Tokenomics: Guide on Supply and Demand of Cryptocurrencies. One common way to describe the inner workings of crypto projects is with the term “tokenomics,” which explains the asset’s operation and the psychological and behavioural factors that could influence its value. Tokenomics is well-planned and designed to incentivize buying and holding, which is crucial to a project’s success.
Conversely, projects with weak tokenomics will fail eventually. When problems are about to arise, it’s because of faulty token mechanisms. The first step in purchasing cryptocurrency is to educate yourself on tokenomics. This article explores tokenomics in-depth, covering its workings, key aspects, supply and demand for cryptocurrencies, token burning, allocations, and more. You will understand the significance of tokenomics and how to apply it to the valuation of cryptocurrencies.
What is Tokenomics?
“Tokenomics” is a portmanteau of “token” and “economics,” describing the demand and supply aspects of a cryptocurrency initiative. It considers all aspects of a cryptocurrency token’s economics, including its issuance, attributes, distribution, supply, and demand.
We will define a crypto token and then look at it. Crypto projects build it on top of an existing blockchain, making it a unit of digital currency. Crypto tokens are tradable and have a fixed value, just like traditional currency.
In the realm of economics, understanding the distinction between token economics and conventional economics will be useful. Throughout human history, governments have always found ways to print more money. The costs of dealing with drought or waging war can add up quickly. When dealing with it, authorities often find that minting currency is a simpler alternative to raising revenue. As more money is printed, the value of the money already in circulation declines.
On the other hand, crypto projects have token issuance timetables that are pre-determined and generated algorithmically. We can precisely estimate how many coins will be in circulation at any given moment. The distribution of coins to the many parties involved is also planned. The distribution strategy and issuance timetable changes are theoretically feasible but difficult to execute.
How Does Tokenomics Work?
Tokenomics establishes the foundation of a crypto project’s economy by outlining the token’s utility and providing incentives to token hodlers, two key drivers of token demand. Developers manipulate several variables to affect different aspects of tokenomics, such as:
Supply
Tokenomics uses the supply of currencies as a key metric for different projects. The total has two parts: the circulating supply and the total. Take Bitcoin, for example. With a price tag of $65,847 per coin, a limit of 21 million coins will be produced. The final coin is anticipated to be struck sometime around 2140. The overall quantity of Solana SOL is $152, which is 508 million SOL.
There is also a cap on the total supply of tokens in nonfungible token (NFT) initiatives. In contrast to Boring Ape Yacht Club’s 9,999 NFTs, CryptoPunks’ v1 and v2 contracts feature 10,000 Punks. Prices of NFTs tend to be greater when they are rare and exclusive.
Token allocations and vesting periods
Now more than ever, crypto projects routinely distribute tokens to stakeholders in great detail. These days, it’s standard procedure to assign tokens to venture capitalists or developers with a vesting term so that they can prove the product’s legitimacy. Developers’ tokens are locked for a specific period because of the vesting period, protecting investors from scammers who run pump-and-dump schemes.
Mining and staking
First, blockchains such as Bitcoin and Ethereum currently provide tokens to reward users for verifying transactions. So, this is known as proof-of-work (PoW). New blocks can only be added to the blockchain when miners employ their computational capacity to create them. Staking validators on proof-of-stake (PoS) blockchains earn incentives when they reach a specific threshold of currency locked away in a smart contract. Ethereum is heading in that direction with the consensus layer upgrade.
Yields
Anyone with cryptocurrency can participate in yield farming and earn more tokens. You can earn tokens for principal and interest by lending cash to anyone who wants them through smart contracts. Massive yield pools in DEXs are powered by yield farming.
Token burns
Crypto protocols must permanently remove tokens from circulation by burning them if they are to prevent inflation. The price will likely rise as the supply of tokens becomes more limited. To decrease the overall supply, Binance burns its native token BNB $594 every quarter. A more than 30% short-term price surge occurred after Stellar destroyed 55 billion XLM $0.116 coins in November 2019, about 50% of its total supply.
Tokenomics Analysis
The price of a cryptocurrency is highly dependent on market forces like supply and demand. How do developers come up with tokenomics?
The supply-side
Knowing the ins and outs of money supply and demand is fundamental to economics. These two aspects shed light on the desirability of a certain currency. When applied to tokenomics, the same theory clarifies the supply and demand for a particular token.
