Tokenomics is a result of the blending of two words – token and economics. It is an important concept to consider when making investment decisions in the crypto space. This is because understanding the design of a project’s Tokenomics is key to finding out its long-term value.
Unfortunately, most investors do not check this out before going on to bet money on a crypto project. In this explainer, we are going to dissect what Tokenomics entails and ways you can utilise it to make better investment decisions.
What is Tokenomics?
It is basically an umbrella term for the elements that make a particular cryptocurrency valuable and interesting to investors. That includes the token’s supply, how it is issued and what utility it has.
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Tokenomics is a field that analyses typical elements found in economics, such as supply, demand, and utility and applies it to cryptocurrency trading.
In this case, investors can easily estimate how supply, demand and other variables can impact a token’s market price using its Tokenomics.
How investors can utilise Tokenomics
One of the significant factors that decide a crypto token’s worth is how the token is being distributed. There are two ways of putting out tokens – by pre-mining or by a fair launch.
The fair launch means that from the inception, a cryptocurrency is mined, earned, owned and governed by the community. It is a decentralised network and no concept of private allocation exists here.
Pre-mining, on the other hand, means a portion of the coins is created (mined) and distributed before it is launched publicly. A portion of the coins is sold to prospective buyers in an initial coin offering (ICO). This is a way to reward founders, miners and early investors with newly minted coins.
As an investor, to make sure that the project you’re investing in is ambitious, viable and legitimate, make sure that it distributes its tokens out to prospective users.
Another important metric required to study a crypto’s Tokenomics is the supply of a token.
There are three kinds of supply for crypto tokens — circulating supply, total supply and max supply. Circulating supply means the number of cryptocurrency tokens that are issued publicly and are in circulation.
Total supply is the number of tokens that exist currently, minus all the tokens that were burned. It is calculated as the sum total of tokens currently in circulation and the tokens that are locked somehow. Max supply quantifies the maximum possible number of tokens that will ever be generated.
The dynamics between supply and demand are important things to analyse when a project issues a token. An excess of supply can negatively affect an asset’s value. We can find examples in fiat currencies that have suffered from hyperinflation and excessive printing (e.g., the Nigerian naira and Zimbabwean dollar)
The same thing is applicable to crypto.
To keep a balance between supply and demand, some tokens feature fee-burning mechanisms that can cause the token to become deflationary, depending on how widely the network is used.
For instance, Ethereum, after the implementation of EIP 1559, is an example of such a mechanism. Other tokens include buyback and burn mechanisms designed to regulate supply and demand. Such is the case for Binance’s BNB.
Market capitalisation (shortly known as market cap) is a metric used to determine the popularity of the token. It is calculated by multiplying the current market price of a token with the circulating supply.
The market cap is a good indicator of the value of the token, especially in the long run. Small-cap cryptocurrencies are largely riskier while large-cap cryptocurrencies often potentially guarantee better returns and safety.
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Before investing in any crypto project, it is important to understand and utilise the concept of Tokenomics to make informed decisions and avoid getting rekt.
This is because ultimately a project that has smart and well-designed incentives to buy and hold tokens for the long haul is more likely to outlast and do better than a project that hasn’t built an ecosystem around its token.
A well-built platform often translates into higher demand over time as new investors flock to the project, which, in turn, boosts market prices.
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