This article aims to provide an overview of Tokenomics in cryptocurrency. It references supply and demand, methods of token distribution, and monetary models. If you are unfamiliar with crypto, read our articles on blockchain, crypto, and DeFi before reading this article.
What Is Tokenomics?
“Tokenomics” is a combination of ‘token’ and ‘economics’. It reflects the supply and distribution of a token within the ecosystem of a project. The tokenomics of a crypto project includes token supply, distribution, vesting periods, emissions, burns, and yields. By looking at these characteristics, users can evaluate the investability and profitability of a crypto project.
Token Supply Metrics
This refers to the maximum number of tokens that can or will ever be issued, including burnt and unminted tokens. For example, the maximum supply of Bitcoin is 21M.
This refers to the total number of minted tokens that currently exist on the blockchain. It includes tokens that are vested or locked up, but does not include burnt and unminted tokens.
This refers to the number of minted tokens on the blockchain that are transferable between wallets. It does not include vested, burnt, and unminted tokens.
Market cap refers to the total value of a cryptocurrency at a given point in time, which can be calculated by multiplying the token’s value with its circulating supply.
Market Cap = Token Value × Circulating Supply
Learn more about DeFi Metrics here!
How Are Tokens Distributed?
A fair launch does not involve token distribution to the founding team, early access users, and investors.
In a pre-mine launch, a certain number of tokens are mined in advance for allocation to a select group, such as founding members and funding partners, before being released to the public. The former is usually allocated tokens with a vesting schedule or lock-up period. This mechanism prevents the immediate dumping of tokens on the market, which could cause it to experience high levels of volatility.
ICO, IEO, IDO, and Launchpads
Initial Coin Offering (ICO)
An Initial Coin Offering (ICO) is the crypto equivalent of an Initial Public Offering (IPO) in the stock market. It is a form of crowdfunding for crypto projects, where a fixed amount of tokens is minted and sold to early investors.
Initial Exchange Offering (IEO)
An Initial Exchange Offering (IEO) is another method of crowdfunding for crypto projects. It is done on a crypto exchange that will carry out rigorous vetting before listing a project’s token for sale. By launching tokens on reputable exchanges like Binance Launchpad, crypto projects are exposed to a wider audience by riding on the publicity of the platform. Investors are also be less skeptical about tokens that have been properly vetted by established exchanges.
Initial Decentralized Exchange Offering (IDO)
An Initial Decentralized Exchange Offering (IDO) is similar to an IEO, but it is hosted on a Decentralized Exchange (DEX) instead. IDOs grant crypto projects instantaneous liquidity and trading at low costs.
Airdrops are a popular method used to bootstrap and generate traction for crypto projects. They involve a mass distribution of tokens to numerous wallet addresses for free. There are usually prerequisites for wallets to be eligible for an airdrop, often involving specific on-chain transactions and interactions with certain protocols.
A token is inflationary when its circulating supply continually increases over time. As the circulating supply increases, the value of a token falls in the long run, assuming that demand does not increase at a faster rate than the issuance of tokens. Dogecoin is an example of an inflationary token with no maximum supply.
A token is deflationary when its circulating supply decreases over time. This is possible with mechanisms like token burning. As circulating supply decreases, the value of a token increases if its demand does not decrease at a faster rate. For example, Binance Coin (BNB) is a deflationary token because Binance buys back a certain amount of BNB every quarter to burn. This will continue until a 50% of its supply is eventually burned.
In a dual-token model, a blockchain uses two distinct tokens, usually, one for financial value and the other for utility purposes. This helps to keep the systems of utility and financial incentives separate. An example that uses this model is MakerDAO, which has two tokens. In the MakerDAO ecosystem, the Maker (MKR) token acts as a governance token, whereas DAI is a stablecoin pegged to the USD.
Tokens that use the asset-backed model derive their value from an underlying asset that they are backed by. Many of such examples are stablecoins such as BUSD, USDT, and USDC that are pegged to the USD.
Learn more about the role of stablecoins in DeFi here!
Governance and Utility Tokens
Governance and utility tokens are often synonymous, but they are not always the same. Governance tokens are a subset of utility tokens, and many times, projects use the same tokens for both purposes. With governance tokens, users can vote for proposals that affect the functions and systems in decentralized autonomous organizations (DAOs). On the other hand, utility tokens are digital assets which carry use cases in a project or ecosystem. One common use would be for payment of transaction fees within a project. For example, the BNB token helps users offset trading fees within the Binance trading platform.
Tokens That Provide Value to Users
Tokens can have a more significant impact when their usage can provide value back to the end-user. Most of the time, a token’s value is derived its monetary value. One example would be the decentralized exchange protocol, SushiSwap and its native token SUSHI. For every trade on the platform, a percentage of the fees will go to the liquidity providers, while the rest will be used to buy SUSHI on the open market and distributed to xSUSHI token holders. xSUSHI is the staked form of SUSHI, and it acts as a placeholder for holders who have staked their SUSHI.
Burning refers to the act of removing tokens from its circulating supply, reducing the number of tokens on-chain. This is usually done by sending tokens to a burn wallet which no one has access to. Different projects have different burn rates to suit their purposes.
Ethereum Improvement Proposal (EIP) 1559 is a popular example of a burn process. With this fee mechanism, base transaction fees on the Ethereum network are burned, reducing the circulating supply of Ether (ETH). This possibly makes ETH deflationary if its burn rate exceeds its emission rate, leading to an upward price action of ETH. EIP-1559 has burned over US$5.7B worth of ETH since its launch in August 2021.
The Future of the Token Economy
Tokenomics presents an economy of tokens, working towards a state where each project and ecosystem can exist as a self-sustaining microeconomy. Currently, the crypto space is still in its nascency, and many projects are still very team-led. The future would be one where projects are able to adapt and adopt models to further its goals while functionality, sustainability, and decentralization.
Through tokenomics, users have an opportunity to involve themselves with the way a project runs through governance votes. Tokenomics also provides valuable information that can be used to evaluate the investability of a token and potential of a project. However, do note that this should not be the only factor you consider when you DYOR!
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