What is tokenomics and how does it impact crypto?

Tokenomics is a relatively new field that involves financials and token design. Combing tokens and economics, it’s the study of how tokens are used within an ecosystem and the economic effects of those token use cases. Fundamentally, tokenomics is about creating incentives for users and developers to participate in and grow a project’s ecosystem.

Tokenomics involves understanding the supply and demand of crypto assets. It also encompasses token velocity, a key metric that measures how quickly users are transacting with and selling their tokens. The study can be applied to any type of token, including utility tokens, security tokens, and even non-fungible tokens (NFTs). Tokenconomics also includes aspects such as token supply, token demand, and token price. It considers the rewards and incentives for different stakeholders in the ecosystem, such as miners, developers, and users and works out how worthwhile a token might be in the grand scheme of the industry.

One key question in tokenconomics is in the design of an economic model and whether incentivising all stakeholders to participate in the ecosystem will actively contribute to its growth.

Before taking an indepth look at tokenomics, it is important to understand what a token means.

What is a token (cryptocurrency)?

A token is a unit of value that can be used to represent assets, access rights, or other privileges within a project’s ecosystem. Tokens can be issued on different blockchain platforms, such as Ethereum, Tezos, and EOS.

Tokens can be used in a lot of different ways, but the most common use-cases are as security, utility and governance tokens.

What are the different types of tokens?

Tokens can be classified into three main categories: utility tokens, security tokens, and non-fungible tokens.

Utility token

A utility token is a token that gives holders access to a product or service. Utility tokens are often used to raise funds for a project during its early stages. Utility tokens are tokenized versions of a good or service that can be exchanged for goods, services, or other utility tokens. For example, a tokenized version of a song could be exchanged for another tokenized song.

Security token

A security token is a token that represents an investment in a company or project. Security tokens are subject to federal and state securities laws. For example, a token that represents an ownership interest in a company would be a security token.

Non-fungible token

A non-fungible token (NFT) is a token that represents a unique asset. Non-fungible tokens are often used to represent digital collectibles, such as art or music.

Key features of tokenomics

In the same way different fiat currencies differ, each crypto asset has a different monetary policy. Before investing in a token, it’s important to understand the key features of its tokenomics.

These are the important variables that developers use to define a crypto’s tokenomics:

Mining

This is the process of creating new tokens. For example, Bitcoin miners are rewarded with newly minted Bitcoin for verifying transactions on the blockchain. In mining, new tokens are given as rewards to people who use their computer power to discover new crypto blocks, append date and add these blocks to the crypto’s blockchain.

Staking

This is another process of creating new tokens, but staking is a bit different from mining. With staking, token holders can earn rewards for holding onto their tokens and keeping them staked, or locked up in a cryptocurrency wallet. When token holders stake their tokens, they’re essentially putting their tokens at risk in order to help validate transactions on the network. If they successfully validate a block of transactions, they’re rewarded with newly minted tokens. The Ethereum 2.0 upgrade is going to ensure the crypto asset becomes staking based.

Finite vs infinite supply

A cryptocurrency token can have a finite or infinite supply. A good example of a token with a finite supply is Bitcoin, which will only ever have 21 million BTC in existence. In contrast, Ethereum has an infinite supply because new ETH is minted every time a block is mined on the network. The tokenomics of a project will usually dictate whether a token has a finite or infinite supply.

Token burns

Some tokenomics models include token burns, which is when a portion of the token supply is permanently removed from circulation. This usually happens when tokens are used to pay transaction fees on a platform, and then those tokens are burned. It’s a way to reduce the circulating supply of a token, which can in turn increase the token’s value. A recent token burn is the one that Binance did with its BNB token.

Yields

In the cryptocurrency space, a yield is the percentage of profit earned on an investment, paid out periodically. For example, if you invest in a token that has a 10% annual yield, you will earn 10% on your investment each year. The tokenomics of a project will often dictate the yields that investors can earn. Defi platforms make use of the feature to allow users to earn interest on their token holdings.

Token allocations

Tokenomics can also dictate how a token is distributed. For example, a token might have a 60/40 split between the team and investors, with the remaining 20% going to a foundation or reserve. Or, a token might have a 70/30 split between the team and the community, with the remaining 10% going to a foundation.

The impact of tokenomics on the crypto industry

Tokenomics can have a major impact on a token’s price and its ecosystem. They can dictate how a token is distributed, how it’s used, and what kind of yield investors can earn from holding it. Understanding tokenomics is essential for any investor interested in buying or holding tokens.

The most important tokenomics metric is market capitalisation, which is the total value of all token units that have been sold on public markets. Market cap is a good indicator of a token’s liquidity, as it shows how much money has been invested in the token. A high market cap indicates that a token is more liquid and is more likely to be traded frequently.

Another important tokenomics metric is velocity, which measures how quickly token holders are trading their tokens. A high velocity indicates that token holders are frequently trading their tokens, while a low velocity indicates that token holders are holding onto their tokens for longer periods of time. Velocity can have a major impact on a token’s price, as it affects the supply and demand of the token.

Token Governance

Token governance is another important aspect of tokenomics. Token holders can vote on proposals that impact the token, such as changing the token’s inflation rate or changing the token’s distribution. Token holders can also vote to elect the token’s governing body, which makes decisions about the token. DeFi platforms are often governed by token holders, as they are decentralised and allow for community involvement.

The importance of tokenomics in crypto investing

Tokenomics is a relatively new field, and there is still much to learn about it. However, understanding the basics of tokenomics can help you make more informed decisions about investing in tokens. Tokenomics will become increasingly important as more and more projects launch their own token sales and as the industry matures.

There are a few key things to look at when deciding to invest in a crypto project:

  • The token’s use case: What is the token being used for? Is it just a payment token or does it have utility on the platform?
  • The token supply: How many tokens are in circulation and how many will be minted in the future?
  • The token distribution: Who is holding the token and how is it being used?
  • The token velocity: How fast are token holders trading their tokens?
  • The market cap: What is the total value of all the tokens in circulation?

Taking all these into consideration will help you come to the best conclusion regarding the crypto asset.

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