Cryptoeconomy

What You Need To Know About Token Economics

It has become clear over the last year that cryptocurrencies can do so much more than replace existing currencies. They can be used to tokenize assets, give access to dapps, represent ownership, make holders become active participants of decentralized networks, among many other uses.

Due to this, digital tokens are creating entirely new economic models which we refer to as token economics.Because of its novelty, token economics can be incredibly difficult. Cryptocurrencies are often used for multiple features on their related blockchain platform, and each cryptocurrency, or token, is programmed in its own unique way.

Understanding the token economics behind cryptocurrencies can assist you with determining which projects are solid, high potential investments and which are not.

These models can make or break a cryptocurrency and its related platform.In this article, we will go through the dynamics of token economics and provide you with several insights to help you understand the token economics behind your next cryptocurrency investment.

Token Economics 101

Token economics essentially refers to the study, design, and implementation of economic systems based on blockchain technology. Every blockchain platform and blockchain application has its own token economic model. The subject of token economics focuses on the actual, new economic models that are created through cryptocurrencies. This excludes tokens that are solely used for fundraising and play no significant role in its underlying platform as they do not pose new models.

Securities have been around for a long time and their dynamics are well understood. Even though blockchain and cryptocurrencies allow for a superior way of dealing with securities in terms of transferability and ownership, they do not change the traditional dynamics of securities. Once regulatory frameworks are in place, tokenized, blockchain-based securities will likely be more or less similar to the current system.

Cryptocurrencies allow for so much more than simple fundraising and they make the construction of entirely new business and governance models possible. Token economics is about blockchain models in which the related digital tokens play a pivotal role.

There is one assumption on which nearly all token economic models are based: people act upon incentives. This is based on incentive theory, a human behavioral theory that assumes behavior is motivated by a desire for reinforcement or incentives. In token economics, these incentives are the tokens themselves and they are used to motivate network members to behave to the benefit of the network. 





Source: https://www.thinglink.com Act according to the rules of the network and you’re awarded with cryptocurrencies. So the rules of a network must be set in such a way that people contribute to the entire network because of personal incentives.

People want more money and they get more money by doing what’s best for the network.These incentives are mostly financial incentives because tokens have a financial value. This financial value stems from the money that has been invested in specific cryptocurrencies in an ICO and on the crypto exchanges.

Designing the Basics of Token Economies

Models for token economies are designed and implemented before a new cryptocurrency is launched. The organization behind a cryptocurrency has to decide on the role of their native token on their platform. This is no easy process as any weakness in their model will sooner or later be exploited by someone in the network, so the economic model must be rock solid.

The first step of designing models for token economies is choosing the consensus model. However, cryptocurrencies can also be continuously created through several consensus algorithms. For example, Bitcoin and Ethereum use Proof-of-Work. In this model, you have miners that secure the network and verify transactions by solving blocks. When a miner solves a block, they are rewarded with cryptocurrencies.

Other cryptocurrencies such as Dash and NAV coin use the Proof-of-Stake algorithm. In this model, holders of the native cryptocurrency stake their holdings in a wallet to solve blocks. The more tokens you hold, the bigger the chances are that your wallet solves the block and that you’re rewarded with new tokens.

In these consensus models, the cryptocurrencies are used as an incentive for participating network members to secure the network, verify transactions, and improve the blockchain ecosystem. Through this, more of the currency come into existence which causes inflation. The supply increases and thus each token becomes worth less, assuming that the demand remains constant. 

Every consensus model employs its own rules for inflation. For example, for each Bitcoin block solved, the miner receives 12.5 bitcoin. This will be halved somewhere around 2021, after which the reward becomes 6.25 and goes on until all 21 million bitcoins are mined. 





Source: https://www.quora.com


This total and limited supply of cryptocurrencies is another key component of the basics of token economics.To prevent endless inflation, most cryptocurrencies have a finite supply.

Through this, the digital coins are scarce and there is no way to create more of it at any point in order to control its price. This measure (of having limited supply) is evident in most cryptocurrencies; it is largely seen as a countermeasure against the current economy in which fiat currencies are endlessly created by the authorities, making the currencies worth less and less, and deteriorating trust in the value of fiat currencies.

