Find out how tokenomics can be used to create potential value for companies, investors, and users.
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The world of blockchain-powered applications is booming, with steadily rising interest in NFTs, smart contracts, and decentralized finance (DeFi). With the breakneck pace at which new innovations are hitting the market, a new field has sprung up to encompass the unique economics of cryptocurrency.
Tokenomics is a unique branch of economics that's dedicated to studying cryptocurrency and crypto-based ecosystems. This encompasses a mixture of general economics information and cryptocurrency-specific subject matter knowledge. Tokenomics refers specifically to the way in which the rules around a token are designed to benefit different actors within that token’s ecosystem. You can typically find this information in a project’s white paper. It may include the token’s functionality, objective, and allocation policy.
Given that any two tokens can be highly different from each other, it's helpful to have a framework through which to understand any particular token. This is where tokenomics comes into play, as you can use it to identify and categorize the key characteristics of any given cryptocurrency as well as understand how it compares favorably or unfavorably to other similar tokens. These factors include allocation, distribution, supply, market capitalization, and the token model.
One of the first cues to look at in a cryptocurrency is the allocation and distribution of the token. Does the supply rest in the hands of many smallholders, or is it excessively centralized in a few larger holders? The latter is often seen as a red flag. Centralization can lead to token governance being contingent upon a small handful of actors. What’s more, the more concentrated a token is, the more susceptible to price manipulation it might be. On the other hand, a more decentralized distribution of tokens is largely regarded as healthy for a cryptocurrency.
The supply of a token refers to how many of the tokens currently exist, and how this number will change in the future. Sometimes supply is defined with even more granularity. If you look at a price tracking site like CoinGecko, you’ll see two different supply numbers. Circulating supply refers to the portion of supply that has been released to the market and is currently tradable. Many protocols have a token emission or inflation schedule that increases the supply over time. Total supply on the other hand refers to the total supply that will ever exist. In some protocols, there is no upper bound - meaning that the supply of tokens will continue to grow over time. Other cryptos have a fixed total supply, with Bitcoin’s 21,000,000 being the most famous. One of the most fundamental design decisions of token economics is whether to make a token have a fixed supply, an inflationary supply (i.e. increasing the supply through ongoing programmatic emissions and token minting), or a deflationary supply. A deflationary supply tends to occur only when there is a token burn mechanism that removes more tokens from supply than are being minted. Ethereum for example increasingly has deflationary properties after the introduction of EIP-1559, through which a portion of the fee for each transaction is burned.
Market capitalization refers to the total value of all of a given cryptocurrency that's in circulation. This is the most useful metric for understanding how large a crypto is, although that's not all that goes into determining the worth and relevance of a token. Crypto market capitalization is also not without its criticisms as a metric. Market capitalization is a relatively simplistic measure of price of a single token multiplied by the outstanding supply. What this doesn’t account for is liquidity. Many cryptos are highly illiquid, meaning that you wouldn’t be able to buy or sell very many without causing a major reaction in the price. What’s more, having a large market cap alone does not mean a token is more useful than other tokens with smaller market caps. However, at the end of the day, market capitalization is the base metric most of the industry uses, so it’s still worth noting how it’s calculated and where any given token stands in terms of market cap.
In short, a cryptocurrency’s Token Model covers the most important quantitative aspects that relate to the token itself: the supply of the token, how the supply changes or stays the same (and what influences the token’s supply) over time. The model also spells out what investors must do to purchase tokens, and how holding the token for specific time periods rewards a user with more tokens.
Models are one of the more complex elements of tokenomics to grapple with if you are just starting out with crypto trading. Sometimes it's quite clear-cut, but in other cases, it's more nebulous.
Bitcoin's token model includes data on its fixed supply, block production that emits more tokens in the form of block rewards, and 4-year halving cycle that reduces the block reward by half each time.
Alternatively, each crypto token itself has its own model and describes what the token does in practice and what value proposition is associated with its functionality. Other token models may include more quantitative details such as emissions/inflation schedule, burns and burn rate, token supply, demand, and which rewards are built-in for those who stake their tokens in liquidity pools.
In conventional economics, inflation refers primarily to the rising cost of goods. On the other hand, inflation in tokenomics refers to the increase of the supply of a coin, which heightens availability while decreasing the value of each coin. Some coins have inflationary properties as their supply grows via mining or other allocation systems, while others have fixed supplies that won’t increase or decrease. There are even deflationary coins that have a shrinking supply.
Even the most enthusiastic cryptocurrency enthusiasts wouldn't have expected how far the applications of blockchain technology have gone in just over a decade. Where the enigmatic Bitcoin creator Satoshi Nakamoto envisioned a digital currency, an entire decentralized financial system has begun to evolve before our eyes. Even if growth slows down, there's sufficient momentum and commitment behind cryptocurrency and its accompanying field of tokenomics that we're sure to see continued evolution and fresh developments with the technology.
The bottom line is that the future of tokenomics is bright, and anyone with an interest in finance and technology needs to keep up with it. You can follow the latest developments in crypto and manage your own portfolio on FTX.us, a US-based crypto exchange and information hub.