Tokenomics is a comprehensive term for the economical characteristics of a token, the word is derived from the words token and economics.
The tokenomics of a cryptocurrency cover all the elements that make a particular cryptocurrency a valuable and interesting investment to investors.
Tokenomics give insight into the use cases and supply and demand of a cryptocurrency project you are investigating. Understanding a cryptocurrency’s tokenomics should be central to your investment decisions in the crypto industry.
The tokenomics of a cryptocurrency comes down to two things, what the token can do, and how many tokens there are/ there will ever be.
The details of a projects tokenomics are often outlined in a project’s whitepaper or on the overviews of the projects on summary websites, you can find the best places to research crypto projects here.
Before we dive deeper into tokenomics, let's see what tokens are and how they may differ from one another.
A token can be seen as a crypto project’s own form of money. Tokens nearly always have a specified use case on their own network.
At Initial Coin Offerings (ICOs) crypto projects are looking for financial support for their project. In order to raise these funds crypto projects offer a token at the ICOs. Yet, the investors must be somehow incentivized to purchase the token, the tokenomics of a cryptocurrency provide this incentive.
Tokens can be used for various things but fall in either of three categories: security, utility, or governance tokens.
Security tokens can be seen as synonymous with stocks in a company. Many cryptocurrencies including Bitcoin are monetary assets or stores of value.
In contrast, a security token is used the same way as a stock, bond certificate or another investment asset merely to showcases a stake in a company or asset.
Security tokens are an investment asset, a digital asset that represents ownership of a company in the form of tokens and therefore have to be approved by the Security and Exchange Commission (SEC).
As of right now, there are not many security tokens on the market.
Utility tokens provide investors with use-case incentives to purchase and invest in a token.
The core purpose of utility tokens is to be initially issued to investors, who gain value through the use case of the token on the project’s native ecosystem.
The utility factor of a digital token should provide the token with constant demand by users of the project’s ecosystem.
An example of a utility token is Binance’s BNB coin which can be used to reduce gas fees on the Binance exchange.
Another example of a utility token is the Smooth Love Potion (SLP) token on the Axie Infinity network. SLP is intended to pay transaction fees on Axie Infinity’s play-to-earn games. SLP has no use case other than on the Axie Infinity Metaverse.
Governance tokens enable investors/token holders to make choices within a given community.
These communities may indlude decentralized application projects (DAOs). With tokens governance tokens you are able to vote on what the DAO, Decentralized Application (Dapp) or decentralized finance (DeFi) project does.
The developers often present a few options on which they will focus their developing efforts next, governance token holders are then allowed to vote on what they would like the project to develop next.
Token holders with larger holdings count as larger votes, which may skew the decision-making into the hands of the richest holders.
Governance tokens essentially allow project to distribute their decision-making power to the communities. This way a project ensures that their goals are not skewed of the goals of their investors and token holders.
This decentralization of decision-making power in the community is used to avoid centralization and decisions that only positively impact the few.
Payment tokens are another type of token that represents the purest form of cryptocurrencies. The primary/only use case for this type of token is as a medium of payment.
The incentive to use this token as a medium of payment is that the payments happen on their own decentralized blockchain and often only take seconds to minutes to transfer.
Usually, payment tokens have no further function or link to other development projects. An example of this form of cryptocurrency is Bitcoin.
There is no real utility to Bitcoin as of right now except for its deflationary nature and the immensely secure blockchain payment network it is guaranteed to provide.
Understanding the tokenomics of a project gives you insight into how useful and rare a token is. If a token is infinite, it is automatically worth infinitely less than if a token has a limited supply.
Since the value of anything is determined by the supply and demand of that given product tokenomics are essential to the financial incentives for the purchasing and holding of a token.
Tokenomics also give you insight into what the use-case for the token is. If there is a utilitarian incentive for investors and users to purchase the token, the price of the token is more likely to rise.
Token issuance is the process of issuing new tokens that are then added to the total supply of the cryptocurrency.
During the development process of a cryptocurrency project the developers program the supply for the token. The initial issuance goals are written in the code and can be viewed in the whitepaper of a cryptocurrency.
Usually, token issuance is regulated by complex algorithmic programs that determine the number of tokens necessary for the blockchain ecosystem to function properly.
For example, Bitcoin’s whitepaper details there will only ever be 21 million BTC tokens. The only way new tokens get released into the circulating supply is through mining block rewards. The mining reward per block is also ever decreasing, by being cut in half every 210,000 blocks (about every four years).
Some of the base-level things to know about tokenomics include how many coins or tokens currently exist, how many may be added to the total supply in the future, who owns the majority of the coins, coins may be set aside to be released in the future to developers, a large number of coins may have been lost or burned.
The tokenomics of cryptocurrency can often change under no circumstances. Only projects that have not programmed their supply can adjust their supply by printing more, which is always a red flag.
Most projects can only adjust their supply through a hard fork. A hard fork means that they copy the history and code of a token and make the wanted adjustments in the new token’s code.
Although, by hard forking a token the token will be a different completely different token.
For example, Bitcoin has gone through forks of its own. In 2017 there were a decent sum of developers that wanted to adjust the currency’s traction limits (block size). Therefore, on the 1st of August 2017, the Bitcoin network went through a hard fork, resulting in Bitcoin Cash.
The adjustments were made and all the history of the original Bitcoin blockchain is converted onto the new forked chain. The tokenomic changes that were made during the fork into Bitcoin Cash in no way affected Bitcoin’s original chain and the two have been functioning separately since 2017.
In conclusion, researching tokenomics should be a primary factor in your assessment of cryptocurrency investments.
Ensure your understanding of any crypto project in which you invest so that you are met by no surprises in the future.
The most crucial information about any project can be found in the project’s whitepaper or on websites that include analytical information about projects. More about these research methods can be found here.