Use Cases of Cryptocurrencies in the Network

After a team has decided on the basic model for the creation of cryptocurrencies, they have to create a model for the usage of their token. For transactional coins such as Bitcoin, Dash, and Monero, this model is easy — the cryptocurrencies are a way to transfer value to other parties and to store value digitally.

This, however, is by far the most basic use case for cryptocurrencies, something that the rise of Ethereum pointed out.Blockchain and cryptocurrencies allow for decentralized networks — networks that are governed and controlled by its members without a central party — and smart contracts, which are agreements between parties that are automatically updated and executed.

To ensure that the network of a blockchain or a blockchain application functions effectively and keeps on developing, cryptocurrencies are used. Because there is no central authority, the tokens are essential to the survival and progression of a decentralized platform, and can be used for many different purposes, which include but are not limited to the following uses.

Incentivize Miners

In this model, the cryptocurrency is used to reward miners for securing the network and verifying transactions. How this functions is based on the consensus algorithm in place. The tokens are distributed to those nodes and the fastest miners, making it competitive. Through this competition, more and more people enter the network because they also want a piece of the pie.

In turn, this makes the network more secure and allows for faster and cheaper transactions.

Staking

In the PoS and Delegated PoS model, token holders can stake their holdings. Staking is the process of keeping your cryptocurrencies in a private wallet related to the cryptocurrency’s blockchain. This helps secure the network and stabilize the price of a cryptocurrency as less token holders trade these tokens. In return, token holders usually receive rewards.


PoS is a mechanism in which staking individuals have the chance to validate transactions based on the amount of their token holdings. For instance, the PoS model is currently employed by Dash and OmiseGo. In the Delegated PoS model, which is used by Lisk and Ark, token holders can vote on delegates that validate transactions for which voters are awarded part of the earnings of the delegates.

Payment of Transaction Fees

Cryptocurrency users that conduct transactions pay a transaction fee. This fee can go to the miners of a blockchain, but also to the entire network. For example, when you send Ripple’s XRP to another wallet, a minor percentage of this transaction is burned as a means of payment. This payment is indirectly awarded to the entire network since the supply of XRP is decreased by doing this.

Governance

This is one of the most interesting aspects of token economics as it involves sociology, psychology, networked cooperation, power distribution, and (new) models of democracy.  Through token-based governance, network members that hold tokens can vote on the direction of the platform.

Developers can propose alterations to the network’s programming, upgrades, new features, and cooperations on which token holders can vote with their token holdings. In this way, token holders are part of the network’s governance process.

The best example of this is a Decentralized Autonomous Organization (DAO). This is a fully]-automated, decentralized network that can perform tasks and provide products and services.

DigixDAO is such a network that lets their token holders decide on protocol decisions. The amount of holdings determine the weight of someone’s vote. DigixDAO has recently launched its stablecoin DigixGold, which is pegged to the value of gold. DigixDAO token holders all share the profits of transaction fees of DigixGold.

This incentivizes token holders to make informed decisions about the future undertakings of DigixDAO.

Contribute to the Network

Network participants can also be awarded for contributions to the network without this being automated. Lunyr, for example, is a knowledge-sharing platform on which users can submit articles. These articles are peer-reviewed by other users and both writer and curator receive tokens for their contributions.

On the other hand, if a contribution violates the platform’s rules or a curator approves something that is not accepted by other curators, they can get penalized.

It is important to note here is that developers are much more inclined to aid in the development of a platform when they own tokens of that platform, since there is a personal financial stake involved.

When the value of the platform increases, so does the value of the holdings of the developer. To increase this effect, the network can distribute tokens to key contributors to increase the personal financial stake involved, incentivizing them to develop the platform even more.

Blockchain-Based Services

When a token is used for this, a blockchain application’s native token is needed by users to access the application’s product or service. An example is Siacoin. Siacoin is a decentralized cloud storage platform in which network members with excess digital storage capacity can rent this out to network members that need extra storage.

Those that want extra storage pay the providers of storage with Siacoins for this service.There are many more applications that use this model, for example Ethereum-based applications such as Augur, Civic, and Golem. As more people start using these blockchain-based products and services, the demand for the native currency will increase, making it more valuable.

Profit-sharing

Some blockchain applications let their token holders share in the profits made by the platform. The token of the cryptocurrency exchange KuCoin, which is called KuCoinShares, entitles holders to 50% of KuCoin’s daily transaction fees.Iconomi also shares their profits with token holders through recurring buybacks.

