This guide provides a breakdown of tokenomics in crypto to help you understand what tokenomics is, how it works, and why it is important in the world of crypto currencies. It also outlines the basics of effective tokenomics for cryptocurrencies.
Public blockchains can be accessed by everyone, including criminals. Tokenomics helps create trust by aligning the behavior of each actor and strengthening blockchain protocols.
When a blockchain experiences an increase in positive behavior from its community, it will likely increase the value of the crypto asset, motivating participants to become good actors.
Crypto tokens explained
Before we dive into tokenomics, you need to understand what tokens mean in the crypto space .
Cryptocurrencies and tokens operating on blockchains are built on pre-determined, algorithmically generated issuance schedules. This means that people can accurately predict the number of coins that will be available on a certain date.
Although some crypto assets may change their issuance schedule, this process is usually difficult to implement and requires the approval of the majority of participants in a particular blockchain. This implies that the tokenomics of a crypto asset will remain unchanged and predictable, unlike fiat money created by governments. Tokens are divided into the following types based on their significance:
Layer 1 tokens : These tokens are native to a particular blockchain and are used to power all activity on the blockchain;
Layer 2 tokens : Layer 2 tokens are used in decentralized applications in certain blockchain networks;
Security token : This is an investment contract token, which must meet several requirements, such as money investment, profitability and mutual enterprise. The security token must also pass the Howey Test;
Utility Tokens : Utility tokens are useful for financing the network and are issued through an Initial Coin Offering (ICO);
Fungible tokens : Fungible tokens have the same value as their replication facility. An example of a fungible token is the ETH token on the Ethereum blockchain;
Non-Fungible Tokens (NFT) : These tokens do not have the same value, making them unique. They are used in the tokenization of digital assets, including images, collectibles or works of art.
What is tokenomics?
Tokenomics is a combination of the words “token” and “economics.” The idea of tokenomics came into the limelight in 1972 when Harvard psychologist BF Skinner first proposed the idea. Skinner believes that token economic models can help align behavior within a given system.
In crypto, tokenomics is a collective term used to describe the economics of tokens by explaining the factors that influence a token's use and value. These factors include token creation and distribution, supply and demand, incentive mechanisms, and burning schedules.
In crypto circles, well-designed tokenomics is essential to the success of a cryptocurrency. Investors and stakeholders need to assess a project's tokenomics to help them make informed decisions before participating. Likewise, founding members and developers need to carefully consider the tokenomics of the native currency before launching a crypto project, as this can contribute to the success of the project and its ability to attract investment.
Ultimately, projects with good tokenomics will likely survive longer and perform better than projects that don't have smart, well-designed incentives in their tokens. A strong platform will likely generate higher demand over time as new investors show interest in the project, ultimately increasing the value of the token.
How does tokenomics work?
To better explain what tokenomics is in crypto, let's take an illustration of the total supply of Bitcoin . The total supply of Bitcoin is set at 21 million Bitcoins, all of which will be available around the year 2140. Before that number is reached, the number of new coins created through the Bitcoin mining process will decrease in half, approximately every four years.
This process, known as halving, is designed to create scarcity—an economic principle that puts pressure on prices to rise. As a cryptocurrency pioneer, Bitcoin's issuance process and schedule have become the foundation for other cryptocurrencies.
For example, Bitcoin Cash ( BCH ), Bitcoin SV ( BSV ), and ZCash (ZEC) also have a total supply of 21 million coins. Other cryptocurrencies, such as Litecoin ( LTC ), use the same framework but also have a larger total overall supply.
On the other hand, some cryptocurrencies operate on different schedules. For example, Dogecoin and SHIB have an unlimited supply of tokens. While Bitcoin has a deflationary supply, Dogecoin has an inflationary supply. However, Dogecoin advocates like Elon Musk believe that tokenomics is what makes Dogecoin a usable currency. Musk once argued that DOGE appeared to be inflationary, but it wasn't.
Between these two positions are many coins and many tokens, some of which operate on the Ethereum blockchain, such as Tron ( TRX ), whose total supply is capped at more than 100 billion. Ethereum also has an annual maximum issuance, with no maximum supply limit.
Some crypto projects also create rules, which allow them to “burn” a certain number of coins or tokens at certain intervals. This concept means the coins are transferred to a wallet where no one can recover them. Burning techniques are used to reduce the supply of an asset, which can then increase the demand and price of that asset.
Fitur inti Tokenomics
The structure of the economy around a crypto coin or token will likely determine the incentives that motivate investors to buy and hold it. And each cryptocurrency has its own monetary policy, just like all the different fiat currencies.
In cryptoeconomics, tokenomics can help define two key things: the incentives that determine how tokens will be distributed and the utility of the token, which influences its demand. In a conventional economy, supply and demand have a large impact on prices and the same principle also applies to the cryptoeconomy where projects with the right incentives will likely have higher demand.
