The combination of the words “token” and “economy” creates the concept of tokenomics, combining all the elements that make cryptocurrency generally valuable and interesting for investors. From the supply of the token to how it is issued to things like its usefulness.
Tokenomics is an important aspect to keep in mind when making an investment decision, because in the long run, a project that has reasonable and well-designed incentives to buy and hold tokens for a long time is more likely to survive and succeed than a project that has not created ecosystem and active community around your token. A well-built platform often results in higher demand over time as new investors flock to the project, which in turn raises the price of tokens and the desire to buy and accumulate them.
Similarly, when launching a project, founders and developers must carefully consider the tokenomics of their own cryptocurrency if their project plans to attract investment and become successful.
Features of tokenomics
The structure of the cryptocurrency economy determines the incentives that encourage investors to buy and hold a particular coin or token. Just like all fiat currencies, each cryptocurrency has its own monetary policy.
Tokenomics defines two things in cryptoeconomics: incentives, which determine how a token will be distributed, and the utility of tokens, which affects the demand for them. Supply and demand have a huge impact on price, and projects that use the right incentives can go up in value.
Here are the main variables managed by crypto project developers that affect tokenomics:
Mining and staking
For base-level blockchains such as Ethereum 1.0 and Bitcoin, mining is the main incentive in a decentralized network of computers to validate transactions. Here, new tokens are issued to those who dedicate their computing power to discovering new blocks, filling them with data, and adding them to the blockchain. Staking rewards those who fulfill the same role but instead freeze some coins in a smart contract – this is how blockchains like Tezos work and this is the model that Ethereum is heading towards with the 2.0 update.
Decentralized finance platforms offer high returns to incentivize people to buy and stake tokens. Placed tokens in huge pools of cryptocurrencies support systems: decentralized exchanges and lending platforms. These earnings are paid out in the form of new tokens. Token Burning - some blockchains or protocols "burn" tokens - permanently remove them from circulation - in order to reduce the number of coins in circulation. . In August 2021, Ethereum began burning some of the tokens sent as transaction fees instead of handing them over to miners. This is a kind of deinflationary model
Limited and unlimited emission
Tokenomics determines the maximum number of tokens. Bitcoin tokenomics, for example, dictates that no more than 21 million coins can be mined, with the last coin expected to enter circulation around 2140. Ethereum, in contrast, does not have a maximum cap, although its release is capped each year. NFT projects take scarcity to the extreme; some collections may only mint one NFT per artwork.
Distribution of tokens and reward periods
Often a certain number of tokens are reserved for venture investors or developers, but the catch is that they can only sell these tokens after a certain amount of time. This naturally affects the number of coins in circulation over time. Ideally, the project team should implement a system in which tokens are distributed in such a way as to minimize the impact of issuance and the rate of distribution of tokens on the circulating supply and price of the token.
All these decisions to define the project tokenomics are made at the protocol level, and most of the tokenomics are built into the code of a particular cryptocurrency by its founding developers. Before a cryptocurrency is released, its tokenomics is often described in an associated whitepaper, which is a detailed document explaining what the proposed cryptocurrency will do, as well as how it and any underlying technology will work (whitepaper).
For example, take the tokenomics of the Terra ecosystem described in the 2019 white paper. The project describes itself as a stablecoin network, a type of crypto token that maintains a stable value using either a reserve of assets or a smart algorithm.
Governance plays a huge role in tokenomics these days. Many tokens function as so-called governance tokens, which means that the holders are given the right to vote in order to influence the future rules and decisions of the project. This is all in the name of decentralization; instead of a centralized group of developers making decisions, token holders can vote on how the platform should work.
DeFi platforms operate through DAO, the name given to a governance system based on the governance of tokens.
Tokenomics is critical to the success of the project; just as a reckless CEO can bring a company to ruin, bad management decisions can kill the best DeFi projects.
If it fails, you can always create a new tokenomic by the process of copying the blockchain codebase, making a few changes that are not compatible with previous versions, and migrating old cryptocurrencies and validators to the new network.