What do you need to know about the cryptoeconomy? There are plenty of skeptics, but just as many believe that decentralized finance, the blockchain, and cryptocurrency are the future of money.
If that is true, what are the important aspects of the cryptoeconomy to pay attention to and learn from going forward? Knowing the issues related to decentralized finance, centralized crypto finance, and tokenized assets may be key to being a long-term investor or innovator in crypto.
Crypto Market Valuation
Just how big is this economy? According to one source, the crypto market is worth over $2 trillion with more than 10,000 crypto projects at press time.
This is an industry that started with a single whitepaper by Satoshi Nakamoto and has evolved into an ecosystem featuring partnerships between crypto innovators and major corporations such as J.P. Morgan, Twitter, and Walmart.
Important Aspects Of The Cryptoeconomy
What IS the cryptoeconomy? For the consumer, credit card companies, game platforms, and luxury fashion houses offer crypto commerce options, and the ability to earn rewards from real-world purchases (using fiat currency) with those rewards paid in crypto. For the investor or innovator, this economy is an alternative to more traditional investments, startup funding, and eCommerce.
Internet Policy Review Volume 10, Issue 2 defines the crypto economy as an interdisciplinary but “experimental” field that includes a variety of more established fields such as security engineering, marketplace design, and information security.
From the outside looking in, cryptoeconomics seems to be about investment, innovation, third-party marketplaces, and the development of virtual worlds. This economy is obviously more complex, and depends on some crucial aspects including:
- Decentralized finance
- Centralized Crypto Finance
- Tokenized assets
- Crypto mining and staking
What does all this mean?
Decentralized Finance, Or DeFi
When it comes to decentralized finance, general areas of interest include innovations to facilitate the sale of cryptocurrency and NFTs, but there is also a decentralized lending aspect to this economy that has grown over time. Some $250 billion is thought to be invested in all aspects of DeFi including exchanges, insurance, crowdfunding, and more.
Decentralized lending is commonly done on the blockchain and you may find your loan options are restricted to cryptocurrency only. That means that, where applicable, you will borrow crypto and pay in crypto.
A DeFi loan may be executed without the anti-money laundering and Know Your Customer safeguards that more traditional lending requires. However, you may need to provide collateral for such loans. And that collateral may be required to be valued in excess of the loan you seek, depending on the lender
Know Your Customer?
DeFi is widely touted in the cryptoeconomy because you don’t need to disclose your identity. But remember that trust is a two way street; in situations where you aren’t screened for money laundering or other illegal-in-real-life practices, should you simply trust the service provider, or treat them with a bit more suspicion due to the lack of KYC safeguards in place?
For some the answer is a definite YES, and for others the answer is a tentative NO. But the “NO” people who are more inclined to trust a DeFi platform not to be a scam or to simply take your money?
Chances are good at least some of this elevated trust has to do either with personal knowledge of the company involved or the fact that the borrower has not yet been burned by a scam operating in the space. Those who have been might be (or should be) far more wary of situations that appear to be a scam hazard.
Centralized Finance (CeFi)
What’s the inverse of DeFi? Centralized finance or CeFi may not be the literal opposite, but CeFi behaves in a more traditional (centralized) way at times. What is it? CeFi can include credit cards backed by cryptocurrency, crypto debit cards, and operations that blur the lines between traditional finance and the crypto economy.
CeFi is typically defined as a financial service that allows you to borrow against or earn interest from crypto. You borrow through an exchange such as Binance, Coinbase, or others. The exchange is, depending on which one you choose, the facilitator of the transaction and not necessarily the lender.
You could think of CeFi platforms as “custodians” of your crypto assets while a lender may be a third party also using the platform.
Tokenized Assets
Tokenization is what happens when you take the assets and/or rights of a real-world investment and convert them to a digital token that can be used like a coin or NFT in terms of using or transferring to someone else.
Investment tokens allow IRL traditional investments to be used or transferred without the need for an investment house or broker, and tokenizing an investment potentially allows it to be fractionalized.
Can you afford a single share of Apple stock? At press time it sold for $150 per share. That may be a drop in the bucket to some, and prohibitively expensive to others. But what if you could buy a digital token that was a fraction of the stock at a fraction of the cost?
Investment tokens theoretically could offer the same rights for investors but without the “analog” equivalent of the actual purchase of the stock in real life. The elephant in the room, so to speak, for the cryptoeconomy is that tokenized stocks are an unregulated version of traditional investing and as such there are big question marks surrounding the future of such investment.
Why? Because it is entirely unclear whether federal regulators might ban such practices outright, regulate them to death, or simply continue to watch to see where it all goes from here. The best advice for tokenized investing? Proceed with caution, do your homework, and make the most informed investment choices you can.
Crypto Mining, Crypto Staking
This is where some believe the heart and soul of the crypto economy began. The process of mining cryptocurrency is controversial because of the high energy use to do so, and it has a limited profitability time where there are scarcity controls; a good example of such controls is Bitcoin, which is capped at 21 million.
Once that number of coins is reached, the rules as we know them today say mining Bitcoin is no longer permitted.
That means you cannot mine Bitcoin forever and realize the same profits. They will get smaller year over year. This is done to add value to the supply–minting unlimited money ultimately results in a devaluation of a currency both in the real world and in crypto.
Artificial scarcity is part of what made the crypto economy what it is today. Without scarcity, digital assets are potentially meaningless. It’s the kind of math you can do with IRL activities like collecting stamps, coins, and vinyl records.
Only so many of them are made, but they are made in mass quantities. The coins, records, or stamps subject to everyday wear and tear aren’t valued by collectors. Only more rare, more pristine versions retain value. Misprints and unusual printings also add value as “variants” of the original which are thought to be more rare. Sound familiar?
Crypto doesn’t have the physical wear and tear variable, so variants, scarcity, and strategic creation of assets are far more important.
Some cryptocurrency mining requires staking, where you make some of your crypto assets unavailable as the collateral for solving the math problems that let you mine crypto. Fail to solve the equation properly and you lose your stake.
Some cryptocurrency transactions may require you to burn crypto, rendering it unusable. This is one way to increase scarcity and regulate the supply of coins or NFTs on the market.
But the drawback here is that these are all practices that are adopted on an individual basis depending on the crypto or NFT. There are no industry-wide best practices or standards to rely on, so you’re basically dealing with a sort of Wild West mentality. In some places, anything goes. In others, there are strict rules of conduct. Who you trust could boil down to how much you personally know about an operation and who runs it.
Joe Wallace has covered real estate and financial topics, including crypto and NFTs since 1995. His work has appeared on Veteran.com, The Pentagon Channel, ABC and many print and online publications. Joe is a 13-year veteran of the United States Air Force and a former reporter for Air Force Television News.
