Tokenomics is crucial to investing, and here's why
by Alyona Shepilova
Jun 16, 2023
What is tokenomics?
Tokenomics is a portmanteau of token + economics. Rather than a science, it's simply a collection of rules for a token. Think how many tokens there are, the issue schedule, the use cases, etc. Tokenomics rules are written into the token's code, which makes them easy to inspect but very difficult, though not impossible, to change. Therefore, the more though-out the tokenomics model is, the higher the chances of the project's success.
NB! Tokenomics is a bit of a misnomer. You know that in crypto, the difference between coins and tokens is that the former have their own blockchains (like BTC or ETH), while the latter (like USDT) are built on the already existing blockchains. For tokenomics, there's no difference: this term includes both tokens and coins.
Why does tokenomics matter so much?
Basically, tokenomics can give you a rough idea of the asset's potential. Is it a sustainable model, or are there flaws apparent even at first glance? To assess the project, go through the tokenomics elements one by one.
5 things you should pay attention to are:
- and Incentive
Let's start with supply.
Supply: Token supply
Three terms to get familiar with here are circulating, total and max supplies.
Circulating supply refers to the coins that are publicly available to buy and sell.
Total supply consists of the circulating supply plus the coins privately held by the asset's founders and team members (see Distribution below)
Max supply refers to how many tokens of a specific asset will ever exist. When a cryptocurrency doesn't have a maximum supply, we say that it is uncapped.
NB! Max supply creates scarcity and makes the token more valuable.
For example, Bitcoin mainly functions as a store of value and, as such, has a max supply.
On the other hand, the Ethereum blockchain was created, so developers could build on it. Currently, it's one of the driving forces behind decentralised finance, a multi-billion industry. If ETH is the oil your car runs on, you can't afford to run out. It makes sense that Ethereum is uncapped or doesn't have a max supply.
Stablecoins (e.g. USDT or USDC) are another matter. As they're supposed to be pegged to real-life currencies on a 1-to-1 basis (there are as many tokens as, say, US dollars in existence), they don't have a max supply either.
NB! When total supply matches max supply, we say the asset is fully diluted.
Model: Deflationary vs inflationary model
When token supply decreases over time, we deal with a deflationary token model. When it increases – it's an inflationary token model.
When supply becomes lower, the asset value increases.
When supply is limited, people tend to hold rather than spend. This leads to the asset falling out of use.
Resembles how fiat money is printed; only the rules of creating new tokens are written into the code and are more transparent.
Inflation always means falling in price (or devaluation)
Whether Bitcoin is inflationary or deflationary is up for debate. On the one hand, it will only reach its max supply around 2140, when it should stop being regarded as inflationary. But then again, we should consider people losing access to their wallets and tokens, meaning a drop in circulating supply. In this case, we can argue for a deflationary model for any currency.
Stablecoins are neither deflationary nor inflationary. Neither are NFTs.
Did you know that the crypto community has its own terms for deleting and creating new tokens? It's 'burning' and 'minting', respectively.
Distribution: How tokens are distributed
The main point behind digital currencies is that they're supposed to be decentralised. In other words, the power is not concentrated in one place but is shared between people.
We have a fairer market when tokens are distributed between many market players. It's very apparent with governance tokens, for example, as they give their holders the right to vote on the project's future. The more tokenholders there are, the more democratic the system. It's not an exclusive club anymore.
But when the majority of tokens is concentrated in the hands of, say, insiders, we have a monopoly instead. And this goes against the idea behind cryptocurrencies.
Utility refers to how a token can be used. For example, many cryptocurrencies, such as BTC, primarily function as a store of value. But then some would have additional properties like giving you a right to vote on the project's future or acting as a currency in the project's ecosystem.
If you look at the token's use cases, it can give you a rough idea of its potential to evolve and rise in price.
Incentive: Incentive mechanisms
'Incentive mechanism' refers to a reward system for processing transactions on a blockchain.
Whenever you send crypto to your friends, someone must 'authorise' your transaction before the funds reach their destination. For Bitcoin, such people are called miners and currently receive a reward of 6.25 BTC. On Ethereum, we have validators, who can expect to earn as much as ~4.0% of their yearly stake.
Why do incentive mechanisms matter? Because they describe how miners and validators are rewarded. And since they are the ones who secure blockchains, and a healthy blockchain means a valuable asset, incentive mechanisms do indeed matter a lot.
To sum it up
Tokenomics gives you a rough picture of how viable an asset is. It pays to include it in your token research before investing in any project.
I know my tokenomics. What else can I do to assess the project?
Be sure to check the project's whitepaper, roadmap, team and community. All these provide decent insights into the project's worth.