The financial market is a dynamic environment that goes through ups and downs in cycles. The…
Tokenomics is another variable in the cryptocurrency space that beginners have to be aware of. It plays an important role in determining whether a specific cryptocurrency is worthy of investment or not.
Centralized financial institutions set rules regarding the circulation of money, its usage, and limitations. Cryptocurrency has the same setup using tokenomics.
Let’s understand more about crypto tokenomics- the meaning, purpose, and impact on cryptocurrency.
Tokenomics is a blend words composed of token and economics. It is an umbrella term for all the characteristics that a particular cryptocurrency possesses. Tokenomics helps describe the elements that make this new crypto coin or crypto token interesting to investors.
It includes information about a cryptocurrency’s demand & supply, distribution, incentives structure, and timetable for token burns.
Remember that Bitcoin has a limit of only 21 million coins? Also, Binance set its limit at 200 million coins. On the other hand, Cardano will only produce 45 billion coins. These limits are part of tokenomics.
Why Is Tokenomics Important?
Unlike fiat currencies where policies are written down and subject to the approval of the authorities, tokenomics’ policies are programmed in codes that uphold transparency and immutability(records cannot be changed or tampered with).
New cryptocurrency projects need to build credibility in the crypto space. Aside from publishing a comprehensive white paper, they can further introduce their concept to the public via tokenomics. They can show their planned incentives for buying and holding tokens. This part is crucial because it is an indicator that this new project will last for the long term.
Seth Klarman, the author of Margin of Safety, one of the reputable guidebooks about investment, said:
“In the short run supply and demand alone determine market prices.”
This saying applies to tokenomics as well because the demand for a new project’s token will depend on their range of utilization for their digital currency For example, if they show that there is a strong link between the platform and the asset, and it has many opportunities to grow the price. These can encourage people to buy coin or token. Hence, increasing the demand for it.
Core Elements of Tokenomics
Various factors influence a tokenomics’ structure. The variables are the following:
Cryptocurrency also abides by the law of demand and supply. The supply of tokens or coins is a major factor in new crypto projects.
There are 2 kinds of supply in tokenomics
Maximum Supply – this is the total supply of coins that a specific cryptocurrency will ever have in the market. Some coins have a limited maximum supply like Bitcoin and Litecoin. Ethereum’s network supply increases annually. Additionally, stablecoins like Binance USD and USDT have no maximum supply limits because it is fiat-backed.
Circulating Supply– this refers to the number of tokens in circulation.
Mining and Staking
Companies like Ethereum 1.0 and Bitcoin rely on mining to distribute rewards to participants who successfully validate transactions in blockchain technology. On the other hand, Proof of Stake blockchains use a staking system. In POS, investors who staked the ideal number of coins receive the rewards.
This is a feature of decentralized finance platforms. They offer high yields as a motivation for investors to buy and stake more tokens. Moreover, yield farming creates liquidity pools where people can loan cryptocurrencies to each other with the protection of smart contracts.
Allocations and Vesting Periods
In particular, new crypto projects reserve tokens for developers and capitalists. The vesting period locks away the reserved tokens for a specific amount of time. This method protects investors from pump-and-dump schemes.
Some companies permanently remove coins from their circulation. This is also known as token burning. Following the law of supply and demand, reducing the number of coins in circulation improves its price because it becomes scarce. To burn tokens is to keep the cryptocurrencies at a deflationary state.
Likewise, non-fungible tokens (NFTs) also use tokenomics but in a different manner. Some projects really make the most out of digital scarcity.
These key elements of tokenomics are necessary because it reflects the value of a cryptocurrency. Tokenomics impacts its usage, scalability, and even its popularity among investors.
Fun Fact about Tokenomics
Harvard psychologist B.F. Skinner first proposed the concept of token economy in 1972. It was his belief that a token economic model would lead to behavior control. If people receive something with value, they will be incentivized to behave positively.
Furthermore, the word ‘tokenomics’ is not yet registered in the Oxford English Dictionary. Hopefully, with the attention that cryptocurrency is receiving, the term will gain more acceptance.
Final Word about Tokenomics
In the traditional finance sector, the authorities call it monetary policy. In the crypto space, we call it tokenomics. When you are interested in a certain crypto project, look into its initial coin offering (ICO). It is part of tokenomics and will give you a hint about the coin’s value, distribution, and price.
In conclusion, pay enough attention to a new project’s tokenomics because it will help you understand the importance and value of a new crypto coin or token.