What Is Tokenomics: A Guide On Supply And Demand Of Cryptocurrencies
Tokenomics, a term used to describe the internal dynamics of crypto projects, gives light on how the asset works and the psychological or behavioural influences that are likely to affect its value. The success of a project is mainly dependent on the effectiveness of the tokenomics and the incentives for buying and retaining the token.
Projects with weak tokenomics, on the other hand, are sure to fail sooner rather than later. Token mechanics that don’t work correctly warn of future problems. If you’re considering buying a crypto asset, you must understand tokenomics before you do so.
Tokenomics is examined in depth in this article, along with the essential aspects, the supply and demand of cryptocurrencies, token burning, and more. Tokenomics is a crucial concept in Bitcoin valuation, and this article aims to elucidate the idea.
Table of Contents
What Is Tokenomics?
As the name suggests, “tokenomics” alludes to the supply and demand aspects of crypto projects. Token economics: issuance, qualities, distribution, supply, demand, and other features are all considered.
Let’s take a closer look at what a cryptocurrency token is. An existing blockchain is a foundation for creating this new digital currency. Tokens in the cryptocurrency world are much like any other kind of money in that they can be bought and sold.
Token economics departs from traditional economics in several ways. It doesn’t matter what period we’re in; governments have continuously printed money. The cost of waging war or coping with a drought might be enormous.
Raising money is not always an option. Therefore, governments turn to mint currency as a more convenient solution. In the long run, printing more money devalues the present coin.
Coin issuance is pre-determined and algorithmically generated in crypto ventures. Distributing coins to various parties is also planned. Although it is technically possible to change the issuance and distribution timetable, the process is challenging.
How Tokenomics Work
Tokenomics build up the economy of a crypto project by setting incentives for the holders of the token and defining the utility of the tokens, a significant element behind their demand. Various variables that developers interact with to alter multiple parts of tokenomics include:
The supply of tokens is a crucial factor in the tokenomics of various projects. There are two aspects to consider: the total and the circulating supply. There are only 21 million Bitcoins in existence, and Bitcoin miners will create the last one in 2140. However, the entire collection of Solana (SOL) is only 508 million SOL.
The number of tokens created in nonfungible projects is also limited.
2. Mining And Staking
To encourage miners to validate transactions, early blockchains like Bitcoin and Ethereum have released tokens. Proof-of-work (PoW) is a term for this process. New blocks are mined and added to the blockchain using the processing power of miners.
Staking models for validators in proof-of-stake (PoS) blockchains ensure that individuals who have locked up a particular number of coins in a smart contract receive incentives. Ethereum is adopting this concept due to the consensus layer upgrade.
3. Token Allocation And Vesting Periods
In crypto initiatives, detailed token allocations to stakeholders have become the norm. Venture investors and developers must keep a vesting time on tokens. The vesting period protects investors against pump and dumps culprits by locking developers’ tokens for a predetermined time.
Yield farming is a way for anyone with a cryptocurrency to make more tokens. As a result of lending your assets using smart contracts, you will earn both interest and principal. Yield farming powers large yield pools on decentralised exchanges (DEXs).
5. Token Burns
For the sake of preventing inflation, cryptographic systems must irreversibly destroy tokens. As tokens become more scarce, their value will rise. Binance reduces the total supply of its native coin, BNB, by burning it every three months. Over 30 per cent of Stellar’s total supply was wiped out in November 2019, resulting in a price hike of around 55 billion XLM tokens.
Supply and demand have a crucial role in determining the price of cryptocurrencies. Now let’s look at the process developers use to create tokenomics:
1. Supply Side
Supply and demand are the cores of economics for different types of money. It is easy to see how valuable a currency is by looking at these two indicators. Tokenomics employs the same premise, allowing you to see the supply and demand of a particular token.
Investigate the supply first. Considering only the store, we need to figure out if the value of a token will rise or fall in actual money. Tokens are more valuable when there are fewer of them in circulation, according to economic theory. We term this condition “deflation.”
Conversely, when the total quantity of tokens grows, the value diminishes; Inflation is the result of this.
Considerations such as utility and the ability to generate cash for its owners are irrelevant when looking at supply. Changing supply is the only factor to be taken into consideration. Considerations are in place as to how many tokens are currently in existence, as well as the quantity that will be mined or released later.
Examining Bitcoin’s supply side can help you better grasp it all. Until 2140, Bitcoin mining within the 21 million limits is every four years. By June 2022, we will have mined over 19 million BTC, and we will mine the last 2 million BTC over the next 120 years. So, from 2022 on, just about 10% of Bitcoin will be mined, preventing any significant inflationary pressure for over a century.
2. Demand Side
There is no value to be created on the demand side alone. Instead, the token’s value is a function of the amount of demand for it.
The value of a fixed supply is not flexible. For people to see the worth in the things they own now and in the future, they must believe in them. The ROI, game theory, and memes are all important considerations when determining whether a token will be in high demand.
To be able to evaluate a crypto project, you will need a firm grasp of tokenomics under your belt. You can get an idea of the supply and demand of tokens by reading their white papers or documents. You will be able to determine how their team is driving demand for the coin and objectively evaluate its future possibilities.