What Is Tokenomics and Why Does It Matter?


Tokenomics, a combination of the words “token” and “economics,” is an important component of conducting fundamental research on a cryptocurrency project. Aside from the white paper, founding team, roadmap, and community growth, tokenomics is critical to assessing a blockchain project’s future prospects. To ensure long-term development, cryptocurrency projects should properly construct their tokenomics.

Tokenomics at a glance 

To incentivize or prohibit specific user actions, blockchain projects create tokenomics rules around their tokens. This is analogous to how a central bank issues money and enacts monetary policies to encourage or discourage consumption, lending, saving, and money mobility. It’s worth noting that the term “token” here refers to both coins and tokens. The distinction between the two can be found here. Tokenomics rules, unlike fiat currencies, are applied through code and are clear, predictable, and impossible to modify. Consider Bitcoin as an example. The total quantity of Bitcoin (BTC) is set to 21 million coins. 

For every 210,000 blocks, the payout, also known as block subsidy, is halved. This schedule calls for a halving every four years. Since the first block or genesis block, was created on the Bitcoin network on January 3, 2009, the block subsidy has been halved three times, from 50 BTC to 25 BTC, 12.5 BTC, and 6.25 BTC now. Based on these criteria, it’s simple to estimate that about 328,500 bitcoins will be mined in 2022 by dividing the total number of minutes in the year by 10 (since a block is mined every 10 minutes) and then multiplying by 6.25 (because each block awards 6.25 BTC). As a result, the number of bitcoins mined each year and the last bitcoin may be anticipated.

The design of transaction fees, which miners get when a new block is validated, is also part of Bitcoin’s tokenomics. This fee is intended to rise in tandem with transaction size and network congestion. It aids in the prevention of spam transactions and encourages miners to continue verifying transactions even as block subsidies decline. 

Key Elements of Tokenomics

“Tokenomics” refers first and foremost to the structure of a cryptocurrency’s economy as defined by its designers as a catch-all word for a wide range of elements impacting a cryptocurrency’s value. Here are some of the most significant elements to consider when examining the tokenomics of a cryptocurrency. 

Token supply

The major elements influencing the price of any commodity or service are supply and demand. The same is true for cryptocurrency. There are several key parameters for determining a token’s supply. The first is known as maximal supply. It signifies that there is a limit to the number of tokens that can exist over the lifetime of this coin. The maximum supply of Bitcoin is 21 million coins. Litecoin (LTC) has an 84 million coin hard cap, and (Binance)BNB has a maximum supply of 200 million coins. Some tokens have an unlimited supply. Every year, the Ethereum(ETH) network’s ether supply grows. Stablecoins such as USDT, USD Coin (USDC), and Binance USD (BUSD) have no maximum supply because they are issued depending on the reserves that back them up. 

Token Utility

Token utility refers to the use cases that have been built for a token. BNB’s utility, for example, includes powering the Binance (BNB) Chain, paying transaction fees and receiving trading fee reductions on the BNB Chain, and acting as a community utility token on the BNB Chain ecosystem. Users can also make additional cash by staking BNB with various products inside the network. Tokens have numerous applications. Governance tokens enable token holders to vote on protocol updates. Stablecoins are intended to be used as a form of currency. In contrast, security tokens represent financial assets. For example, during an Initial Coin Offering (ICO), a corporation could issue tokenized shares, offering the holder ownership rights and dividends.

Analyzing token distribution 

Aside from quantity and demand, how tokens are allocated is critical. Individual investors and large institutions behave differently. Knowing what types of entities possess a token might provide information into how they are likely to trade their tokens, which will affect the token’s value. 

Tokens are generally launched and distributed in two ways: fair launches and pre-mining launches. There is no early access or private allocations before a coin is produced and distributed to the public in a fair launch. This category includes cryptocurrencies such as Bitcoin and Dogecoin. Pre-mining, on the other hand, permits a portion of the cryptocurrency to be minted and allocated to a select group before it is made available to the general public. Two instances of this type of token distribution are Ethereum and BNB. In general, you should consider how evenly a token is distributed. A few major organisations holding a disproportionate amount of a token are often regarded as riskier. 

Examining token burns

Many cryptocurrencies frequently burn tokens, which means they are permanently removed from circulation. Coin-burning, for example, is used by BNB to remove coins from circulation and reduce the overall quantity of its token. With 200 million BNB pre-mined, the total supply of BNB as of June 2022 is 165,116,760. BNB will continue to burn coins until 50% of the overall supply is destroyed, reducing BNB’s total supply to 100 million BNB. Similarly, Ethereum began burning ETH in 2021 in order to limit its overall supply. Deflation occurs when the supply of a token is reduced. Inflationary behaviour occurs when the supply of a token continues to grow. 

Incentive mechanisms

A token’s incentive mechanism is crucial. How a token incentivizes participants to ensure long-term sustainability is at the center of tokenomics. How Bitcoin (BTC) designs its block subsidy and transaction fees is a perfect illustration of an elegant model. The Proof of Stake mechanism is another validation method that is gaining prevalence. This design lets participants lock their tokens in order to validate transactions. Generally, the more tokens are locked up, the higher the chance to be chosen as validators and receiving rewards for validating transactions. It also means that if validators try to harm the network, the value of their own assets will be placed at risk. These features incentivize participants to act honestly and keep the protocol robust. 

What’s next for tokenomics

Tokenomics has progressed dramatically since the creation of the Bitcoin network’s genesis block in 2009. Many other tokenomics models have been investigated by developers. There have been both achievements and setbacks. The tokenomics concept that underpins Bitcoin has withstood the test of time. Others have failed due to inadequate tokenomics designs. Non-fungible tokens (NFTs) offer a tokenomics paradigm that is built on digital scarcity. The tokenization of traditional assets such as real estate and artworks may lead to new tokenomics developments in the future.

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