Tokenomics is a combination of the words “token” as in crypto token and “economics” and is about understanding the economics and fundamentals of a crypto token.
Economics is at the root of our lives and has always been. Whilst today's economies are way more complex and sophisticated than from the days of our ancestors the basics still remain the same. There is always some form of demand and supply, some form of value measurement and some form of exchange like a currency or barter system to facilitate transactions.
Today's economies are highly complex and fast-moving, economists, governments and businesses need to understand the trends and in the case of businesses navigate the economy for maximum benefit or in the case of governments fine-tune their economies based on the prevailing conditions and desired outcomes.
In much the same way, investors, traders and others interested in crypto need to be able to understand the fundamental economics behind the tokens they are interested in in order to be able to ascertain if they are wise investments. Tokenomics is the study of the economics and fundamentals of a crypto token.
What are tokens?
The first thing we need to look at and understand is what are tokens?. A crypto token can typically represent an asset or a utility that resides on a blockchain, allowing for the user to use it as an investment or for economic purposes. In the non-digital world, one could imagine a piece of gold as a token, as it could be used as a means of pure investment, hold onto it and let it appreciate in value, as a currency, pay for something with gold, not common nowadays but technically still possible or you could turn the gold into a piece of jewellery which can be considered a form of utility, a piece of jewellery to wear. If we looked instead at a €100 note, it serves no other purpose other than as a way to hold and transfer value, there’s nothing else you can actually do with it. These two examples could be used to see the difference between a crypto coin such as bitcoin or a token just to be able to understand what a crypto token in fact is. In more specific terms a coin is native to the blockchain, for example, ETH or Ether is the native coin for the Ethereum blockchain whereas a token is not native to a blockchain such as Ethereum but independently operates on the Ethereum blockchain and provides some form of utility or service.
Let’s examine some token types so as to see how this fits into tokenomics?
There are four principal types of crypto tokens, these are:
Payment tokens – payment tokens are generally coins and their primary purpose is to act as a medium of exchange, a way to hold value or as a unit of account. In economic terms, the price of the payment token is highly influenced by supply and demand, just as in fiat currencies like the EURO, GBP or USD.
Security tokens – security tokens are similar to securities in the world of stocks and shares. If one owns shares in a company they can use their shares to vote for actions, hold onto the shares as investments in the hope the price will rise and also be able to enjoy a share of profits in the form of dividends. In a similar way, security tokens come with certain rights, privileges and means to earn money beyond simply the appreciation of the price of the token.
Utility tokens – utility tokens give the holder access to a blockchain-based product or service. Where security tokens have some form of money-making at their core, utility tokens provide some form of utility hence the name. Imagine a piece of software like WinZip, it compresses and decompresses files on a computer, you cannot make money with it. However, you could buy shares in the company behind WinZip which would be a security token in this case. WinZip itself would be a utility token.
Non-fungible tokens – all crypto coins and most tokens are interchangeable, my one bitcoin is exactly the same as your one bitcoin. Just like my €20 banknote is worth exactly the same as yours. Non-fungible tokens (NFTs) are different as these tokens can represent a unique item, property or asset such as the deeds of a particular house, a piece of artwork or a collectable, no two are the same. The NFT can be considered as the legal title or deed to that asset, much like the ownership papers of a particular car.
What is tokenomics in crypto?
Okay, so now we have an understanding of what tokens are and the common types of crypto tokens out there. How does tokenomics fit into the picture? As we determined at the very beginning of this article, demand and supply are at the root of all economic systems, they in most cases determine the supply and the price. If the demand for something is high and there is limited supply the price will go up, if demand is low and/or the market is flooded then we can expect the price to come down. In much the same way, in tokenomics we need to study the demand and supply of a crypto amongst other things in order to get at the fundamentals and determine if it's a good buy or simply goodbye!
Below are some of the fundamentals we would be looking at in tokenomics
Allocation and distribution of tokens – how are the tokens being distributed, there’s a fair launch in which case the token is mined, owned, earned and governed by the community at large without any pre-release. On the other hand, some tokens can be pre-mined and issued to developers and early investors in an ICO for example. Imagine there’s a wallet with a huge amount of tokens sitting there, the owner of this huge amount of tokens could dump them on the market and cash in causing the price to plummet, this would represent a significant risk to the other token holders.
Token supply – the supply is probably one of the biggest factors when it comes to the ongoing price of the token, there’s circulating supply, the amount of the token currently in circulation potentially available to buy and sell, there’s the max supply which is the maximum amount of the token that will ever be produced and there’s total supply which is the total amount of tokens out there excluding any that may have been burned.
Market capitalisation – the market capitalisation of a token is similar to that of a company, it’s basically the price of a share multiplied by the number of issued shares. In the same way, it’s the price of the token multiplied by the number of tokens in circulation. The higher the market capitalisation the more solid the token, or in theory at least.
Inflationary or deflationary token type – a token is deemed to be deflationary if there is a limit to the total supply, for example, there will only ever be 21 million bitcoin, no more can be produced and this should lead to an increase in value in the long run due to the ultimate scarcity, just as with oil or gold, there’s only so much out there and this keeps the price up. An inflationary coin is the opposite, there is no upper limit to the amount that can be created, very much like fiat currencies like the EUR or USD, in these cases, oversupply can force the price down and this means that each token has less buying power or inflation as it is known in economic terms.
In summary, tokenomics is about understanding the fundamentals of a token in order to be able to determine if it is a potentially good investment. Just as government and business economists study economic fundamentals and patterns the same is true with tokenomics when it comes to crypto.