This means that the Iconomi platform uses portions of their profits to buy ICN tokens back from the market and burns these tokens, decreasing the overall supply of ICN tokens.

Why Token Economics Matter

The most important question to ask yourself before buying a cryptocurrency is: what is the purpose of the cryptocurrency I’m buying? The token economics behind a cryptocurrency will guide you towards answering this question.

Currently, there are several problems with token economics.

One problem is that newly-issued cryptocurrencies are mainly created just to attract (ICO) funds and the actual purpose of the cryptocurrency comes later, if at all.

Second, too much of a network’s tokens are held by investors and the creators instead of by who they are meant for—developers and users of the network.

These two problems give an insight as to how to value a cryptocurrency based on its token economics. A platform’s token economy describes how a token will be used on the platform. If a cryptocurrency is only used as a tool for attracting funds, the demand for the crypto will die out over time.

Also, if the token is only used for profit-sharing, the token will not be able to compete with tokens that serve multiple purposes and thus have multiple reasons to create demand.

A strong demand and valuation derives from the actual usage of a cryptocurrency.The more use cases a token has on its platform, the more it will increase in value as the platform gets used more. Lisk is a solid example of this.

The Lisk token, LSK, has various use cases on the platform. LSK is used to pay for transactions, vote for delegates, and is awarded to the top delegates. It is also used to launch applications and sidechains on the Lisk blockchain, and as a base currency to trade native application tokens.

As the Lisk ecosystem increases in size and usage, its LSK token will grow in value with it because more people need the token to participate in the ecosystem. The intrinsic value of cryptocurrencies is based on the utility it provides. The more use cases a currency has, the more utilities it serves.

Another important aspect of token economics is whether the token plays a role in the governance of its platform. In the end, blockchains and blockchain-based applications are meant to be decentralized; to make decisions on a decentralized basis, its users must have a way to let their voices be heard.

Through decentralized governance, a platform can move forward by making community-based decisions on upgrades, alterations, and new opportunities.

For a more technical analysis on how to assess the value of a utility token, click here.

Conclusion

As we’re still in the early stages of the blockchain era and most blockchains and blockchain applications aren’t used yet, the question as to whether a coin will actually be used is still highly speculative. A thorough analysis of the token economics behind a cryptocurrency will provide insights on whether there will be a demand for a cryptocurrency in the long term.

We are just getting started and already we are seeing an increasing number of different models for token economics. Governance, providing incentives, profit-sharing, access to applications, and contributing to the network are currently the most widely applied token economic models, but there are still numerous ways to utilize tokens in other economic models and these ways are still completely unexplored.

When looking for your next new cryptocurrency investment, find out what purpose a cryptocurrency serves on its platform. The more sensible use cases a cryptocurrency has, the higher the chances are that the demand for it will increase in the long term.

Related: A Guide to Long-Term Cryptocurrency Investment Strategy


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Tags: token economics, token economy

About Jorn van Zwanenburg

As a technology and innovation MBA graduate and a passionate libertarian, blockchain technology was the only logical next step for Jorn. Besides trying to know all there is to the blockchain revolution, he wants to explore the world, surf every wave it has to offer and write his brain empty.

If you’ve been a member of the cryptocommunity for more than a couple of weeks, you’ve probably heard the term ‘hard fork’ thrown around. A lot of people may be wondering, what that exactly means. Perhaps you’ve heard of the most popular hard fork, Bitcoin Cash, and you’ve got a brief idea of its meaning.

The goal of this article will be to simplify the concept of a ‘hard fork’ in an easily understandable manner and help you dissect and digest the different hard forks that exist, what they mean, and how they happen. This article will also do its best to present the definition of a hard fork in the most nonbiasedmanner possible.

The formal definition of a hard fork in blockchain is:

A permanent divergence from the previous version of the blockchain, and nodes running previous versions will no longer be accepted by the newest chain.

Unfortunately, it’s not quite that simple. So, let’s take it back to the basics for a moment. The fundamental concept of blockchain technology, as created by Satoshi Nakamoto when he made Bitcoin, is that decentralization would occur via a distributed ledger. So, in other words, everyone on the network would have a copy of all the transactions that were made.

