Tokenomics 101

Tokenomics, as you may have guessed, is made up of two words – token and economics. Tokenomics can therefore be described as the study of how cryptocurrencies work in the broader ecosystem. It involves understanding the demand and supply characteristics of cryptocurrency. Does this sound complicated? We will break this down for you. 

Let’s start by understanding what a token is: 

Token is a term you will come across very often in cryptocurrency. Crypto tokens can seem similar to cryptocurrencies, however, they are a different digital asset class altogether. Tokens don’t have their own blockchain (this differentiates them from crypto coins). Instead, they operate on blockchains of crypto coins. They are generally built on top of an existing blockchain, and used with decentralized applications. 

Tokens can be classified into many categories – the most common ones being security, utility and governance tokens. In brief, utility tokens are used in a payment ecosystem (e.g. watching a web series). Through a security token, one gets ownership stake in an asset. With governance tokens, you get voting power – you have a say in deciding the new features as well as changing the governance system in a blockchain project.

Tokens can be assigned value and exchanged, just like cryptocurrency. A token can also represent tangible asset, service, utility etc. Some crypto tokens represent assets such as art and real estate and art. 

What Is Tokenomics?

Tokenomics, simply put, is the study of the token economy. It includes all factors that have the slightest bearing to the value of a token. This can include creating, managing and even removal from a network. Listed below are a few of the metrics that must be looked at when studying token economics. 

• Distribution

The projects must be such that they distribute coins out to participants. One of the ways this can be done is by rewarding validators with new coins. Another example can be an initial coin offering, where a part of the token supply is sold to prospective users. Tokens may also be distributed for certain actions like distributing rewards for verifying facts. When a project distributes tokens to many users, there is assurance the project is legitimate. 

• Allocation

Like the case for any project, resources must be invested before a blockchain project can go live. Tokens are allocated in advance to attract early investors. The investors get their reward when the project is live and the value of tokens rises. The initial allocation of tokens is an important element to the success of a project. Investors can gauge the initial valuation on the basis of the sum that has been raised during the early stages. Additionally, it has been noted that team members who worked on a token have been given tokens as rewards. 

• Price Stability

We know how volatile cryptocurrencies can be. The fluctuations can bring in speculators who buy and sell in mass, thus stopping the network from properly functioning. To prevent this from happening, projects have to ensure there are sufficient coins to match the supply levels. This helps in creating a stable price, and in turn this encourages participants to use the tokens for what they have been designed for.

• Market Capitalization

When you look at a token’s market capitalization, you will know the total funds that have been invested in a crypto project. Here, one needs to look at the fully diluted market capitalization of a project. This is the crypto’s total value at today’s price in the instance that the maximum supply of the token was already in circulation. The greater a token’s market capitalization and lower its circulating supply, you can expect its value to be higher in the future.

• Model

It is important to know whether a token is inflationary or deflationary. In case of an inflationary token, there is no maximum supply. This means it will go on producing as time goes on. It must be noted that the supply of such tokens generally becomes more than the demand over time. 

A deflationary token model, on the other hand, is one where the number of tokens goes down with time. There is a maximum supply the token is capped at. Their supply is regulated through the removal of tokens from circulation. 

• Governance

Behind every project, there are people who set up the rules about how the tokens are created and put into and taken from the network. The approaches differ depending on the project. Some can have tokens held in reserve that can be added at a later time into the ecosystem to promote growth. Others have a hands-off approach to how the network functions. 

There are some networks that incentivise users to hold and use tokens as a way of preventing participants from holding coins and keeping the network from being used as it was meant to. PoS systems help ensure users behave honestly. In the event they don’t adhere to the rules, the tokens can be forfeited.

Incentive Theory 

Tokenomics makes use of the incentive behaviour to develop the required behaviour in the blockchain ecosystem. The incentive theory states that the desire for incentives (rewards) can drive the desired human behaviour. Incentives have a vital role to play in tokenomics – it encourages people to take part in exchanges of value by blockchain networks. 

Not only that, it motivates users to ensure improved safeguards for the blockchain and transaction validation. Incentives help to implement distinct functionality in the blockchain network. Those who adhere to a network’s rules are rewarded in cryptocurrencies. 

The operations should be configured in such a manner that allows users to earn higher tokens by contributing positively. Token economics ensures that incentives are financial in nature on account of their financial value and contribution to a project’s market capitalization. 

Importance Of Tokenomics

Investors must understand the demand and supply factors of the crypto market. In doing so, they will gain knowledge of the market’s short-term performance. In addition to that, tokenomics helps to gauge the future worth of an asset. And finally, it helps one comprehend the profitability of one crypto asset over another in future.

Uses Of Tokenomics 

Some of the instances where you see tokenomics being deployed include:

• Staking 

This is one of the important topics you will come across in tokenomics. Here, the network stores value in a wallet. Those validators with more value in their wallets have better chances of getting greater rewards for verifying transactions. 

The Delegated PoS model is an example of the use of tokenomics in staking. The random delegation and selection is what differentiates this model from a PoS model. On account of this, users who have the highest stakes may find it hard to regularly receive validation rewards.

• Value of Tokenomics

Tokenomics can help with reflecting the economics and social costs in accounting for token projects. This is a big requirement at a time when we can expect tokens to represent almost any real-world asset like artwork, precious metals and real estate. It is even capable of giving the value of community-based solutions aligning with values of consumers.

• Value Exchange 

Tokenomics also finds its use in exchanging value. Ethereum has proved that token projects can make use of tokenomics to exchange and create value. Token economics can be leveraged for encouraging fundraising activities and introducing decentralized apps. 

Conclusion

Tokenomics has a vital role to play in the workings of a blockchain. It utilizes certain hard-coded rules and a token to align the behaviour of all actors in a manner that is beneficial to the protocol. There is no perfect tokenomics model. On the basis of the blockchain services offered, tokenomics will differ. 

(Note – The facts and information contained in this article have been sourced from multiple websites.)

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