue and image. Alternatively, you can go all-in and make every use case of your product inherently linked with tokens. If tokens are your primary way of early-stage financing and it would make sense in your business model, such a strong relation can be quite justified. It enhances the potential for token growth, making it more attractive for early adopters.
One of the main aspects of building the token economy at the very dawn is modeling the projected demand for tokens. This serves as a basis for the initial distribution of tokens, staking programs, and other decisions, so having this modeling done right is essential.
Speculative demand is created by individuals who buy a token to sell it later at a better price, use it within the decentralized finance protocols, profit from arbitrage, et cetera. This type of demand is usually wildly unpredictable and, therefore, hard to control.
The fundamental method of attracting speculators is giving them more flexibility to profit from the token. This can be done by adding tokens to different blockchains, listing them on several exchanges, enabling their use within DeFi protocols, and adding various engagement mechanics. However, having an overly diverse ecosystem in the early stages is not recommended, as the initial liquidity is already relatively narrow. Such diversity can lead to further fragmentation, making the token practically non-tradable.
Although it's less vital than the organic demand, having speculative demand can still provide certain advantages. It's especially beneficial in the early stages when the organic demand is minor or even non-existent if the product is still in development. First tokenholders who make the project possible will be speculators who aim to resell tokens at a 10-fold return.
Moreover, speculators can smooth out market fluctuations, for instance, sell or even short-sell the token when it's overpriced, reducing the probability of pump-and-dumps that would damage the trust in the project team.
Modeling utility token supply
You can control supply to a higher degree than demand. The company sells new tokens to the market, and it can buy out tokens from the market insofar as it has the budget for it.
- Selling the tokens on the market is the most straightforward tool for regulating the token supply. Usually, only a fraction of the token supply is sold at the initial offering. If your business is mature and has a large audience, you shouldn't expect a significant demand for a token as soon as it's launched. Therefore, it makes sense to release tokens gradually depending on the current demand.
You can release the supply either manually or algorithmically. The latter case is especially common for native blockchain tokens, which can only be mined. The algorithmic supply release makes it even more crucial to design the token economy properly. Decentralized autonomous organizations stand in between: the decision is still made ad hoc by the enterprise but the company itself is governed algorithmically.
Related: DAOs: a new and better way to consolidate people thanks to blockchain
- Token burn program. If the tokens are used as a means of payment for the services, the company can burn them to reduce the general supply. Alternatively, the project can buy out the tokens directly from the market and burn them. The last method is quite costly, so you shouldn't rely on it too often. But it can be relevant in rare situations such as the market shock.
- Lockup. Lockup is a restriction to sell tokens during a certain period of time, like 12 or 24 months. It is often imposed on big investors or project team members to prohibit them from releasing a lot of tokens at once and dumping the price. Effective lockups are especially important if the company retains only a small number of tokens in reserve, therefore giving away the control of supply. The duration and severity of lockups depend on the projections of demand for tokens. Thus, getting the demand modeling right is necessary for correct lockups, ensuring the token price's stability.
- Staking programs. Initial speculative investors can sell the token before the organic demand grows enough to absorb the selling volume. You cannot avoid this via lockups because many early speculators will buy tokens directly from the market and not from you.
An alternative solution is incentivizing tokenholders to lock their tokens willingly by offering them a reward. Most commonly, you would reward participants of the staking program simply with more tokens. In such a case, you must strike a balance between offering lucrative profits and not giving away so many tokens, which would unreasonably increase selling pressure when the program expires. Alternative solutions include rewarding participants with bonuses for using your product or with a different token if you have one, such as your governance token.
Proper supply and demand management ensures stable price and market cap growth. But there is one last factor that dramatically impacts the satisfaction of your tokenholders.
Creating liquidity for the token is the last piece of the token management puzzle. To ensure the price is not too volatile and the token is convenient to trade, there must be a sufficient market for such tokens.
If you target decentralized exchanges, you need to create the liquidity pools for the most common trading pairs on the blockchains that your community uses the most. There should be enough liquidity in each pool, so the token price doesn't get too volatile. Fewer pools with more liquidity are preferable to more pools with less liquidity.
Related: How asset tokenization brings liquidity to equity crowdfunding
In the case of centralized exchanges, you need to aim for exchanges with a progressively larger community and deeper liquidity as your token grows. Unlike with decentralized exchange, where market-making is automated, here, you need to conduct market-making yourself or hire the providers who would help with that.
Market makers place buy and sell orders on particular price levels, allowing tokenholders to buy or sell tokens even when counterparts for trade aren't immediately available. It's imperative in the early stage when tokenholders don't create sufficient volume, and the lack of market makers may disrupt trading.
Tokenomics is essential for project survival and success. It's crucial to find the right fit between the business model and the token, carefully model demand, and choose the suitable approaches for managing supply. Given the importance and complexity, hiring professionals who can assist you in getting the token economy right is highly advisable. To verify whether Stobox is the right partner for you, book the 30-minute complimentary consultation on our website.