 If Jim sends 10 coins to Sarah, everyone has this information.People obtain these copies by running a node. A node is a connection point. Basically, to set up a node, one would just download the necessary software and connect it to the Bitcoin network. Once connected, nodes receive an updated version of the ledger with ALL payments ever made.

All of these transactions are stored on something called a blockchain.The rules of the chain are enforced by full nodes. This is an important fact to remember when examining and studying hard/soft forks and their occurrences. Miners are free to mine any type of blocks that they want, it is up to the full nodes to validate those blocks.

However, if there is just one full node or even a small percentage of full nodes that validate blocks that a majority of miners are mining on, then there is an imminent risk of a chain split.  Another critical piece of information one must understand to really ‘get’ how hard/soft forks are created is the fact that full nodes are needed to enforce consensus rules on the blockchain.

If miners choose to mine blocks that do not abide by these rules, then the full nodes will reject the block. There is also a difference between consensus and consensus rules.

Consensus merely refers to the adherence of nearly-all full nodes to the consensus rules of the network.Below are some of the consensus rules on the Bitcoin network:

• Block Size
• Proof of Work
• Bitcoin Reward per block
• 
  

And many more…

How do hard forks occur? 

 

The concept of a hard fork is somewhat similar to that of a software fork. However, the implications for Bitcoin are a bit more pronounced. Check out the graphic posted below:





This is a good, basic example of what a blockchain should look like conceptually. It is linear, so order is extremely important here.Bitcoin was designed with a specific code by Satoshi (founder of Bitcoin) and others, which dictated the consensus rules that were discussed above. Every block that is added to this ‘chain’ abides by said rules.

A hard fork occurs when these consensus rules are expanded through different software. For example, when Bitcoin Cash was created, it loosened the rules on block size, making it a hard fork. SegWit is an example of the rules being constricted. So, a restriction of the block size would represent a soft fork.See below to get a better visual conception of how this process manifests itself:





As stated in the definition in the beginning, this divergence is permanentand there is no longer any compatibility between the two.Generally, there are two different ways which a hard fork can occur. It can either be: Contentious or planned. As their names suggest, both entail entirely different things. 

A planned hard fork means that the creators/developers were all in agreement as to how the coin would be forked. When this occurs, there is no split in the chain. This is because all of the nodes have agreed to upgrade to the latest version of the coin’s client that possesses the rule change.

There will be a split in the chain if all nodes do not adhere to the new rules set by the hard fork implementation. This chain will more than likely die off without enough economic support. Therefore, planned hard forks are usually under little to no threat unless there is an invisible negative sentiment — which is an unrealistic scenario.

If there was disagreement in the community about the path of a coin, like Bitcoin, for example, then a contentious hard fork would occur. The most notable example of this is the creation of Bitcoin Cash, which we will explain in more detail later in this article.

Given the nature of blockchains, hashing power, and hard forks, there must be a fair amount of support for the hard fork for it to be economically viable in the long-term.Hard forks, by definition, are always incompatible with the original chain. Thus, a hard fork will always be irrevocable and permanent.

However, it is worth noting that the original chain will always be compatible with the hard fork chain by definition.

Typically, a contentious hard fork occurs when some of the nodes – which previously mined on the old network – decide to switch to the new chain; this ultimately splits the mining community into two camps, one which now follows the rules of the new chain and another one which continues to adhere to the old one.Here is a great graphic that shows what this would look like:




Source: https://masterthecrypto.com/guide-to-forks-hard-fork-soft-fork/

Hard forks pose a systemic risk to Bitcoin

As the graphic above shows, when a contentious hard fork is created, there are two running versions of the blockchain. This is something that any coin would want to prevent at any costs for the following reasons:

• Blockchain reorganization
• TX being confirmed by the wrong chains
• Political/Social Turmoil Within the Community Regarding the “real” and the “fake”  

And many others…Another facet of hard forks, which is a bit more complex to explain, is that users will receive “free” coins. However, since everything is digital in nature, this is a phenomenon that’s hard to create an analogy for in an accurate way. Essentially, when a hard fork occurs, all previous TX made on that chain are considered legitimate.

Even future blocks that are created with legacy rules would technically still be considered legitimate (unless otherwise coded to not accept any of the legacy blocks). Therefore, money that prior could be spent on the hard fork ledger as well as the original ledger simultaneously – effectively giving one “free” coins.

