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What are tokenomics and why do they matter?
The tokenomics of a cryptocurrency project are an incredibly important factor to consider when deciding whether it has future growth potential. As the number of coins and tokens available on the market continues growing, it is more important than ever for all digital asset investors to familiarize themselves with this term and understand how tokenomics can be used in practice to find the most profitable long-term passive income opportunities.
The cryptocurrency market has seen exponential growth over the past year alone, with its total market cap increasing by some 600% in just one year since November 2020 to stand at around $2.8 trillion today, according to CoinGecko. As digital assets have grown in popularity, the number of coins and tokens available to investors has ballooned to around 6,000. Understanding tokenomics can help investors sort the wheat from the chaff and avoid projects that have no sustainable future.
What are tokenomics?
Tokenomics – a combination of the words “token” and “economics” – is a term that refers to all the aspects that dictate the economics of a crypto token, making it appealing to investors. This includes a token’s functionality, objective, allocation policy, and emissions schedule. These are all important attributes and should be carefully considered by investors before committing their funds to a particular cryptocurrency.
Tokenomics are an important aspect of the cryptocurrency ecosystem, allowing projects to prevent bad actors, create trust, and build a strong, long-term ecosystem. Strong tokenomics support the value of a token over the long term and incentivize early adopters, while controlling a token’s inflation rate and promoting sustainable growth.
There are several metrics investors can consider when trying to understand the tokenomics of a project. Typically, most of the factors that make up the economics of a token can be found on CoinMarketCap and CoinGecko, but it is still advisable to check a project’s whitepaper to be sure the information is correct. This can also help investors identify and avoid fraud, such as rug pull schemes.
Key metrics to consider
Investors should search for the following information when researching a token or project:
- The allocation and distribution of tokens
During the initial launch stages of a project, the executive team or the community will decide how tokens are allocated or distributed. This can include dividing tokens up between different departments, such as marketing and development, allocating some tokens to the treasury to be issued when needed, or offered up to investors during rounds of investment. The latter can include private sale rounds to early investors or fundraising rounds called Initial Coin Offerings (ICOs) or Initial DEX Offerings (IDOs). Team members working on a token may also receive tokens as a reward for their work. This can help investors gain an insight into the initial valuation of a project based on the amount of money it is raising during these early stages.
- A token’s supply and emission schedule
There are three types of supply investors need to know about: circulating supply, total supply and max supply. The circulating supply is the number of tokens currently in circulation, while total supply also includes any tokens that have been created and then burned. The max supply is the maximum number of tokens that can ever be generated (though not all tokens have this).
A healthy token would see its circulating supply steadily increased by the developers, but it’s important that new tokens are not released too quickly or too frequently, as this could hurt its value over the long term. A token’s emission schedule can help you understand what future supply will look like.
- A project’s market capitalization
A project’s market capitalization is another important metric which shows the value of the circulating supply of its tokens, usually in US dollar terms. You can also look at the fully diluted market cap of a project, which is a theoretical market cap if the entire token supply was in circulation. The higher a token’s market cap and the lower its circulation supply, the more valuable it is likely to be in the future.
- A token’s model
Tokens can be inflationary or deflationary. An inflationary token is like fiat money – there is no maximum supply. A deflationary token is one where supply is capped, such as Bitcoin, with a maximum supply of 21 million.
Some tokens have a dual token model, where a project issues two tokens – a security token for fundraising and a utility token. The security token, issued to obtain investor funding for the project, gives investors ownership rights in the project. Governance tokens are a type of security token which gives users voting rights in the project. Governance tokens incentivize users to remain invested in the protocol long-term, ensuring a more sustainable ecosystem.
A utility token can be issued at any time and is a normal transaction token on the platform. An example of a dual token model is MakerDAO’s MKR, which has a utility and governance token version.
- Other things to consider
When doing your research, be sure to also look into the team behind the project by checking out their social media, LinkedIn profiles and professional credentials. A token’s historical performance, use cases and any technical analysis metrics can also be useful.
Real life examples
The most successful cryptocurrencies have strong tokenomics models involving careful emissions management, dual token models, and strong incentives for users to remain in the project’s ecosystem for the long term.
It is typical for cryptocurrency protocols to manage the emissions rate in some way. For example, Bitcoin employs a halving mechanism to decrease the number of BTC entering the ecosystem and slow down emissions. A halving is a deflationary event where the rewards received for validating the transaction are cut in half, which is happening every four years for BTC. This ensures that the maximum supply of 21 million BTC will not be reached until 2140.
Protocols that use governance tokens to create a strong ecosystem and reduce volatility include 1inch, which has a governance staking function that sees the fees generated by the platform sent to those staking their 1INCH token in the governance section of the exchange. If the price of the tokens increases, the fees will also increase, which incentivizes users to buy tokens from the governance function.
Meanwhile, Curve incentivizes users to lock their tokens, CRV, for a period of time. This helps control the amount of trading that takes place, therefore keeping the price more stable and inflation lower. The protocol has introduced the so-called vote-escrow CRV (veCRV), which allows users to lock away their tokens in exchange for voting rights and a portion of the trading fees, and earn a boost on the liquidity they are providing for the protocol. The longer the CRV is locked away for, the more veCRV the user receives.
As you can see, tokenomics are an incredibly important aspect of cryptocurrency which covers pretty much anything to do with the token, so investors should pay attention. Choosing a token with strong tokenomics can help investors avoid scams and volatility, ensuring their investments grow and prosper over the long term.