There are numerous topics that have been discussed throughout the crypto sphere, and one of the main words that you might have come across while discussing the crypto space as a whole is the word “tokenomics.”
- Tokenomics is a combination of the words “token” and “economics” and describes the factors that go into the value of a cryptocurrency.
- It includes a variety of different factors, such as the maximum token supply, how new tokens get added or removed from circulation, as well as its utility, and the incentive for token holders.
- Tokenomics is a simple term used to refer to all of the economics that form a specific cryptocurrency and project.
But what is the meaning behind this word, and what do tokenomics actually represent for a crypto-related project? Let’s dive in and go over everything you need to know.
Tokenomics: Everything You Need to Know
Tokenomics is essentially the topic surrounding the supply as well as the characteristics of a specific cryptocurrency.
Before diving into tokenomics, however, it is important for each person to understand what a token actually means. A token is essentially a digital unit of a cryptocurrency that gets used as a specific asset or aims to represent a particular use-case of a blockchain.
Within the crypto sphere, tokens have a multitude of different use cases. However, the most common ones include security, utility as well as governance tokens.
Cryptocurrencies and tokens that are built on a blockchain feature pre-set algorithmically created issuance schedules, and what this means is that we can predict with accuracy how many coins can ever be created within a specific point in time.
In the world of decentralized finance (DeFi), we have decentralized applications (dApps) and use-cases that are powered by two types of tokens:
- Fungible tokens – Bitcoin (BTC), Ethereum (ETH), Polygon (MATIC), and other tokens which are equal in value to other tokens within the blockchain.
- Non-fungible tokens (NFTS) – Collectibles, artworks, or any other unique item which cannot have the exact same value as any other NFT.
These tokens can be traded manually. However, DeFi transactions are executed through smart contracts. Smart contracts automatically execute at a point in time when their pre-programmed terms and conditions are met.
All of the DeFi transactions get recorded on the blockchain, which is the distributed ledger, and are typically paid for in the form of the native cryptocurrency that powers that specific network.
The Use-Cases of Tokens
There are numerous use-cases when it comes to tokens, and these include:
- Ownership – a token can represent ownership or be utilized as a means of gaining access to specific features in a network, such as voting in a decentralized autonomous organization (DAO).
- Exchange of value – tokens are primarily utilized internally as well as externally as a means of exchanging the value that is created by a project within the DeFi sphere.
- Utility – DeFi projects feature infrastructure, where the utility tokens are used to reward miners, or minters of tokens, for any other purpose. Ethereum, for example, features a gas fee, which is paid out in gwei. Gwei is a denomination of the cryptocurrency ether (ETH), where a gwei is one-billionth of one ETH.
- Distribution of benefits – tokens are responsible for the equal distribution of increased value and allow owners of a token to share the upside of holding them, for example.
Moving Towards Tokenomics
Tokenomics is the study of choice as well as scarcity, where the goal of tokenomics is to essentially analyze and understand the potential value surrounding a DeFi project by considering all of the aspects of a token’s creation and management and including its supply, allocation, and distribution.
Due to the fact that the law of supply and demand is immutable, tokenomics have an enormous impact on the value of every cryptocurrency, NFT, DAO, or any other type of project that features its own native coin or token.
Typically the tokenomics analysis begins with the allocation as well as the distribution of tokens. Here, the project needs to answer questions such as if the tokens are pre-mined and if it is a fair launch.
When there is a pre-mined token launch, investors, developers, as well as specific individuals and institutions, get exclusive access to the tokens before the public offering.
In a fair launch, there is no early access to the tokens, and there are no private allocations prior to the tokens becoming publicly available.
Furthermore, when evaluating the potential value of a cryptocurrency, there are two main numbers that are considered in terms of the token supply, and these are the circulating supply as well as the maximum available supply.
- When we look at the circulating supply, this is the total number of tokens in existence, excluding the tokens that have been burned, lost, or inaccessible.
- When we look at the maximum supply, this is a representation of the maximum number of tokens that can ever be created, which is the process of mining or minting them. In the use-case of NFTs, every single token is unique. In other cryptocurrencies, such as Bitcoin, there is a maximum number of 21,000,000 coins that can ever be mined, but some projects do not have a limit or a cap.
Then there’s market capitalization. Market capitalization is the sum of the funds invested. The fully diluted market cap would be the market cap if the maximum available number of tokens were in circulation, which is an indicator of a token’s value. In other words, a token that has a high market cap but a low circulating supply could increase in value over time.
There are also inflationary and deflationary tokens. If there is an unlimited supply, then a token can be considered to be inflationary. For example, Ethereum (ETH) is inflationary as it does not have a maximum supply limit, while Bitcoin (BTC) is deflationary because it does.
The Bottom Line
All of the DeFi projects have extensive documentation regarding their founding principles, goals, and the type of governance they implement.
Make sure to always read these documents prior to investing in any DeFi project and go over all of the aspects surrounding its tokenization so you can know what kind of potential value the cryptocurrency in question can actually have.