Tokenomics is an emerging field that seeks to explain how blockchain assets change in value. In many cases, tokenomics looks into the social or individual behavioral forces that affect the value of crypto markets and individual cryptocurrencies.
The practice is invaluable to both crypto developers and investors, as the buying and holding of tokens is dependent on human motives. Projects that take tokenomics into account tend to run into fewer serious risks and often have better odds of success. On the other hand, projects with poor tokenomics generally fail to get market traction.
When deciding to buy, hold, or dump a crypto asset, it helps to understand the wider tokenomic backdrop of your decision. For instance, examining the tokenomics of a cryptocurrency like Monero (XMR) may influence your choice of Monero wallet, particularly if you want to expand on XMR’s security features.
As with mainstream economics, tokenomics can be confusing at times. However, with the FAQ guide below, you should be prepared to take on more advanced concepts in the field.
Where Did the Word Tokenomics Come From?
Tokenomics is an amalgamation of the words “token” and “economics,” specifically referring to the supply and demand characteristics of crypto projects. Like mainstream economics, tokenomics considers a wide array of factors in cryptocurrency projects outside of simple supply and demand. These may include issuance, specific attributes like security, and distribution, among many other characteristics.
How Does Tokenomics Differ from Traditional Economics?
Traditional economic models assume governments can create theoretically infinite amounts of additional fiat money at any time. In contrast, most cryptocurrency projects have pre-determined and algorithmically created issuance schedules for tokens. The predictability of supply and the limits on issued tokens necessarily create different considerations than would normally be applied to mainstream currencies.
What Are the Key Variables in Tokenomics?
Some of the most critical variables in tokenomics include token supply (total and circulating), token allocations, vesting periods, mining and staking mechanisms, yields, and token burns. Any changes in these areas will directly affect the economy of a crypto project and the value of its coins.
Why Is Token Supply Important in Tokenomics?
Scarcity is often viewed as a fundamental advantage of cryptocurrencies over fiat money. A limited supply of tokens can lead to higher demand and value for its coins, while an increasing supply might result in inflation and lower coin value.
What Are Vesting Periods?
A vesting period is a set time during which tokens cannot be sold. This practice usually takes place upon the launch of new coins. Vesting has become more common because of prevalent pump-and-dump schemes in the earlier days of cryptocurrencies. Forcing investors to hold may help a cryptocurrency retain more value and increase its odds of long-term adoption.
What Are Mining and Staking?
All cryptocurrencies use decentralized blockchains that involve different mechanisms for network security. Chief among these are mining and staking, each of which affects the tokenomics of a given coin.
Mining is an essential part of maintaining this security, using computing power to validate transactions and add new blocks to the blockchain. Network users who perform mining activities earn tokens as a reward.
Staking, on the other hand, is an alternative validation method that reduces computational requirements by selecting validators who have a certain proportion of holdings in the given cryptocurrency. Similarly, validators are rewarded with a small amount of tokens upon completing the staking process.
What is Token Burning?
Token burning permanently removes tokens from circulation. This has the effect of
reducing supply and potentially increasing the value of the remaining tokens.
Burning is sometimes done intentionally to preserve the value of a coin. However, there are practical limits to how much token burning can increase value, and coins that are widely perceived as poor bets will not significantly benefit from the practice.
What Factors Influence the Demand for a Token?
Like with any asset, demand for a token is influenced by its perceived utility and return on investment (ROI). Some tokens like the aforementioned Monero offer real-world applications like enhanced privacy and may, therefore, have high demand from certain types of crypto traders. Likewise, coins that offer governance rights and incentives for holding are more likely to be in demand.
What Are Utility Tokens?
Utility tokens provide access to a specific product or service offered within a blockchain ecosystem. Unlike conventional cryptocurrencies, utility tokens are not created as investments but as a means to interact with a platform.
However, a surge in demand for the platform’s services can still cause them to rise up in demand. Utility tokens are, therefore, still subject to tokenomics, even though they are not necessarily designed as investment vehicles.
Avoid Cryptocurrency Risks with Better Tokenomics Know-How
A firm grasp of tokenomics makes it possible to cut through the noise and evaluate a crypto project on its merits. You will be able to figure out how a coin development team is driving demand for the token and make educated assumptions about how well the coin will do once it is made available for investment. Taking a wider view, tokenomics know-how will also give you an idea of how well a coin will perform against popular fiat currencies and established cryptocurrencies like Bitcoin (BTC).
Importantly, if you are an investor, understanding tokenomics helps in identifying red flags like unsustainable token supply models or weak demand generation strategies. This knowledge will make it easier for you to mitigate the risks associated with blockchains and enjoy better investment outcomes.
