The Economics of Blockchain Protocols

The Economics of Blockchain Protocols

The Economics of Blockchain Protocols

It is expected that more than one hundred cryptocurrencies will be in the market by the third quarter of this year. Under this scenario and after the speculative phase of cryptocurrency trade that we are currently witnessing, experts figures that a sobering will follow and a great portion of current protocols and currencies shall be useless and without value.

So and in order to measure the value of blockchain protocols and the cryptocurrencies that are based on them there are three main aspects to look at: a cryptocurrency having means of payment and a store of value function, if a cryptocurrency has a utility value, and if a cryptocurrency is backed by yield or assets, according to blockchain economist, Primoz Kordez.

  • Cryptocurrencies as a means of payment

In this aspect, Bitcoin is the most recognisable of all means of payment cryptocurrencies. Its usefulness and value are measured according to three properties that every currency should have: means of payment, store of value and unit of value. Despite the fact that Bitcoin has all three properties in theory, in practice there is a problem with the means of payment property, as Bitcoin is rarely actually used in exchange of goods and services, mostly because of its volatility, long transaction confirmation times and because the technology is still foreign to average users.

If it were to examine Bitcoin for its currency value it can be observed that there is a large discrepancy between the fundamentals and the market price, the reason probably being that the prices are rising as a result of user speculations due to the current growth momentum of prices instead of using it as a proper currency, that means, buying-sell good transactions.

Precisely this is the key to answering whether digital currencies such as Bitcoin have value or not. Experts on this matter criticize that there are more discussion about their prices instead of talk about the technology as such, and finding solutions for quicker adoption.

However, some investors are starting to see some cryptocurrencies, especially Bitcoin, as a store of value. So many people are using Bitcoin as an alternative to gold . The two have some similar properties: limited production and not under control of countries. The difference being that Bitcoin is much easier to transfer and much more accessible than gold.

What gives additional value to Bitcoin’s store of value function is its low or almost non-existent correlation with real economy, which attracts asset managers who are seeking safe haven assets during time of financial crises.

Bitcoin evolution since 2012 Image source Kaiko

  • Cryptocurrencies with a utility value

Apart of the utility value these cryptocurrencies have, there is another important aspect in their protocols: the possibility of issuing tokens or units of value. The issued tokens are a type of fuel that runs the protocol or the platform and the first investors at the same time become the first users of the platform on the side of demand for a certain service. This allows the popular ICOs funding.

This make possible the utility of Cryptocurrencies in a micro-economy ecosystem. A business model following ICOs funding and out of the blockchain system would have a networking effect as increased dynamics take place in this process. Therefore the micro-economy suddenly gains value as a currency that was initially generated “out of thin air”.

Also, this utility value the cryptocurrencies have give us a “service” value as the blockchain enables individuals to have low friction access to markets that were inaccessible to them before, and the contribution of individuals is transparently recorded in a decentralised register. Accordingly an automatic payment in accordance with rules determined in advance, is carried out, without any intermediaries. One of the main markets they reaching is the cloud data storage.

The Blockchain Protocol behind the cryptocurrencies

Blockchain is a foundation technology for the operation of protocols, based on which people can exchange value units in the form of cryptocurrencies.

So, when evaluating the market value of a certain cryptocurrency, we are actually indirectly also evaluating the protocol, on which the currency is based, as the protocol is only worth something if activity present. The value of such a protocol is equal to the product of cryptocurrency market value, determined by demand and supply and the velocity of currency, determined by the number of users and their activity. If that specific protocol is shared, the more value it will get.

Nonetheless, a built blockchain protocol cannot be owned by anyone, so it doesn’t matter how many Ethereum’s tokens someone has, he cannot control its protocol and production. The blockchain protocol is run by a number of computers around the world and they are rewarded for their contribution of computer operations in a cryptocurrency.

Inside the Blockchain Economy: The Helicopter money and inflation

Through innovation and high risk the blockchain community has developed a great number of cryptocurrencies with high utility value. That is so because the protocol thus recognizes the contribution of an individual in the system and accordingly rewards them by issuing new money.

The concept of this type of money printing is similar to so called “helicopter money” in today’s monetary system, the difference being that the new issuing of money is directed towards users, for which a contribution in the system can be measured.

However, high user activity in the blockchain wouldn’t necessarily bring high inflation in the cryptocurrencies economy as in that case of an increasing activity on the protocol (increased exchange of services and growth of users) the network effect can actually offsets the inflation effects.

Final Thoughts

Instead for many people’s criticism and fears, blockchain is not all about an independent and decentralized monetary system, but a technology and a new economic field that uses incentives to establish networks in which interactions between stakeholders are set with the final goal of fairly rewarded individuals and a higher network value.

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