What is Tokenomics and why does it matter? Tokenomics is all about the factors that impact a token’s use and value. It is not limited to the token’s creation, distribution, supply, demand, incentive mechanisms, and token burn schedules.
The well-designed tokenomics are critical for the success of crypto projects. It is necessary for the investors and stakeholders to go through a project’s tokenomics before making decisions for investors in an order to participate.
Introduction
Tokenomics is an essential component of fundamental research on a crypto project. Apart from looking at the white paper, roadmap, and the growth of the community, tokenomics are said to be central in evaluating the future prospects of the blockchain-based project. Crypto projects need to design their tokenomics carefully in an order to ensure sustainable long-term development.
Blockchain-based projects create tokenomics rules around their tokens to motivate or demotivate various user actions. Notably, Tokenomics are similar to how a central bank prints money and brings in monetary policies to motivate or demotivate spending, lending, and saving of money.
The word “token” refers to both coins and tokens. In the meanwhile, you will be able to learn the difference between coins and tokens. The rules of tokenomics are implemented with the help of code. These are transparent, predictable, and hard to change.
Let’s have a look at bitcoin, for instance. The overall supply of bitcoin is pre-arranged to 21 million coins. The bitcoins are created and circulated by mining and the miners are provided with some bitcoins as a reward after each block is mined every 10 minutes or so.
The reward is also known as a block subsidy. It is divided into every 2,10,000 blocks. Likewise, the process of dividing takes place every four years. Ever since the first block was created on the Bitcoin network, the reward was halved three times from 50 BTC to 25 BTC, 12.5 BTC, and 6.25 BTC, currently.
On the basis of these rules, it becomes easy to calculate that over 328,500 bitcoins will be mined, this year, by dividing 2022’s total number of minutes by 10 as a block is mined every 10 minutes and later multiplying it by 6.25 because each block gives 6.25 BTC as rewards.
Bitcoin-based tokenomics consists of designs related to transaction fees which are received by miners while validating a new block. The transaction fee is designed to increase on the basis of transaction size and the rise in congestion network. With this, you can be secured from spam transactions and keep validating transactions even though block subsidies keep vanishing.
Bitcoin tokenomics are said to be simple and feasible. Everything, on Tokenomics, is transparent and predictable. The incentives around Bitcoin allow participants to be compensated in an order to keep the network robust and give to its value as a cryptocurrency.
Tokenomics Key elements
Tokenomics refers to the structure of a cryptocurrency’s economy as created by its creators. Let’s have a look at some of the most important factors to be considered while looking for a cryptocurrency’s tokenomics.
Token supply
Just like crypto, the supply and demand of a token are the key factors that impact the price of any good or service. There are various critical metrics that measure the supply of a token.
The first one is known as a maximum supply which means there will be a huge number of tokens coded to be in the lifetime of the cryptocurrency. Notably, Bitcoin has a maximum supply of 21 million coins while Litecoin has a supply of 84 million coins and BNB with a maximum supply of 200 million.
Notably, there are some tokens that don’t have a maximum supply. In the meanwhile, the Ethereum network increases the supply of ether every year.
Token Utility
The utility of a token refers to the use cases for a token. With this, the users are enabled to stake BNB with other products within the ecosystem in an order to earn additional money.
There are several other use cases for tokens. While the governance tokens allow the user to vote on changes as per the token’s protocol, the stablecoins are created to be used as a currency. On the other hand, the security tokens represent financial assets.
These factors help an individual to determine the potential use cases for a token as it is essential in understanding how a token’s economy may evolve.
Analysis of token distribution
Apart from supply and demand, it’s necessary to go through the process of distribution of tokens. Understanding the variety of entities helps you to hold a token that gives you an insight into how they are likely to trade their tokens.
Generally, there are two ways to distribute tokens. Firstly, it can be a fair launch or a pre-mining launch. Secondly, it could be pre-mining that allows a part of the crypto to be minted and distributed before being offered to the public.
Several large organizations hold a huge amount of tokens which are typically considered riskier.
Examining the token burns
A lot of crypto projects burn tokens on a regular basis. It means pulling the tokens out of distribution permanently.
After the supply of a token is reduced, it is said to be deflationary. On the other hand, when a token’s supply has been expanding then it is considered inflationary.
Incentive mechanisms
The token’s incentive mechanism is very important. Likewise, the Proof of Stake mechanism is yet another method of validation that has been gaining prevalence. This allows participants to hold their tokens in an order to validate their transactions. The more the tokens are locked up, the higher the chances to be chosen as validators and getting rewards for validating the transactions. So, if validators try to affect the network, the value of their own assets turned out to be at risk.
Several DeFi projects have gone through innovative incentive mechanisms in an order to achieve growth. A crypto lending platform ‘Compound’ allows the investors to deposit cryptos in the Compound protocol. It also allows the users to collect interest on them besides receiving the COMP tokens as an additional reward.
Also, the COMP tokens work like a governance token for the Compound protocol.
What’s next?
While the genesis block of the Bitcoin network was established back in 2009, tokenomics has been evolving significantly. The developers have looked for several tokenomics models. Indeed, they have seen successes and failures. Notably, the tokenization of traditional assets like real estate and artworks is potentially able to generate new innovations in tokenomics in the coming future.
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