What’s the current status of previous/impending hard forks for Bitcoin?

Technically, the earliest Bitcoin hard fork occurred in 2013. However, this was a planned hard fork and not meant to be contentious.  Our goal in this section will, however, be to give an overview of all contentious hard forks that occurred, cover their proposed changes, provide the logic behind said changes, and explore their resulting impact, if any.

#1 – Bitcoin XT (2015) – BIP101

In many ways, Bitcoin XT served as the prelude to the eventual Bitcoin Cash hard fork. The manifestation of the Bitcoin XT hard fork was borne out of the age-old debate in the Bitcoin community regarding scalability. As many in the community had noted as early as in 2010, the usability of Bitcoin would be threatened without some tangible change was made to the consensus rules.

 Philosophically and technically, this argument elicited a variety of different viewpoints, arguments, and criticisms. Some individuals felt that the best way to increase the scalability and usability of Bitcoin would be to increase the block size.

If you used Bitcoin in December of 2017, you probably noticed that the fees were exorbitantly high.The reason for this was because there was not enough room within the blocks for miners to include all the TX that were being sent to the network.

This meant that increasingly higher fees had to be paid in order to incentivize the miners to include one’s TX to be included. In some cases, TX fees needed to be in excess of $20 if one wanted a realistic opportunity to have their TX confirmed.

Many in the Bitcoin community saw the inevitability of this fate years prior. Thus, many had advocated for increased block size. However, there were was a stronger segment of the community that was against such increases.

This increase, they argued, would harm the stability of the network because it would reduce the # of full nodes on the network.Why would they think that?This criticism was actually noted directly in the BIP101 through the statement:





As noted earlier, only full nodes can validate blocks. By increasing the block size, one must also increase their computer/device’s memory and technical capacity. Opponents to the increase of Bitcoin’s block size argued that this increase in capacity would reduce the number of full nodes on the network, subsequently making the network less secure.Below is an image detailing the requirements necessary to run a full node:





Proponents of the increase in block size argued that the increase in technology over time would mitigate these necessary increases in computing power and network capabilities of those who wished to run a full node.Bitcoin XT was launched before the Bitcoin network had truly reached a boiling point on this issue.


Mike Hearn, the most outspoken advocate for the increase in block size at that time, spearheaded the Bitcoin XT movement. However, Gavin Andresen also joined forces with Mike Hearn later on and they both partnered up to develop Bitcoin XT.Who are Mike Hearn and Gavin Andresen?

For those unfamiliar with those two names, both Mike Hearn and Gavin Andresen were instrumental in assisting the development of Bitcoin from its earliest stages.

Gavin Andresen, who’s noted for a number of things, is perhaps most famous for being the last person that Satoshi ever talked to.Before Satoshi’s departure, Gavin, in many respects was the ‘point person’ for Satoshi in the weeks prior to his eventual disappearance.

After Satoshi died, Gavin also took up the torch as the de facto ‘leader’ and ended up assembling individuals that would make the first incarnation of the ‘core’ team.  

Hard Fork rulesAccording to another Howtotoken article that covered this issue briefly, the hard fork rules established by Bitcoin XT was an increase in the block size from the limit (still in effect) of 1 MB to 8 MB. However there are many other notable changes were introduced within the BIP101 as well. Namely:

• “The maximum size shall be 8,000,000 bytes at a timestamp of 2016-01-11 00:00:00 UTC (timestamp 1452470400), and shall double every 63,072,000 seconds (two years, ignoring leap years), until 2036-01-06 00:00:00 UTC (timestamp 2083190400).”
• “Deployment shall be controlled by a hash-power supermajority vote (similar to the technique used in BIP34), but the earliest possible activation time is 2016-01-11 00:00:00 UTC.”
• “This BIP proposes replacing the fixed one-megabyte maximum block size with a maximum size that grows over time at a predictable rate.”

According to Mike Hearn in his exit article from the Bitcoin world (which had a monumental impact on the community and signaled the “blowing up” point of this argument), he initiated the Bitcoin XT hard fork for the following reasons:





The reception from the community was poor at best. Mike Hearn summarized some of these community reactions in his exit article:




Brief research provides some strong evidence that any and all dissension against any block size increasing alternatives to Bitcoin was both fiercely and aggressively attacked, shunned, condemned, ridiculed, and excommunicated in the community.

