Cryptocurrency tokenomics combines two words. Token and Economics, both of which are vital in the lifecycle of a cryptocurrency project.
The term tokenomics denotes the forces of demand and supply surrounding a particular cryptocurrency’s features, issuance, distribution and governance.
What are Tokenomics?
Tokenomics is the economic and incentive structure governing any blockchain project. As an umbrella term that covers every aspect of distributing a given blockchain’s digital currency, Tokenomics also define the value of a given blockchain.
Supply and demand drive the value of these tokens, hence demand is a valuable component across tokenomics.
Any project listed on Coinmarketcap has a set of rules for rewarding holders of a project’s token. These rewards, or incentives are another factor for driving demand.
In some cases, the incentive structure defines how the community of holders, developers, founders and supporters will benefit from the project.
What are supply Tokenomics?
Supply is one of the three major facets that define crypto tokenomics.
Gauging the total supply and circulating supply of any cryptocurrencies is one of the steps for evaluating the investment value of a cryptocurrency project. A must-have indicator for finding a project’s real value.
Bitcoin will always have a maximum supply of 21 million BTC coins. However, not all of them have already entered market circulation. According to estimates, the last on-chain Bitcoin will come into circulation in 2140.
It’s a good practice for blockchains to limit the number of coins in circulation. This is because scarcity drives demand, and demand drives prices upward.
Tokenomics is not only restricted to cryptocurrencies. Non-fungible tokens also limit the amount of circulating tokens.
For example, there will only exist 10,000 CryptoPunks, and Bored Ape, a popular NFT project has 9,999 tokens.
Blockchains release cryptocurrencies into circulation by rewarding the people who take part in validating transactions. These people are called validators. There are various methods of reaching consensus when validating transactions, but the major ones are proof-of-work(PoW) and proof-of-stake (PoS).
What are Demand Tokenomics?
Supply metrics can gauge the value of a cryptocurrency project. However, it is the demand metrics that create value for a crypto. When a project is good, solves a universal problem -there will be more demand and the price will go high.
Cryptocurrencies are volatile in nature due to the forces of demand and supply. At any given time, these two variables appear to be in an intricate fight. When supply is high, more people are selling and the price drops.
Nonetheless, it is important to note that tokenomics does not provide much details about demand. The only noteworthy aspect to consider when reading a white paper is whether the supply is fixed.
The Law of Demand and Supply in Cryptocurrency Tokenomics
While not all the time, a fixed supply is one of the factors that often contributes to high demand.
There are three methods for gauging whether a cryptocurrency project will have demand. These are :
- Game Theory
- Return on Investments
Crypto projects generate cash flow for their creators and holders. This cash flow is called Return on Investments (ROI).
For example, Ethereum requires a minimum of 32 ETH for one to be a validator and earn from its proof-of-stake method.
According to research, the annual percentage rate or APR for Ethereum staking ranges between 6 and 15 per cent, which is approximately 3 – 5 ETH with an Ethereum price of $1,500 – $2,000. Ethereum’s staking ROI is one of the many aspects attracting the community to the ecosystem.
When a blockchain lacks ROI, people will not feel obligated to participate in its tokenomics. In addition, a project needs to be trustworthy, transparent and secure for people to stake their money in its token.
Game theory defines how people systematically make decisions. At the heart of it, game theory aims to use mathematic models to gauge conflict and cooperation when evaluating user behaviour.
When implemented across cryptocurrencies, the concept enables developers to determine how users will make decisions.
For example, lockups are one of the elements in game theory that can galvanize demand for a token.
When community users acquire the token and lock it up, the protocol incentivizes their actions and they gain more rewards over time.
Mining and Staking in Tokenomics
Bitcoin uses the PoW, the process of utilizing computing resources to add blocks of transactions to the blockchain. Providing proof-of-work is called mining.
On the other hand, Ethereum uses PoS, the process of locking a particular amount of coins within the blockchain’s smart contract so as to take part in network validation. Providing a proof-of-stake is called staking.
As such, each network validator needs to be rewarded. For this reason, crypto tokenomics defines how each of these validators gets their rewards.
What are Token Burns?
Token burns are a mechanism for destroying tokens from circulation so as to control their scarcity and drive demand.
For example, Stellar Lumen destroyed over 55 billion tokens in November 2019, approximately half of the total supply. This resulted in a short-term price increase of 30%. Here is a graphical representation of Stellar’s tokenomics after the 2019 token burn:
It bears mentioning that not every blockchain protocol executes a token burn.
Yield Farming is more like earning interest on your savings account in a traditional bank.
What is Yield Farming?
Yield Farming is the process of depositing cryptocurrencies or tokens into a decentralized finance (DEFI) protocol to earn rewards.
The DeFi protocols earn interest on these funds through multiple methods like crypto lending and borrowing, compounding and providing liquidity.
Crypto Tokenomics Example:
In Tokenomics, investors and potential adopters are interested in four main pieces of information. These are utility, incentives, supply and distribution.
We are going to evaluate a few blockchain examples on the basis of these four components.
What are the tokenomics of Ethereum?
- Utility: Ethereum’s utility includes a means of payment, cross-border settlements, smart contracts deployment, staking and investment.
- Incentives: As earlier mentioned, Ethereum offers rewards to everyone who stakes Ethereum for a given period of time. Staking at least 32 ETH qualifies one to become a network validator and unlock more earnings from the network.
- Distribution: According to the Ethereum whitepaper, the Initial distribution of Ethereum had 16.7% for early contributors and 83.3% for a crowd sale.
- Supply: All Ethereum coins are already in circulation, the total is 120,482,192. Instead of occasionally releasing more coins to the market, Ethereum prefers token burns as a way of controlling market supply and driving demand. See the representation below to understand Ethereum’s steady burn rate, emission rate and the blockchain’s consistent growth.
What are the Tokenomics of Cardano?
- Utility: Cardano(ADA) has utility around payments, global settlements, network delegation and staking for rewards.
- Incentives: The Cardano blockchain rewards users for locking their ADA holdings for a particular time via its proof-of-stake consensus mechanism.
- Supply: Cardano has a total supply of 35.3 billion coins and a circulating supply of 34.5 billion ADA coins.
- Distribution: The launch of Cardano saw the team allocate 57.6% to the Initial Coin Offering, 11.5% to the founding team and 30.90 to staking rewards.
What are the Tokenomics of the NEAR Protocol?
- Utility: NEAR Protocol’s whitepaper describes the protocol as a data storage, staking, payments and governance network.
- Incentives: The protocol incentivizes validators on the network who take part in validating transactions, securing the network and conducting other computing tasks.
- Supply: The maximum and total supply of NEAR tokens is 1 billion coins.
- Distribution: The chart below will help you understand the distribution tokenomics for the NEAR Protocol.
Understanding cryptocurrency tokenomics will enable you to understand blockchain white papers at a deeper level when conducting DYOR. Insights into the utility, value, supply and demand of a cryptocurrency help gauge whether it will have a return on investments.
If the coin is a ‘shitcoin’ as hundreds of them are already in the market with no value and waiting to rug pull; you are going to know by understanding Tokenomics. The ability to gauge what drives the demand for a token opens one’s eyes to whether to make short-term or medium-term investments in the project.