TL;DR
Tokenomics covers the financial aspects of tokens. It details the generation and distribution of the token, as well as supply and demand, incentive mechanisms, and token burn dates, all of which affect the token’s utility and value. The success of cryptocurrency ventures depends on thoughtfully crafted token economics. It is crucial for potential participants and investors to evaluate the tokenomics of a project before becoming involved.
Introduction
Tokenomics, a combination of “token” and “economics,” refers to the study of cryptocurrency from a theoretical and practical perspective. In addition to the white paper, the founding team, the roadmap, and the expansion of the community, tokenomics is crucial to assessing the long-term viability of a blockchain enterprise. To guarantee long-term success, crypto ventures should properly craft their tokenomics.
Tokenomics at a Glance
To encourage or discourage specific user behaviours, blockchain projects create tokenomics rules for their tokens. This is comparable to how a central bank issues new currency and alters interest rates and other monetary policies to promote or inhibit certain monetary activities. Keep in mind that the word “token” can mean either coins or tokens. Here, you can study the distinction between the two. Tokenomics, in contrast to fiat currencies, has code-based laws that are open, predictable, and impossible to alter.
Consider Bitcoin as a case in point. There will only ever be 21 million bitcoins in circulation. Bitcoins are “mined” into circulation, or created, by users. When a block is mined, roughly every 10 minutes, miners receive a small amount of bitcoins as a reward.
For every 210,000 blocks, the reward (also known as the block subsidy) is cut in half. At this rate, every four years would be half gone. There have been halved three times reductions in the block subsidy from its initial value of 50 BTC on the Bitcoin network on January 3, 2009, when the first block genesis block was created. to its current value of 6.25 BTC.
If you divide the total number of minutes in a year by 10 (because a block is mined every 10 minutes) and then multiply by 6.25 (since each block gives out 6.25 BTC as rewards), you get an estimate of 328,500 bitcoins that will be mined in 2022 under the current protocol. As a result, it is possible to estimate the total number of Bitcoins that will have been mined up until the year 2140.
The creation of transaction fees that Bitcoin miners earn when a new block is validated is also part of Bitcoin’s tokenomics. As the size of transactions and the amount of traffic on the network increase, so will this cost. It discourages spam purchases and encourages miners to continue verifying purchases even when block subsidies decrease.
Bitcoin’s tokenomics are, in a word, brilliant. There is complete openness and predictability. Bitcoin’s incentives ensure that its participants receive payment for their efforts to maintain the network’s integrity, which in turn increases the cryptocurrency’s value.
Tokenomics’ Key Elements
The term “tokenomics” is sometimes used to refer to a variety of elements that affect the value of a cryptocurrency, but it most commonly refers to the fundamental nature of the cryptocurrency’s economy. When analyzing the tokenomics of a cryptocurrency, these are some of the most crucial aspects to bear in mind.
Tokens supply
Supply and demand play a major role in determining any commodity’s price. The same is true with cryptography. The availability of a token can be evaluated in a number of important ways.
The first is a state known as “maximum supply.” This means that the creators of the cryptocurrency have programmed a cap on the total number of tokens that might ever be created. There will by no means be more than 21 million Bitcoins in circulation. There will in no way be more than eighty-four million Litecoins and two hundred million Binance Coins in circulation.
For some tokens, there is no hard cap on production. Ether generation on the Ethereum network is annual. Since stablecoins like USDT, USD Coin (USDC), and Binance USD (BUSD) are issued in proportion to the value of the reserves backing them, there is no hard cap on the total number of coins that can ever be created. They can possibly expand indefinitely. Additionally, Dogecoin and Polkadot are unlimited-supply cryptocurrencies.
The circulation of tokens currently in use is the second factor, like circulating supply. Tokens can be locked away in a vault or destroyed after they have been minted. This impacts the value of the token as well.
By studying the token supply, one can get a decent idea of the total number of tokens in circulation.
Value of Tokens
The terms “token utility” and “token use case” are synonymous. BNB is a community utility token on the BNB Chain ecosystem, and it may be used to power the BNB Chain, pay transaction fees and trading fee reductions, and more. Staking BNB with various product items is another way for users to profit.