The vast majority of these measures were implemented by Theymos (a member of the community since 2010, who runs the Bitcoin reddit, Bitcointalk, and Bitcoin.org). Here are some examples of this censorship below:

• Theymos threatens to remove Coinbase entirely from /r/Bitcoin on Reddit as well as the bitcointalk forums if it dares support Bitcoin XT(alternative chain created by Gavin and Mike with bigger blocks to test community support for the idea).
• Petition to remove Coinbase from the ‘Choose Your Wallet’ page on GitHub for endorsing/running Bitcoin XT nodes.
• Shutting down all of the Bitcoin XT nodes.
• There is an active keyword list of words/topics/phrases that are automatically removed from the Bitcoin subreddit.
• Reddit CEOs ponder whether Theymos should be removed as moderator due to his active censorship of conflicting/competing ideas.
• More general information/dissection of Theymos’ censorship habits.  

Ironically, at the time of writing, Vitalik issued a statement approximately 10-12 hours ago denouncing the censorship of different internet hubs that host Bitcoin as ‘deplorable’.

There were also multiple publications around the time of the hard fork release that reported that Bitcoin XT nodes and users were attacked en masse to disrupt the project.  However, to state that the community was devoid of support for Bitcoin XT would be inaccurate.

There are numerous reports that attest to the relatively strong support behind the concept. Several corporations signaled their support for the project and many developers and miners were on board as well, in addition to Coinbase.  

Without digging too much into unsupported theory, one could at least conclude that there was a segment of the Bitcoin community that not only strongly disliked the Bitcoin XT project but possessed enough power to effectively impede the progress of Bitcoin XT.Current status

As you probably guessed from everything that was stated above, Bitcoin XT was effectively destroyed. At the time of writing, there are only 11 Bitcoin XT nodes in service.




Source: https://coin.dance/nodes/xt

If you look closely, you can see that there was very solid momentum at its onset, then the number of operating nodes crashed down by 60% before eventually being all but defunct by the middle of 2016, less than a year from implementation.

Bitcoin Classic

Despite the failure of Bitcoin XT, this did not discourage the community from attempting yet another hard fork of Bitcoin.Mike Hearn actually alluded to this in his farewell piece:





Born in 2016, much of the same sentiment that manifested Bitcoin XT was also prevalent in Bitcoin Classic, as Mike Hearn noted above.The website itself, www.bitcoinclassic.com, still possesses the coin’s original initiative. See the screenshot from the homepage below:


In terms of the developers, the site states:

Bitcoin Classic was an international team co-operating on development and distribution of free, open source software tools that build and support the Bitcoin network

• In terms of changes to the consensus rules, Bitcoin Classic introduced a more tempered block size increase of 2MB rather than the initial 8 MB proposed by Bitcoin XT.
• In addition, it modified the TX format to something called ‘FlexTrans’ to address the issue of transaction malleability (something that SegWit is supposed to address as well).  
• ‘Xthin-blocks’ was a new implementation that was designed to address the ‘block propagation’ issue still present in Bitcoin today.

Bitcoin Classic eventually introduced the idea of block-size voting, which relies on the principle of a variable block size.  

However, in the end, the project was shut down voluntarily in favor of advocating for the Bitcoin Cash project, which the development team states that it believes will fulfill Satoshi’s original vision as expressed in his whitepaper release.

TNW is a clear leader in Technology Reporting and Publishing. Discover more insights from TNW here: https://thenextweb.com/hardfork/2018/04/28/comprehensive-guide-to-hard-forks-a-look-into-the-differe...

Speculators flocked to Bitcoin and many of the alt-coins in hopes of getting in early and making a big exit, but everyday users haven’t warmed to cryptocurrencies.

There are many reasons why, but one of the largest barriers to mainstream adoption is the price volatility of cryptocurrencies. So the question is, why do the prices change so much in the first place? It comes down to supply and demand:

Most cryptocurrencies have only a fixed total supply, and yet demand for the coins is uncertain and constantly fluctuating thanks to speculation.Of course, it’s easy enough to talk about the problem — coming up with a solution is quite another matter.

Why is stability so important?

The need for stability is not unique to cryptocurrency. Any currency needs to be stable in order to be used as a trusted medium of exchange. The more that prices rise and fall, the more ordinary people will shy away from using the coins for everyday transactions.

