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Tokenomics is the study of how tokens work in an economy. Tokenomics describes the factors that affect the use and value of a token, including but not limited to the creation and distribution of tokens, supply and demand, incentives, and token burn schedules. For cryptocurrency projects, a well-developed tokenomics model is the key to success. Before deciding to participate in a project, it is important for investors and stakeholders to carefully evaluate the tokenomics of the project.
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The term tokenomics is a combination of the words “token” and “economics”. Understanding tokenomics is an important part of conducting basic research on cryptocurrency projects. Not only do you have to focus on the whitepaper, founding team, roadmap, and community development, but you also need to understand tokenomics, as this is central to evaluating the future prospects of blockchain projects. The economic model of the token should be carefully designed when developing a cryptocurrency project to ensure long-term sustainability.
A Preliminary Look at the Economics of Cryptocurrency
Blockchain projects design their operating mechanisms around tokens to encourage or discourage various user behaviors. The principle is similar to that of a central bank that prints money and implements monetary policy to encourage or discourage consumption, loans, savings, and money flows. Note that the word “token” here covers both cryptocurrencies and tokens. clickHereto understand the difference between the two. Unlike fiat currencies, the rules of tokenomics are implemented through code. These rules are transparent, predictable, and difficult to change.
Let’s take Bitcoin as an example. Bitcoin has a pre-set total supply of 21 million coins. The coin is mined and enters the circulating market. Miners can mine a block every 10 minutes or so and be rewarded with some bitcoins.
Rewards, also known as block subsidies. For every 210,000 blocks mined, the reward is halved. According to this schedule, the award will be halved every four years. Since January 3, 2009, the first block on the Bitcoin network (i.eGenesis blockSince its inception, the block subsidy has beenHalved three times, from 50 BTC to 25 BTC, and then to 12.5 BTC, currently 6.25 BTC.
Based on these rules, it is easy to conclude that about 328,500 bitcoins will be mined in 2022. It is calculated by dividing the total number of minutes in a year by 10 (a block is mined every 10 minutes) and then multiplying by 6.25 (6.25 BTC is awarded for each block). From this, we can extrapolate the number of bitcoins mined each year, and the last bitcoin is expected to be mined around 2140.
Bitcoin’s tokenomics model also includes:Transaction fees。 Once a new block is validated, the miner receives a transaction fee. As transactions scale, the network becomes more congested, and transaction fees rise. This design helps eliminate spam transactions and incentivizes miners to continue validating transactions as the block subsidy continues to decrease.
In short, Bitcoin’s workings are designed to be simple and clever. Everything is transparent and predictable. The incentives designed around Bitcoin give participants an incentive to continuously inject value into the cryptocurrency and keep the network running smoothly.
Key elements of tokenomics
The term tokenomics encompasses a variety of factors that affect the value of a cryptocurrency. The term refers first and foremost to the economic structure of cryptocurrencies designed by the founders. Here are some of the key elements to look at when researching the tokenomics of cryptocurrencies.
Token supply
For any good or service, supply and demand are the main factors that affect the price. The same goes for cryptocurrencies. Here are a few key metrics to measure the supply of tokens.
The first one is:Maximum supply, which is the maximum number of tokens specified by the default code. Bitcoin has a maximum supply of 21 million. Litecoin’s hard cap is 84 million, and Binance Coin’s maximum supply is 200 million.
Some tokens don’t have a supply cap. The Ethereum network’s ETH supply is increasing every year. Stablecoins such as USDT, USDC, and BUSD do not have a maximum supply because these coins are issued based on backing reserves. Theoretically, the supply of these coins could be constantly increasing. Dogecoin and Polkadot are two other cryptocurrencies that do not have a supply cap.
The second indicator is:Circulating Supply, i.e. the number of tokens in circulation. Tokens can be minted and burned, or otherwise locked. This will also have an impact on the price of the token.
Looking at the token supply gives you an idea of how many tokens will be generated in the end.
