“Tokenomics” is a famous term in the crypto space with a broad meaning. Every successful crypto investor considers the Tokenomics of any cryptocurrency before investing in it. But even though it is a crucial factor in the success of any cryptocurrency, Tokenomics is not well known among beginner investors.
Therefore, we have prepared this concise blog through which you can understand Tokenomics in just a few minutes.
So, let’s dive in.
Tokenomics
Tokenomics is a term used to describe the supply-demand characteristics of cryptocurrencies to help investors estimate their value. It is formed from two words, Token and Economics, combined meaning “ Economics of a Token”. Though this term has “token” in it, Tokenomics applies to crypto coins and tokens both.
Let’s understand the concept of Tokenomics through Bitcoin.
Bitcoin has a pre-set total supply of 21 million BTC. BTC mining takes place through a specific consensus mechanism. The miners compete to solve a mathematical problem, and the winner gets a block to verify and an amount as a reward. This reward, time for every block generation, and the difficulty level of mathematical problems keep changing. Bitcoin includes a halving event every four years when the mining reward gets halved once 2,10,000 blocks get mined.
All these pre-decided rules that decide the estimated supply and demand of Bitcoin in the upcoming time form the tokenomics for Bitcoin.
Types of Tokenomics Models
Different coins have different types of Tokenomics models. However, we can divide most of them into the following types-
Deflationary Tokenomics Model
A Deflationary Tokenomics Model is one with a fixed coin/ token supply that keeps decreasing with time. The maximum limit of such tokens never increases or decreases. The idea behind limited supply is that only demand will increase, not the maximum supply that will cause the price to hike.
Advantages
The Deflationary model gives an edge to such tokens over Fiat currencies. Their limited supply eliminates the worry of inflation to a very extent.
Disadvantages
Some theories say Deflationary Tokens may flop because their mining reward might not stay attractive after their maximum supply gets finished. Also, such tokens motivate their hoarding among investors instead of spending, which may cause their scarcity in market circulation.
Examples of Deflationary Tokens are - Bitcoin (BTC), Cardano (ADA), Solana (SOL), Tron (TRX), etc.
Inflationary Tokenomics Model
Cryptocurrencies that follow the Inflationary Tokenomics model do not have any maximum limit of tokens to be created. This model is similar to the fiat currencies that get minted periodically as per demand. The developers of such a model control the supply of tokens through some elimination mechanism like Crypto burning.
Advantages
The economic model of Inflationary currency has already been mass tested and understood through Fiat.
Disadvantages
The unlimited possible supply and continuous minting of these tokens can cause their devaluation like fiat currencies.
Examples of Inflationary Tokenomics model currencies are Polkadot (DOT), Ethereum (ETH), Dogecoin (DOGE), etc.
Duel-token model
In this model, two different types of tokens work under the single blockchain of a project. Here, one token serves as the means to raise funds for the project, and the other fulfils certain activities of that blockchain network. These certain activities vary with blockchains depending on the platform’s design and what it has to serve. This way, the dual token system in blockchain projects separates the ecosystem into two parts that lead to better management.
The best way to understand this model is through an example-
Axie Infinity is an NFT gaming platform that offers two tokens: SLP and AXS. The SLP is a utility token with an unlimited supply that is usable on Axie infinity to pay the breeding fees for game characters and similar tasks. At the same time, the other token of Axie infinity, AXS, gives its holders the right to participate in the in-game governance and gain good rewards. Both the involved tokens have separate functions with a single blockchain interconnecting them.
Advantages
Having two distinct tokens is a great way to separate a blockchain’s financial incentives and utility functions.
Disadvantages
It is more complex to understand such models because two interconnected tokens are present in them.
Some examples of Dual Token model cryptocurrencies other than Axie infinity are VeChain (VET/VTHO) and Ontology (ONT/ONG).
Asset-backed model
This model involves currencies backed by another asset so that users can drive the value of that currency through the underlying asset.
Advantages
The asset-backed model cryptocurrencies are more stable as compared to other volatile counterparts. They prove useful in international trade and other long-term transactions.
Disadvantages
Since a physical asset backs these Cryptocurrencies, they become more dependent on that asset. Due to that reason, they can only be considered partially decentralized.
A famous example of an asset-backed model cryptocurrency is Tether (USDT).
Key factors to consider in Tokenomics
Below are some key factors one must consider while considering the tokenomics of any cryptocurrency:
Token supply
Supply is a crucial factor that decides the demand trajectory of any cryptocurrency and its value. Therefore, always consider the maximum supply and circulation supply of cryptocurrencies to determine their tokenomics. Some tokens have a limited maximum supply, while others have an unlimited supply possible throughout their lifetime. Another matrix to look for is circulating supply which stands for the number of coins actively available in the trade market. For Bitcoin, this circulation supply is 19 million, which is 90% of the total supply of Bitcoin. A high circulation supply is good because it means a good market cap for that currency.
Token Use Case
The token use case is the second important factor that needs consideration to check its tokenomics. For example, a governance token Aave (AAVE), is the native token of a DeFi platform, giving its holders the right to have a say in the future developments of the Aave platform. Similarly, The gas fee to use the Ethereum blockchain is also payable in its native ETH token, Ethereum. This token is also usable to buy NFTs. Such attractive factors and use cases make the tokenomics of a cryptocurrency stronger than its counterparts.
Token Distribution
Another important tokenomics factor is fair token distribution. It involves how a cryptocurrency is distributed among institutions and individual holders. A single organization owning most of a cryptocurrency is generally risky because it creates heavy chances of market manipulation for cryptocurrency. An even Token distribution among institutions and investors in a way that no single authority can manipulate its supply is a positive sign for that cryptocurrency.
Consensus Mechanism
The consensus mechanism of a cryptocurrency is directly related to its long-term performance. A faulty consensus mechanism fails to sustain for long, and a right consensus mechanism helps to gain recognition and support. Some popular and successful consensus mechanisms are proof of work, proof of stake, proof of burn, proof of history, etc. Decentralization, security, and scalability are the three factors you should check in a consensus mechanism of a crypto blockchain. According to the concept of blockchain trilemma, all these factors can not be present in a blockchain network simultaneously. However, projects have developed some countermeasures like Sharding and Lightning networks to fight this trilemma. The blockchain that closely fulfils these three ideal properties is considered good.
Closing Thoughts
Tokenomics is like the resume of a cryptocurrency that investors consider before putting money into it. Many Ponzi schemes, rug pulls, shit coins and other fraudulent crypto projects will come to light sooner if more investors become aware of Tokenomics and its factors. Hence, involve tokenomics in your crypto research to make a strong portfolio that can reap good returns.