The following are the main variables that influence tokenomics:
Mining and staking
Base layer blockchains such as #bitcoin , Ethereum 1.0, Bitcoin Cash, or BNB Chain use mining as a core incentive for teams of participants who use a decentralized computer network to verify transactions and add new blocks.
After successful validation of a new block, participants are rewarded with newly mined coins for devoting their computing power and discovering the new block. Similarly, for blockchains that use a Proof-of-Stake ( PoS ) consensus mechanism or layer 1 blockchains, participants are rewarded with new coins for locking some of their coins in a smart contract.
Results/incentives
This #tokenomics feature is closely related to the Decentralized #Keuangan ( DeFi ) platform, which offers high yields to attract and motivate investors to buy and stake tokens.
Tokens are often staked in large pools of cryptocurrencies known as liquidity pools, which support a variety of platforms, including crypto exchanges and lending platforms . Participants can get rewards in the form of new tokens.
Token burnt
As mentioned previously, some #blockchain or protocols may choose to “burn” tokens to reduce the number of coins in circulation. This can help support prices by creating scarcity of remaining tokens. For example, in August 2021, Ethereum launched a token burning practice that saw a portion of its tokens burned as transaction fees.
Limited and unlimited supplies
Tokenomics captures the maximum supply of tokens. For example, Bitcoin's founders capped the total supply at 21 million coins, and the last coins will be in circulation around 2140.
On the other hand, Ethereum does not have a maximum supply, but its annual issuance is capped. NFTs also have their own tokenomics that regulate scarcity. For example, some collections may only produce one NFT for a work of art.
Token distribution
Cryptocurrency tokenomics also revolve around token allocation and vesting periods, as illustrated in the Chainlink tokenomics image ( LINK ) below. This feature involves granular distribution of tokens, with a certain portion of tokens reserved for developers or venture capitalists. However, the tokenomics of such projects states that reserved tokens can only be sold after a certain period of time.
These rules ultimately affect the supply of cryptocurrency in circulation during a certain period, thereby affecting its price as well.
From the features mentioned, it is clear that the tokenomics of a crypto asset primarily revolves around managing the supply and distribution of tokens. This starts with whether the token is inflationary or deflationary. Inflationary tokens are tokens whose supply increases over time, while deflationary tokens are tokens whose supply decreases over time.
For token inflation, founders need to find a practical way to add new tokens to circulation through their transaction validation process. For example, more participants are likely to chip in by providing incentives to validators, which can ultimately increase the token supply.
For deflationary crypto assets, the problem is how they reduce the number of tokens in circulation. Most crypto projects achieve this by “burning” tokens, which can involve burning a certain percentage of the transaction fees paid by users or taking a tax from each transaction and burning a portion of it.
Who decides cryptocurrency tokenomics?
Decisions regarding tokenomics, its features, and how it works are the sole discretion of the crypto token developer. As mentioned earlier in this guide, tokenomics revolves around the following aspects of tokens:
Maximum supply;
Mining or burning processes;
Transaction fees;
Incentives for token holders.
These decisions are made at the protocol level where the founders seal most of the tokenomics in a particular crypto asset's computer code. Before releasing the cryptocurrency, the developers and founders provided an outline of the tokenomics according to the whitepaper.
A whitepaper is a comprehensive and detailed document that provides a proposed journey and timeline for a crypto asset, as well as any underlying technology.
The importance of tokenomics in cryptocurrency investment
In the crypto world, understanding the impact of supply and demand is important for investors and speculators. These two market forces can influence market prices. Crypto tokenomics sets a clear roadmap for how digital currencies will be used.
It also clarifies whether there is a definite link between the use of the platform or service being built and the proposed digital asset. These factors collectively determine whether an asset will continue to increase in value. The following questions are important when deciding on the tokenomics of a cryptocurrency:
How many coins or tokens are currently in circulation?
How many coins or tokens will be available in the future, and when will they be created?
Who owns the coins?
Are there any coins set aside for future release to developers?
How do I account for lost, burned, erased or unusable coins?
Final thoughts
Tokenomics plays an important role in cryptocurrency dynamics, covering almost everything related to tokens. Both experienced and prospective investors need to spend time studying the tokenomics of a project before participating to understand the financial and governance rights they can gain by purchasing the token.
A proper understanding of tokenomics gives investors the knowledge and skills they need to evaluate crypto projects. In addition to project documents or whitepapers, analyzing the tokenomics of a token is one way to gain insight into its supply and demand.
It can also help founders know how their team is driving token demand to help analyze future prospects and how it will perform against the US dollar, Bitcoin, or other altcoins.
Disclaimer: The content on this site should not be considered investment advice. Investing is speculative. When investing, your capital is at risk.