First, we’ll take a look at the supply side. Considering only the supply, we must ascertain if a token’s value will rise in actual terms or be inflated. If there are fewer tokens in circulation, their value will grow, according to economic theory. Deflation describes this situation. Conversely, the value will fall as the overall token supply grows. Inflation looks like this.
Considerations like usefulness and the ability to provide money for its holders are irrelevant when looking at the supply side. The only thing that matters is how the supply changes over time. When deciding how many tokens to release, you consider the total number of tokens in circulation and the amount that will be mined or distributed in the future according to an algorithm.
A greater understanding of Bitcoin can be gained by looking at its supply side. There will only ever be a total of 21,0,000,000 Bitcoin in circulation. The supply will be reduced in half every four years or until 2140. By June 2022, more than 19,000,000,000 Bitcoin had been mined, with an additional 2,000,000,000 to be issued over the next 120 years. Thus, beginning in 2022, there will be no significant inflationary pressure because only about 10% of Bitcoin will be mined. This will continue for over a century.
The demand side
The supply side is the only one that fails to generate value. On the contrary, the demand side determines a token’s value. This phenomenon needs to be understood. Imagine you own ten lovely baskets. The elaborate pattern makes you think they’re in high demand, which is a false assumption. You establish a fixed supply when you declare you will not bring more of them home. Is this a good job? Suddenly, baskets are worth more than diamonds. An astute decision? No.
The value of a given supply is not immediately proportional to it. The items must be believed to have present and future value by the people who own them. Considerations, including ROI, game theory, and memes, might help you forecast a token’s demand.
ROI
The return on investment (ROI) is the amount of money an individual may expect to make simply by owning a token. Case in point: an Avalanche AVAX $38.53 hodler can earn even more AVAX by staking their tokens to protect the network. Stakeholders can walk away with a portion of the profits from certain protocols. If you own $1.02 worth of SushiSwap SUSHI, for instance, you have a right to the protocol’s earnings.
People won’t want to own a token if they don’t think it will provide any return on investment. You will be prepared to invest in the token if you conclude that other people believe it is worth it.
Energy levels of the community
The level of community enthusiasm for a token can tell you a lot about the people who have invested time, money, or sentiment in it. Please find out how enthusiastic they are on Twitter, Discord, and other platforms. Get a feel for how long these folks have been around. Would they accept the token as an integral part of who they are?
The amount of community energy also plays a significant role in determining the token’s future demand. Dogecoin DOGE $0.16 is a great illustration of how belief alone can propel a token forward. Because of its devoted fan base, a meme token rose to the ranks of the most valuable cryptocurrency tokens.
Game theory
Game theory is the underlying mechanism of all technologies. Put another way, it studies decision-making processes and their underlying motivations. To comprehend decision-makers actions, it employs mathematical models of cooperation and conflict. The crypto domain uses it so developers can measure stakeholder decision-making in an interactive setting.
The design of tokenomics includes components that increase the demand for tokens. In tokenomics, lockups have shown to be a useful game theory. Token holders can lock their tokens in a contract and receive extra rewards according to the protocol.
To participate in the profits of the Curve Protocol, you must secure your Curve Protocol (CRV) tokens. Your profits will increase in proportion to the time you lock the tokens. There are a few reasons for stakeholders to release their tokens when there are huge incentives to stake CRV for longer.
Tokenomics Examples: Near Protocol
Very Close to the Protocol The Near Protocol’s NEAR $6.90 has several potential uses, including protocol security, internal and external application and resource exchange, and more.
Token utilities include:
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Fees for executing transactions
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Data storage
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Staking and participating in network security
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Governance participation
There will be a limit of 1,000,000,000 NEAR tokens issued. One feature of the protocol is the annual fixed release of tokens, which amounts to about 5% of the overall supply. Validators secure transactions, storage, and computing with 90% of tokens as a reward. The network keeps inflation in control by burning transaction fees.
Conclusion
You can assess a crypto project with basic competence if you have a solid grasp of tokenomics. Token supply and demand can be better understood with the help of their documentation or white paper. After reading this, you should have no trouble understanding the team’s strategy for increasing token demand and making an informed decision about the token’s future.
How a token compares to the dollar, Bitcoin, or alternative cryptocurrencies is heavily influenced by tokenomics. By analyzing the data, you can see if the developers have thought outside the box regarding token distribution or if they have merely followed the herd. To further increase your investment’s worth, choosing projects with strong tokenomics is crucial.