Whether they hoard the coins in the hope that prices will rise sharply soon, or they avoid using them altogether for fear that they will lose all of their value, people are not yet accustomed to seeing cryptocurrency as real money.

Worse, the unpredictability of prices wreaks havoc on regular money services, like remittance, currency conversion, and the use of ATMs. In order to use cryptocurrencies, businesses have to hedge their risks by charging exorbitant fees.

Bitcoin ATMs can charge up to 15 percent just to convert to fiat currency. This totally defeats the original purpose of cryptocurrencies, which was to offer a cheaper and more flexible alternative to other payment methods. With no advantage over government-printed money, why would the average person use them?

Patience is a virtue

Price volatility has plagued Bitcoin from nearly the beginning. With what we have learned over the better part of a decade, why have cryptocurrencies still not solved this problem of fluctuating prices? Human nature gets in the way, as it tends to do.

It is difficult to stabilize prices in a world where people would rather play the market and get instant gratification by re-selling their coins for as high a price as possible. Without careful planning from the very onset of a cryptocurrency’s existence, it’s hard to recover from the effects of speculation.




Image: JaaakWorks/iStock/Getty Images

Phase 1: Building a stable ecosystem

When building a cryptocurrency from scratch, you first need a solid foundation. From this foundation, the currency can grow and self-correct as it develops.

Gauging demandThe first piece of the puzzle is being able to reliably predict demand. Uncertainty around demand is the main cause of price fluctuation, as every user’s intentions are a mystery to every other user.

Having a way to gauge real demand for a coin would go a long way in fixing this problem.The issue with predicting demand, though, is the existence of speculators creating artificial demand.

This is the core of the problem: With so much speculation, the price for the cryptocurrency will not reflect its actual usage and demand. It simply becomes a bubble that is constantly on the verge of bursting, and no one wants to risk their hard-earned money on that.

Traditionally, the solution to the problem of stability was to have a central bank. The government could then alter the money supply at will, for example by causing inflation. Cryptocurrencies are by definition decentralized — that is part of their advantage — and without a central bank they need an entirely new approach when it comes to squashing volatility.

They need to do this without compromising the freedom of the users and without resorting to inflation. Cooperation over competition: A decentralized community“United we stand, divided we fall.”What if there was a currency that encouraged people to cooperate?

What if people were incentivized by a spirit of growth, rather than of greed? Under the ideal model, a network of cooperative businesses and services would coordinate with each other as a single unit.

The coin would be shaped democratically by this co-op (shaped not controlled). Every user would have incentives to help the network grow as a whole, and the use of a blockchain would help make the process be fair.Instead of rampant online speculation, users would visit local exchanges to buy and sell the currency.

The community as a whole would vote on when to increase the coin’s price, which would keep things democratic and guard against sharp spikes.



Official local exchanges

Having to look other users in the eye can make a world of difference. Face-to-face exchanges at trusted locations means that the sale of a coin can be more easily limited, and this can act as a throttle to gauge demand. People on the “front lines,” seeing the real demand for the coin in person, can then vote to increase the price.

Having stable locations to exchange the currency also creates consistency. It removes the guessing game of wondering where you can buy and sell your coin. The advantages are not just purely economic, either. Cryptocurrencies don’t exactly have the best reputation thanks to their penchant for attracting unscrupulous people.

Unethical or illegal businesses will tend to be voted out of cooperative networks with face-to-face exchanges, however, which can go a long way toward legitimizing the currency. It would still be possible to run such enterprises of course, but they would never be part of the co-op.

Local exchange dominance

This kind of approach can only work if there are dramatically more local exchanges than online exchanges. It would mean that the local exchanges would dictate the pricing of the currency. Marketing early can be disastrous Marketing is a powerful force, and as such it needs to be handled with care. On the one hand, founders naturally want to attract investment early on.

This will raise the price of the coin and help pay for infrastructure, as well as boost the growth of the coin. On the other hand, historically the earliest investors in cryptocurrency have been extremely low quality — they are the speculators who doom the currency in the long run and scare away mainstream users.

With speculation, capital infusion is needed to keep the currency stable, which can be a significant task. Take Bitcoin for instance: With a market cap of roughly $20 billion, it would need a huge amount of capital to have a stable floor.