Token utility
Token utility refers to the stated use of a token. For example, Binance Coin’s utility includes powering the BNB Chain, paying transaction fees and discounting transaction fees on the BNB Chain, and serving as a community utility token on the BNB Chain ecosystem. Users can also access the Various productsStake Binance Coin and earn extra income.
There are many other use cases for tokens. Holders of governance tokens have the right to vote on changes to the token protocol. Stablecoins can be used as money, while security tokens represent financial assets. For example, a company can issue tokenized shares during an initial coin offering (ICO), granting ownership and dividends to holders.
These can all help you identify potential use cases for a token and are critical to understanding where the token is headed in the future.
Analyze token allocation
In addition to supply and demand, it is also necessary to understand how tokens are distributed. Large institutional and individual investors behave differently. Once you understand the types of entities that hold your tokens, you can further infer how holders are likely to trade, and how they trade will determine the value of your tokens.
In general, there are two ways to launch and distribute tokens: a fair launch and a pre-mined launch. A fair launch is when no one buys or distributes a small amount of tokens before they are minted and distributed to the public. Both Bitcoin and Dogecoin have taken this approach to launches.
In the second way, pre-mining refers to minting a portion of the cryptocurrency and distributing it to a specific group before making it available to the public. Ethereum and Binance Coin have been pre-mined.
In general, you need to pay attention to whether the distribution of tokens is equal. Typically, holding the vast majority of the tokens by a few large institutions means that the risk is higher. If patient investors and the founding team hold the majority of tokens, the interests of the holders will be more aligned and they will be more likely to achieve long-term success.
You’ll also want to take a look at the token’s lock-up and release schedule to see if there will be a large number of tokens in circulation, putting downward pressure on the token’s value.
Find out about the token burn
Many crypto projects burn tokens on a regular basis, which means that some tokens are permanently removed from circulation.
For exampleBinance Coin uses the method of destroying tokensRemoving a portion of the tokens from circulation, reducing the total supply. The pre-mined amount of Binance Coin is 200 million. As of June 2022, the total supply of Binance Coin is 165,116,760. A large amount of Binance Coin will be burned in the future until the remaining amount is 50% of the original total supply. This means that the total supply of BNB will be reduced to 100 million. Similarly, Ethereum also began burning Ether in 2021 to reduce its total supply.
Reducing the token supply is known as deflation. On the contrary, the continuous expansion of the token surplus is inflation.
Incentives
The incentive mechanism of the token is crucial. How to motivate participants to ensure long-term sustainability is a core question of tokenomics. The block subsidy and transaction fee design in Bitcoin is a good example of a clean model.
Proof-of-stake mechanismis another verification method that is becoming more and more common. Under this design, participants need to lock tokens to validate transactions. Generally speaking, the more tokens you lock, the better your chances of being selected as a validator and receiving rewards for validating transactions. This also means that if validators try to compromise the network, their own assets are at risk. These settings motivate participants to act honestly and are able to maintain the robustness of the protocol.
Many DeFi projects have leveraged innovative incentives to achieve rapid growth. on cryptocurrency lending platformsCompound, investors can deposit cryptocurrency, receive interest, and receive COMP tokens as an additional reward in the Compound protocol. In addition, the COMP token is also the governance token of the Compound protocol. These designs reconcile the interests of Compound with all participants and benefit the long-term development of the project.
Where is tokenomics headed?
Since the creation of the Bitcoin network’s genesis block in 2009, tokenomics has evolved considerably. The developers have explored multiple token economic models. There are successes and failures. Bitcoin’s tokenomics model has stood the test of time and is still working. Some other tokens with poorly designed models are in trouble.
Non-fungible tokens (NFTs) use a different token model based on digital scarcity. The tokenization of traditional assets such as real estate and art may give rise to new tokenomics innovations in the future.
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Tokenomics is a fundamental concept you must understand if you want to enter the cryptocurrency space. Tokenomics covers the main factors that affect the value of a token. It is important to note that the assessment cannot be generalized. As many factors as possible should be taken into account to make a holistic analysis. Tokenomics can be compared with other onesFundamental analysistools combine to help to judge the future prospects of the project and the price of its tokens more comprehensively.