What is Tokenomics?
Tokenomics is a new term that is often used among cryptocurrency investors. It is a portmanteau of two words namely token and economics. Tokenomics is about the economic forces associated with a given token such as supply/demand, distribution, minting, incentives, transaction fees, burn schedules, etc.
Tokenomics is an important aspect of a digital currency project in order to ensure its success and continued price appreciation.
Main Factors of Tokenomics
Here are some main aspects that determine the Tokenomics for a given digital currency project:
The most important and foundational aspect of Tokenomics is its total supply. Most digital coins are not minted in advance when they are introduced. As new transactions are added to the blockchain, the network mints new coins and adds them to the circulatory supply based on the consensus mechanism.
The maximum supply of a given token is the amount that will ever exist for a given project. On the other hand, the circulatory supply of a given token project calculates the total supply of the token at present.
The maximum, total, or circulatory supply is going to have an impact on the price of a given digital currency. Therefore, supply is an important metric of Tokenomics.
The utility associated with a given token is also one of the defining features of Tokenomics. Based on the use case of a given token, investors are likely to acquire it more when they opt to avail the feature.
For example, ETH has a utility for staking in the PoS mechanism. Therefore, the value of ETH tokens is likely to increase when the trading volume on the Ethereum blockchain increases leading to increased transaction verification and validators.
In addition to supply and demand, the value of a given token is also linked to its distribution mechanism. Most blockchain projects introduce native tokens in two ways either a fair launch or a pre-mining debut. In a fair launch, tokens are not distributed among private investors or venture companies.
All tokens are made available to the public at once starting at equal opportunity. On the other hand, pre-mining distribution method is a process that allows issuers to introduce their products to a select group of investors before public offering.
This can take place in the form of funding rounds that can test the project on various fronts before it is available for the general public.
As mentioned before, the total supply of any token at a given time can make a huge difference for its overall prices and value.
Most cryptocurrencies aim to have a capped total supply meaning that the total number of tokens in the project cannot exceed beyond a specified quantity. However, some token projects can also have infinite supply or massive capped limit of coins.
This situation poses the threat of losing the unit price of a given token overtime. Therefore, some token projects tend to incorporate burning mechanism or events.
Token burning is a process that allows investors or issuers to send a given cryptocurrency to burn addresses that take them out of the circulatory supply for good. Some digital coins incorporate token burning at random while others have organized token burning events such as BNB.
Incentives and Fees
Blockchain networks do not have already minted tokens. New tokens are minted to award validators or miners on the network for verification of transactions and adding new blocks. Therefore, the circulatory supply of a given project is often connected to the miners on a project based on their token rewards.
However, there are some blockchains such as Bitcoin that also address the issue of token incentives in the form of new minted coins or transaction fees. Bitcoin has a mechanism called halving that slashes new token rewards for miners in half after every four years.
On the other hand, blockchain networks can also make changes in the transaction fee ratios after conducting governance voting or adding new updates to the blockchain project.
Tokenomics is an important aspect of a cryptocurrency project. Investors can study the dynamics of Tokenomics and carry out the fundamental analysis of a given token project before investing in it.
In this manner, they are able to ascertain the price movement expectations for their investments and increase their profit earning potential.