There are numerous other applications for tokens. Holders of governance tokens have a voice in any decisions regarding the token’s underlying system. Digital assets with a stable value are known as stablecoins. But security tokens stand in for actual money. During an ICO, for instance, a company could distribute tokenized shares to investors, entitling them to the benefits of stock ownership.
These considerations can aid in identifying possible applications for a token, which is crucial for forecasting the token’s economic trajectory.
Examining Token Distribution
It is crucial to consider the distribution of tokens in addition to supply and demand. The actions of large institutions are distinct from those of ordinary people. The types of entities that possess a token can determine its supply and demand, both of which affect its value.
When releasing and distributing tokens, there are two main approaches: a fair launch and a pre-mining launch. When a token is created and distributed to the public without any form of early access or private allocations, this is considered a fair launch. Bitcoin (BTC) and Dogecoin (Doge) are two popular examples.
Pre-mining, on the other hand, permits some of the cryptocurrency to be mined and handed to an exclusive group before it is made available to the general public. Token distributions like Ethereum and BNB are two instances.
In most cases, you should check how uniformly dispersed a token is. It is more concerning when only a small number of really large institutions own a considerable amount of a token. If patient investors and founding teams hold the majority of a token, stakeholders’ interests are more likely to align in the long run.
You should also consider the token’s lock-up and release timetable to see if an excessive supply of tokens will be released into circulation and drive down its price.
Examining Token Burns
Token “burning” refers to the practice by which several cryptocurrency projects frequently remove tokens from circulation.
Limiting the available quantity of its token, for instance, uses a practice known as BNB adopt coin-burning.” To date (June 2022), there are 165,116,760 BNB in circulation out of a total pre-mined amount of 200,000,000. More BNB coins will be burned until half of the total quantity has been destroyed, bringing the total supply down to 100 million BNB. In a similar vein, in 2021, Ethereum began burning ETH to limit its total supply.
Inflation occurs when there is a significant drop in the available supply of a token. When the opposite occurs and the supply of a token keeps growing, this is known as inflation.
Incentive Mechanisms
The mechanism that incentivizes token use is essential. Tokenomics focuses on how a token incentivizes members to ensure the token’s long-term viability. Bitcoin’s block subsidy and transaction fees are a beautiful example of a well-thought-out model.
Similarly, the Proof of Stake technique is becoming more widely used as a means of validation. Participants can secure their tokens for use in verifying transactions with this setup. More tokens locked up means a greater possibility of being selected as validators and receiving incentives for doing so. This also means that validators’ assets will be in danger if they attempt to harm the network. These additions encourage truthfulness on the part of participants and maintain the stability of the protocol.
Many DeFi initiatives have adopted creative incentive structures to rapidly expand their efforts. The Compound is a cryptocurrency lending and borrowing platform where users may store their cryptocurrency, earn interest, and receive COMP tokens. Additionally, COMP tokens are used as a protocol governance token on the Compound network. These structural decisions ensure that everyone’s financial incentives are aligned with Compound’s long-term success.
The Future of Token Economics
Tokenomics has changed dramatically since the Bitcoin network’s genesis block was created in 2009. The development community has participated in a wide variety of tokenomics models. Both successes and calamities have occurred. The tokenomics model behind Bitcoin has proven to be stable over time. Poorly conceived token economies have failed elsewhere.
Using digital scarcity, non-fungible tokens (NFTs) offer an alternative tokenomics framework. Tokenizing more conventional assets like real estate and artwork may inspire future developments in tokenomics.
Final Thoughts
If you’re serious about entering the cryptocurrency market, familiarity with tokenomics is a must. Token fundamental is a concept that sums together the most important aspects that determine a token’s worth. Keep in mind that there is no one determining element. You should consider as many relevant aspects as possible when making your evaluation. By combining Tokenomics with other forms of fundamental analysis, investors may better assess the value of a project’s token and its potential in the market.
Ultimately, the economics of a token will have a significant impact on its use, the ease with which a network can be built, and the level of interest in the token’s use case.