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The term tokenomics describes the economics of a token, that is, the factors influencing the use and price of a token, its creation, distribution, demand, supply, incentive mechanisms and burn schedules. Well-designed tokenomics is the key to the success of most crypto projects. It is extremely important to evaluate this before making an investment decision.
Introduction
Токеномика (от сочетания слов «токен» и «экономика») — это ключевой компонент фундаментального анализа криптопроекта. Она помогает оценить его перспективы, как и техническая документация, команда основателей, дорожная карта и рост сообщества. Тщательная проработка токеномики обеспечивает устойчивое и долгосрочное развитие блокчейн-проекта.
What is tokenomics
Blockchain projects develop tokenomic rules for their tokens to encourage or restrict certain user actions. By the same token, central banks print money and implement monetary policies to stimulate or restrict spending, savings, savings and money flows. Moreover, within the framework of tokenomics, the word “token” refers to both tokens and coins. You can find out how they differ in this article. Unlike the fiat currency system, the rules of tokenomics are enshrined in the project code and are transparent, predictable and difficult to change.
As an example, consider the tokenomics of Bitcoin. Its total supply is predetermined at 21 million coins. They are created and put into circulation through mining. Miners create a new block approximately every 10 minutes and receive a reward in bitcoins for this.
The block reward is halved every 210,000 blocks, that is, every four years. Since January 3, 2009, when the first block (the genesis block) was created on the Bitcoin network, the reward has been halved three times - from 50 BTC to 25 BTC, then to 12.5 BTC and 6.25 BTC.
According to these rules, approximately 328,500 Bitcoins will be mined by 2022. This value can be calculated by dividing the total number of minutes in a year by 10 (since a block is mined every 10 minutes) and then multiplying by 6.25 (since a miner receives 6.25 BTC for mining a block). This way you can predict the number of Bitcoins mined each year. The last Bitcoin is expected to be mined around 2140.
Bitcoin tokenomics also determines the amount of transaction fees that are charged to the miner for confirming each new block. Fees increase in proportion to the increase in transaction size and network load. This prevents transaction spam and incentivizes miners to continue confirming transactions even if the rewards decrease.
In other words, Bitcoin tokenomics is simple and ingenious. All the rules here are transparent and predictable. Bitcoin incentives allow network participants to receive rewards for maintaining reliability and help increase the value of Bitcoin as a cryptocurrency.
Key elements of tokenomics
The term “tokenomics” covers a wide range of factors that influence the value of a cryptocurrency. It refers primarily to the economy that the creators of the project developed. When considering cryptocurrency tokenomics, it is worth considering the following factors.
Token Offering
Supply and demand are the main factors that influence the price of any product, service or cryptocurrency. There are several critical indicators that measure the supply of tokens.
The first is the maximum offer. This indicator indicates the maximum possible number of tokens for a specific cryptocurrency. For example, the maximum supply of Bitcoin is 21 million coins. Litecoin has a hard cap of 84 million coins and BNB has a hard cap of 200 million.
However, not all tokens have a maximum supply. For example, the supply of tokens on the Ethereum network increases every year. And stablecoins such as USDT, USD Coin (USDC) and Binance USD (BUSD) do not have a maximum supply since these coins are issued based on the reserves backing the coins. Theoretically, their number can grow indefinitely. Two other examples of cryptocurrencies without a limited supply are Dogecoin and Polkadot.
The second supply metric is the circulating supply, which refers to the number of tokens currently available. Tokens are constantly being created, burned, or locked in some way, which directly affects the price of the token.
The current number of tokens in circulation allows us to calculate how many tokens will ultimately be issued.
Token usage
Options for using the token are pre-provided in the code of each project. For example, BNB powers the BNB Chain network, is used to pay transaction fees and discounts on fees, and also serves as a community utility token in the BNB Chain ecosystem. Users can also stake BNB through various ecosystem products and earn additional income.
Tokens can be used in other ways. Thus, governance tokens allow the owner to vote on changes to the token protocol. Stablecoins are used as a currency. And security tokens serve as financial assets. For example, a company might issue tokenized shares in an initial coin offering (ICO), which grant ownership and provide dividends to the owner.
Consider these factors when analyzing use cases and developing the token economy.
Token distribution
Besides supply and demand, it is also important to consider token distribution. Large companies and individual investors operate differently. If you know which entities own the token, you can guess how they plan to manage their assets and how this will affect their value.
Typically, there are two ways to launch and distribute tokens: fair launch and pre-mining launch. An honest launch implies the absence of early access and private distributions, bypassing the general public. Through a fair launch, BTC and Dogecoin were launched.
Pre-mining, or pre-mining, allows a portion of a cryptocurrency to be distributed to a select group of users before it becomes publicly available. This is how Ethereum and BNB were launched.
Notice whether the token is evenly distributed. If one large company owns a large share of the supply, the situation is risky. If the tokens are mainly held by investors and founders, then their actions will be aimed at achieving long-term success.
We also advise you to study the blocking and release schedule of tokens. The release of a large number of tokens can affect its value, which is important to consider when planning an investment strategy.
Burning tokens
Many crypto projects regularly burn tokens, removing them from circulation.
For example, BNB burns coins to remove them from circulation and reduce the overall supply. Considering the 200 million BNB pre-created, as of June 2022, the total supply of BNB was 165,116,760 coins. BNB will continue to burn them until it destroys 50% of the total supply, meaning it will reduce it to 100 million BNB. Similarly, in 2021, Ethereum began burning ETH to reduce the overall supply.
A decrease in the supply of a token is called deflation, and an increase is called inflation.
Incentive mechanisms
The incentive mechanism is a key element of tokenomics, as it motivates users to take certain actions and ensures the long-term sustainability of the project. An example of a successful model is block rewards and transaction fees on the Bitcoin network.
Proof-of-stake mechanism is another block verification method that is rapidly gaining popularity. It invites participants to lock their tokens, become validators and confirm transactions. Typically, the more tokens locked, the higher the chance of being selected as a validator and starting earning rewards for validating transactions. If validators try to harm the network, they will lose their staking assets. This incentivizes participants to act honestly and maintain the integrity of the protocol.
Many DeFi projects are using innovative incentive mechanisms to ensure rapid growth. For example, the crypto lending platform Compound allows investors to deposit cryptocurrency into the protocol, earn interest, and receive rewards in COMP tokens. They are used as governance tokens for the Compound protocol. This structure allows us to coordinate the interests of all network participants and guarantees its long-term development.
The future of tokenomics
Since the creation of the genesis block of the Bitcoin network in 2009, tokenomics has undergone significant changes. The developers tested many different models, both successful and unsuccessful. The Bitcoin model has stood the test of time and is still in demand. And projects with poor tokenomics have failed.
There is another tokenomics model based on the scarcity of digital resources. It is used by non-fungible tokens (NFTs). Tokenization of traditional assets such as real estate and art could bring a lot of innovation to tokenomics in the future.
Summary
Tokenomics is a fundamental concept that needs to be learned to work with cryptocurrency. This concept covers the main factors affecting the value of a token. However, none of them guarantee the success of the project, so when assessing risks, try to take into account all aspects and conduct a comprehensive analysis. Tokenomics can be combined with other fundamental analysis tools to objectively assess the prospects of a project and the price of a token.
In general, tokenomics determines how a token can be used, the complexity of creating a network, and the interest of users in the project.