Introduction to Tokenomics
Money is used everywhere. International corporations transact in it; citizens pay tax with it; without it, people would struggle to have life’s basic necessities: food, clothes, and a roof over their heads.
Such a pervasive asset used to be until very recently controlled by governments. Central banks were the only institutions in most states authorized to issue currency to their citizens.
A whole science, that we now call monetary policy, has developed around this process. Cryptocurrency has changed this. Individuals can create their micro-economies. Tokenomics essentially takes what central banks use as monetary policy and applies it in blockchain networks.
We believe “tokenomics” did not get enough attention in the crypto community. People are following the news and checking the charts constantly. However, when it comes to studies and research on crypto projects, there is a gap.
That is why we made this article breaking down everything you need to know about tokenomics to help you with your investment decisions.
However, investors are not limited to investing only looking to technical analysis of the token but also checking the tokenomics fundamentals. So, before we consider what tokenomics means and its concepts, it is important that we first know what a token is.
What is a Token?
Well, a crypto token or simply token in case anyone needs to recall the definition is essentially a crypto coin based on a blockchain platform that can be exchanged with another blockchain, and that provides many incentives to the holders of said token.
Tokens have multiple use cases, but the most common are security, utility, and governance tokens. Now, tokenomics. The term is formed by pairing up the two words “token” and “economics.”
Honestly, I got all the frustration and confusion about the term. The first time I heard someone talk about “tokenomics” and the importance of researching it, I was baffled.
I did not know precisely what that term meant or where I should do research on it. If you also fall into this situation, worry no more.
What is Tokenomics?
As I earlier said, the word “tokenomics” is a combination of “token” and “economics” and is a term for all the factors that go into the value of a cryptocurrency.
In fact, tokenomics is the science of the token economy. It basically points to the economics of a crypto token. It covers all aspects involving a coin’s creation, management, and sometimes removal from a network. Let’s break down each of the concepts of tokenomics next:
Crypto projects need to be able to distribute coins to prospective users. If not, the network can exist, but no one will be able to use it!
There are different ways this can be achieved. The networks reward validators, or miners, with newly minted coins; others sell a portion of the token supply to prospective users in an initial coin offering.
Other tokens are distributed to users via certain actions and behaviors. Augur, for example, rewards people for verifying facts on its betting network.
It’s true that cryptocurrencies are notorious for their volatility. This is a problem, as fluctuations attract some investors who can stop the network from working properly by buying and selling all at once.
Projects can combat this by ensuring there are enough coins to match the levels of supply. This helps to create a stable price for the coin, which encourages people to use the tokens for what they’re designed for.
The core team behind each project comes up with the rules for how tokens are created or minted as well as how they are injected into, and taken out of, the network. Different projects take different approaches.
Some projects can include tokens held in reserve that can be added to the ecosystem at a later point, as a way to promote growth or pay for system maintenance, and XRP of Ripple is a good example of this.
Other projects, meanwhile, take a deliberately hands-off approach to how the network works. Augur’s developers, for example, play no role in how the network runs; they merely maintain the infrastructure.
A network like Tether, however, “burned” tokens in October 2018 to help regulate the coin’s value in the marketplace. The act of burning happens when currency is sent to a wallet whose address no one knows.
Most teams building a network won’t go on to be its rulers That’s not how decentralization works. However, most developers know that what they build now may not necessarily work in the future.
How tokens are governed may need to be altered as the network grows and matures. Some, but not all, have come up with provisions for how network users can effectively change the way tokens are managed within the ecosystem through consensus.
Tokens as Governance
Some networks incentivize people to own, hold, and use tokens as a way of preventing people from buying and saving coins for longer periods and preventing the network from being used as it was designed.
Proof-of-stake systems, which rely on validators to actually “stake” their coins, help ensure they act honestly and fairly. If they don’t play by the rules, their tokens can be forfeited.
Why is Tokenomics important?
Well, blockchain technology enables projects to create micro-economies. To become self-sustaining, they need to figure out how tokens should work within their ecosystem. There can be no “one size fits all” attitude when it comes to tokens.
Blockchain has enabled a diverse range of use cases and implementations. Tokenomics enables teams to create a new model or adapt an existing one that works with what the project wants to achieve. This can create a high-functioning and stable platform if done well.
The principles, philosophies, and models by which tokens, coins, and the projects that underpin them are at the very beginning of experimenting with what works, and what doesn’t.
There are plenty of models that won’t work, and we expect those projects to fade away. But the ones that do will go on to inspire and guide new projects yet to come.
So, why does Tokenomics matter when investing in crypto?
Value investing expert Seth Klarman explains that “in the short run, demand and supply alone influence market prices” in his well-known investment book, Margin of Safety. If that is the case, and if it holds true for both the stock market and crypto-assets based on blockchain technology, then knowing the variables that will affect demand and supply is important for both investors and speculators.
In that situation, there are several things to think about when examining crypto-tokenomics. The usage of digital currency is perhaps the most significant factor. Is there a definite connection between using the platform or service that is being developed and the asset? If there is, there is a good chance that a service that is expanding will call for purchases and usage, which ultimately contributes to raising the price. What can the token be used for if there isn’t one?
Using tokenomics as a guide can help you determine what an asset might be worth in the future. For instance, many people who are new to cryptocurrencies may believe something along the lines of, “If this coin becomes as valuable as Bitcoin, then one day…” even if this may never be possible.
Let’s use these two coins, Tron and Bitcoin Cash, as an example. Because Bitcoin Cash has the same total supply as Bitcoin, the idea that one might eventually become just as valuable as the other is possible. Tron would need to become the most valuable company in history, but with over 100 billion already in existence, how can one coin be valued at thousands of dollars?
Although the answers to these questions may appear complicated, they will add another perspective on crypto assets and help determine whether one asset is more likely to have a bright future than another.
You should have a good idea of what tokenomics is, its concepts, and why it is important. But if you are interested in knowing more about blockchain technology and some of the greatest networks and applications being built today, stick around for future articles to come.
What do you think about this video? Do you know a project with good tokenomics?
Kindly let us know what you think in the comments section below.
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Disclaimer: This article is provided for informational purposes only. It is not offered or intended to be used as legal, tax, investment, financial, or other advice.