Tokenomics is the science of the token economy. It covers all aspects of creating, supplying, managing, and sometimes removing a coin from a network.
Projects must be able to distribute their tokens to users who wish to do so. If this is not possible, the network will exist but no one will be able to use it!
There are several ways to achieve the above. Networks reward validators, or miners, with new coins. Other projects sell a portion of the token supply through an Initial Coin Offering (ICO).
Other tokens are distributed to users through specific actions. Augur, for example, rewards its users for verifying events on its betting network.
Generally, cryptocurrencies and tokens embedded in a blockchain have predefined and algorithmically defined rules for issuing new coins that determine supply. This means that we can predict fairly accurately how many coins will have been created by a certain date. Although it is possible for most crypto assets to change these rules, it usually requires the agreement of the majority of its users for such a change, and it is difficult to achieve this and implement the change. This provides some comfort and security to the holders of the coins because they know that their currency will be issued in a much more predictable manner than the governments issuing the money.
Cryptocurrencies are known for their price volatility. This is a problem as these fluctuations attract speculators who can stop a network from functioning properly by buying and selling en masse.
Projects can combat this by ensuring that there are enough coins to match the level of supply. This achieves the creation of a stable value for the coin, which encourages users to use the tokens for what they were originally designed for and not for profit-making purposes.
The team behind each project devises the rules for how tokens are created, or “cut”, as well as how they are entered and removed from the network. Different projects follow different approaches.
Some projects may include tokens held in their reserve, which can later be added to the ecosystem, as a way of promoting the development of the project or as a way of paying for the maintenance of the system. Ripple is a good example of this.
A project can, however, like Tether in October 2018, “burn” some tokens to help regulate the value of the coin in the market. The act of burning occurs when the coin is sent to a wallet that no one knows the address of.
Some networks encourage users to own, hold and use tokens as a way to prevent the network from being used other than as designed.
Proof-of-Stake (PoS) systems, which rely on validators staking their own coins, help ensure that they act honestly and fairly. If users do not follow the rules, their tokens can be lost.
Blockchain technology allows projects to create micro-economies. To become self-sustaining, they need to find the right recipe for how tokens should work within their ecosystem.
There is no one-size-fits-all strategy when it comes to tokens. Blockchain has been created and can be used in a wide range of potential uses and applications. Tokenomics allows teams to create a new model or adapt an existing one that works with what they want their project to achieve. This, if done in the right way, can create a solid, high-quality platform.
Also knowing the tokenomics of a coin is very important when it comes time to make an investment decision like buying it. Then, understanding the factors that will affect either supply or demand is vital for both speculators and investors.
In this case, there are several factors that one should consider. Perhaps most important is understanding how the digital currency will be used. Is there a clear connection between the use of the platform or service being built and the currency? If there is, it increases the likelihood that a service being developed will require purchases and usage that will ultimately help drive up the price. If not, what can the token be used for and what is its purpose?
Other important questions to know the answer to before making an investment decision include the following:
- How many cryptocurrencies or tokens are there currently?
- How many will there be in the future and when will they be created?
- Who owns the coins? Is the majority in the hands of a few?
- Is there any percentage of the coins intended to be given in the future to developers or other team members?
- Is there information to suggest that a large number of coins have been lost, burned, deleted or otherwise unrecoverable?
- Has some kind of Premining happened? Meaning that coins have been given to someone, usually a team member or the founder, before the coins become available to the public?
Tokenomics is also useful as a guide to understanding the value of a currency in the future. For example, many newbies to crypto will think something like, “If this coin reaches the price of Bitcoin, then one day…” when in reality that would never be possible. For example, let’s consider two random coins, Zcash and Tron. Zcash has the same total supply as Bitcoin, so believing that one can become as valuable as the other has some basis purely from a tokenomics perspective. However, in the case of Tron, with more than 100 billion Tron already in existence, the supply is too large for such a coin to be worth several thousand dollars. If this were the case in our example,
Although these questions seem to require complex answers, they provide an additional perspective on cryptocurrencies and understanding whether one cryptocurrency is more likely to see more growth than another.
Would you like to creat your own tokenomics strategy? Contact Enkronos team today.