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how to properly invest in cryptocurrencies

Why Do Blockchains Need Tokens?

Published On: October 27, 2022
The existence of crypto tokens is among one of the most debated topics in the blockchain industry. Many blockchain skeptics often ask ‘why do blockchains need tokens?’ Even small dapps (decentralized applications) almost always have tokens, which technically-speaking, might not be really needed in the first place.

So, why do almost all public blockchains always have their own native cryptocurrencies? And is it true that most crypto tokens are issued only for quick cash grabs?

Incentivization and Decentralization

There is no perfect answer to these questions, unfortunately. However, it’s very important to acknowledge that the existence of cryptocurrencies inside public blockchains is pretty much justified.

Think of it like this. Why would anybody put their computer resources to support a public blockchain if it’s just for the ‘common good’ and nothing else? It’s normal to expect most people want something back in exchange for their support to the blockchain network.

This is where the incentivization matters. By having a native cryptocurrency inside your public blockchain system, it incentivizes the outside participants to provide their resource to help you secure the network. They support your network, they get your crypto when they successfully verify a transaction, and your system grows and becomes more decentralized.

The thing is, it’s less realistic to expect a better level of decentralization when you don’t provide incentives. And that’s the problem with a blockchain system. You always want to have a fair level of decentralization. Check Wikipedia explanation on Bitcoin economics, it might help you to understand things better.

The bigger issue comes down to the crypto economics itself. How much is considered enough and fair incentive? How much do you need to spend to lure validators or miners to support your blockchain? What would be the consensus mechanism? and so on.

While every blockchain has different answers to these questions, at least they all can agree that giving incentives to network validators or miners is extremely important to keep a fair level of decentralization. To understand why decentralization matters, you should read our centralized network vs. decentralized guide.

Dapps and Crypto Tokens

How about decentralized applications (dapps)? They live on other blockchain systems. Why do they need their own native crypto tokens in the first place? Well, many decentralized applications are governed by their community, and this is the reason why crypto tokens for the dapps exist. 

For example, take a look at Uniswap protocol, the most popular decentralized exchange (DEX) on Ethereum blockchain. It has the UNI token which serves as a governance token. It means that you can vote on governance proposals by using your UNI tokens, to direct the development plans of the protocol itself.

Many other dapps have other use cases for their tokens. Sometimes the tokens are used as incentives for liquidity providers while the other times they are used as the only in-app currencies to purchase NFTs.

So, to answer the original question about whether crypto tokens are used as fast cash grabs or not, it is not always the case. You can say half of the time it’s true though, how many dapps don’t really need to launch their own tokens, and the tokens are just used as easy cash grabs for the developers.

Bigger dapps that want to decentralize the governance mechanism of their protocol, however, will always require governance tokens if they want to be successful.

The Right Answer Is Somewhere In The Middle

So, we are back to the original question. Why do blockchains need tokens? The right answer is somewhere in the middle. As mentioned above, blockchains need tokens so they can build incentivization mechanisms to decentralize their networks. Without these incentives, you can’t expect a decent level of decentralization.

On the other hand, it’s also true that developers can make much more money by issuing their own cryptocurrencies. A crypto-less blockchain, unfortunately, is almost always very centralized. You might as well use SQL in that case.

To find the perfect balance between incentives and decentralization is the hardest part. Even the most advanced cryptonomics analysts might struggle since the crypto industry is changing at a very rapid pace.

One thing is certain, though. You can’t expect to have thousands of different nodes supporting your network in the long-term if there are not enough incentives. There are other types of incentives you can give but having your own native cryptocurrency is the most convenient and instant way to automate the system.

If you want to learn more about cryptocurrency basics and why they are needed in our blockchain mechanism, you can start here and become crypto expert in a short period of time!
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