Slow and steady wins the race

Cryptocurrencies are still in their infancy, and it’s hard to tell where the path for most of the major currencies is headed. What is the “finish line” that they are aiming for? What will the end game be? Most cryptocurrencies have little direction besides the whims of the market, so there’s no telling where they will end up.

However, there are a handful of interesting coins that have invested in strategies that nudge them in a specific direction.

The central app coin method

This is a strategy that is centered around creating value with unique products and services that are associated with the currency. In this way, you could say that the currency is backed by something that people actually want.

For example, the MaidSafe network incentivizes users to provide something of value to the network (storage space), and offers the use of apps and services in return for coins. This naturally leads to better cooperation. People want to create value and channel their efforts toward the growth of the currency that they have in common.

The setup and switch methodSimilar to the central app strategy, this method establishes a user base first, and then introduces the currency. Bitshares and its array of associated startups is a good example of this.

Several networks with varying currencies — Steemit and their STEEM currency, Peerplays and their tokens, for instance — slowly built their user base and value exchange system, and now they plan to adopt a central currency with Bitshares.

This allows them to create a stable base first before pooling their resources. The grassroots movementFinally, the best way for a currency to create that all-important foundation of true users is through bootstrapping. Just like a business startup, a currency like this would need a user base that believed in a common mission.

It would need everyone in the system to be able to see the inherent value of the coin, and to understand that it could be worth much more than the value it is traded for in its early stages.

An example of one of these grassroots efforts is FairCoin. It’s a currency established and led by FairCoop, whose strategy is to build an ecosystem where businesses cooperate to give users maximum value.

It is a currency built from the ground up to incentivize the long-term interests of users instead of their short-term greed — not just because it’s the right thing to do, but because it makes sense.

FairCoin focused from the beginning on building infrastructure for everyday users. Because of the strong relationships among members of the co-op, they can have thousands of ATMs, debit cards and exchanges that make mass adoption much easier.

An approach like this allows the currency to slowly build itself in the background without the need for a spotlight and the barrage of speculators that come with it. This offers the huge advantage of stability from the very beginning, though it does pose the problem that FairCoin has to bootstrap with less capital than most coins.

Unlike other cryptocurrencies, they can’t rely on CoinMarketCap to sing their praises by displaying artificially rising prices (the effects of speculation).In other words, FairCoin traded the excitement of volatility and greed for a quiet, long-term stability.

The only problem is that people might not notice! Drama catches the human eye, after all.




Hard forks

Let’s take a look at the hard fork that looms in the horizon for Bitcoin. As if things weren’t complicated enough, now there could be two competing chains for the currency.

There are already many technical barriers to Bitcoin’s adoption among mainstream users, and this is yet another one. This makes the price even more uncertain, and uncertainty is like poison for a currency.

On the other hand, if you have a large community and a co-op on top of an immutable blockchain, then a hard fork is extremely unlikely — and unnecessary.

Cryptocurrencies like MaidSafe, Bitshares and FairCoin all represent solid communities that are incentivized to cooperate instead of speculate.

This means that the coin can be worth more than its market price; it has a high inherent value within the system itself.

This makes it so that users have very little reason to defect from the existing community. A hard fork would mean giving up many benefits of the co-op, so people stay loyal to the original vision of the currency. When something deeper than just greed ties a community, hard forks don’t occur as often.

Conclusion

Stable prices don’t just happen by accident. They are not a miracle of the market — they require a carefully constructed foundation. A stable currency needs a stable ecosystem first.

While it’s tempting to market the currency too soon because capital injection can do a lot to raise prices in those critical early periods, it’s better to wait. Advertising is like opening up Pandora’s box and inviting the world to look inside.

Some of those users will be interested in the actual currency, but others will be undesirable speculators that just leech off the system. For a currency to be stable, it needs to be used by “the 99%,” not just a handful of investors.

A currency needs to grow with the people, not past them. Look at the state of Bitcoin and its inflated prices.

The everyday person can no longer either mine the coin or expect to use the coin in everyday transactions without high fees or risk. It has been given up to the speculators.

With a truly stable currency, on the other hand, you can have currency conversion, remittance, ATM withdrawals and other financial services with lower fees than fiat systems. In other words, it can be used as intended — as money.

This is what will ultimately attract a mainstream audience and will actually incentivize them to make the switch to cryptocurrency.