Tokenomics might be the essential key to the success of a crypto token in the long term. Here's how it works.

Money is such a crucial element in the day-to-day lives of basically every individual on this planet and it keeps circulating around as time goes. What we sometimes forget is that money has always been subject to control by central authorities such as banks and governments. The whole mechanism, also known as the monetary policy, has kept everything in order for many years. However, the arrival of cryptocurrency has created a new perception of the global financial system. By using the famous blockchain technology and its decentralized principle, cryptocurrency is able to make its own microeconomics.

Beginner's Guide to Tokenomics

This is where tokenomics appeared as an attractive alternative for applying monetary policy to blockchain networks. Tokenomics is also useful to determine which tokens are worth investing in. In this article, we're going to provide a detailed guide on tokenomics to help you understand what it is, how it works, and why it is important.

 

Crypto Token and its Types

Before diving into tokenomics, it's important to understand the basics of crypto tokens. Crypto tokens are units of value that are built on top of existing blockchains.

These tokens, like cryptocurrency, can be exchanged and used as a form of payment, but they can also serve different functions on the network. The concept of token in the crypto world has been greatly improved with the creation of the Ethereum network because it offers a wide range of decentralized services other than merely a place for transactions.

 

1. Based on their structure, crypto tokens can be divided into two categories:

  • Layer 1 Tokens
    This type of token is native to a specific blockchain and it's also used to power all services on the network. Some examples are BNB and Ether.


  • Layer 2 Tokens
    In contrast, layer 2 tokens are used in various decentralized applications in a particular network. For instance, OMG tokens are considered layer 2 tokens because they are used for a decentralized project called OmiseGO, which operates on the Ethereum network.

2. Another way is to classify crypto tokens into two categories, namely fungible and non-fungible tokens:

  • Fungible tokens
    Fungible tokens are tokens that can be exchanged without changing their value. Think of it like regular money. The value of 1 BTC is identical to other BTCs, so they can be exchanged with one another.


  • Non-Fungible tokens
    Non-Fungible Tokens (NFTs) are tokens that are unique and cannot be replicated. NFTs have gained massive traction recently due to the rising popularity of blockchain and DeFi projects. Typically, an NFT represents a certain asset, which can be anything from artworks, pictures, collectibles, and more. Since it's one of a kind, NFTs are considered more exclusive and valuable.

3. Apart from the two classification methods, we can also divide tokens into categories based on usage. This includes security tokens and utility tokens:

  • Security Tokens
    Security tokens are basically digital investment contracts that represent ownership of a certain part of an asset. This type of token should involve a money investment, common enterprise, and profitability from different contributors. One of the examples of security tokens is the Siafunds of the Sia network.


  • Utility Tokens
    Utility tokens are more common and it is important for financing a network. They are usually issued through an Initial Coin Offering (ICO) and can be used to fund project development. One of the examples is the Basic Attention Token (BAT) that can be used for decentralized advertising on the Brave browser, which operates on the Ethereum network.

 

What is Tokenomics?

The word "tokenomics" is made up of two words: token and economics. Put simply, tokenomics is essentially the study of the economics of crypto tokens. It involves all aspects of a token cycle which includes the creation of crypto tokens, distribution, management, and so on.

Deciding to invest in cryptocurrency is definitely not an easy thing to do for everyone because cryptocurrency is often considered very risky. While some people believe that crypto is able to shape the future of the financial world, others simply refuse the idea and are very skeptical of the potential of digital currency.

These days, it's not uncommon to hear token creators boast that their crypto assets will rival Bitcoin, but how many of them will actually make it? No one knows for sure. For this reason, many people begin learning about tokenomics by making in-depth analyses about cryptocurrency as a part of their risk management in order to ensure that the asset will have significant value in the future. Therefore, tokenomics has become more relevant as it is strongly related to the future of crypto tokens and their values.

With that being said, by studying tokenomics, we will be able to understand the short-term performance of each token along with its potential value in the future. Blockchain has allowed developers to make various types of tokens, each with unique purposes and implementations. With tokenomics, investors will be able to narrow down the options of tokens worth investing in for the long term. Not only that, but developers can also use tokenomics to create a new or existing model that has a higher chance of succeeding.

 

Important Factors to Consider in Tokenomics

As previously mentioned, tokenomics can be used to determine the value and the potential value of a crypto token. Instead of just placing bets on random tokens and hoping for the best, you can actually make a more scientific-based decision by considering the following factors:

 

1. The Allocation and Distribution of Tokens

One of the most important factors in deciding a token's worth is regarding how the token is being distributed. Tokens can be generated through pre-mining or by a fair launch. If it's generated through fair launch, then that means the token is mined, earned, and managed by the community on the network. There's no early access or private allocation before it went public. Bitcoin and Dogecoin are examples of this type of distribution.

Meanwhile, in the pre-mining method, a portion of the tokens are created and sent to certain people (usually team developers and early investors) before it's distributed to the public. These early coins are usually sold to interested buyers in an ICO.

Many projects these days come with pre-mined tokens, so it's not a bad sign at all. However, make sure to check if there's anyone holding a large percentage of the supply because this means there's a chance that they would be whale dumping their tokens one day, causing the price to drop drastically.

Therefore, you must make sure that the project distributes its tokens out to as many users as possible. This shows that the project is legitimate and genuinely cares about further development.

 

2. The Supply of Tokens

The token's supply is one of the primary components of tokenomics. There are three phases that you need to keep an eye on: the circulating supply, the total supply, and the max supply. The circulating supply is the number of tokens that have been issued and are currently in circulation. The total supply is the tokens that exist at present, excluding the ones that have already burned. Finally, the max supply is the maximum amount of tokens that can ever be created and used.

Being aware of the supply of a token is a good indicator for the future. If you notice that the circulating supply is increasing, then that is a good sign that the token's value might go up in the future. On the contrary, if you notice that there are too many tokens being generated, it shows that there's a chance the value might drop.

 

3. The Token Model

Unlike fiat currencies, cryptocurrencies and tokens actually have pre-determined issuance schedules. This means we can predict the number of coins that will be generated by a certain date of time as well as the token's maximum supply. In this case, there are two models of tokens, namely inflationary and deflationary.

Inflationary tokens don't have a max supply and will keep producing as time goes by. Examples of inflationary tokens are Dogecoin and Grin. The founders of these cryptos believe that this system will make it easier to maintain a stable price and thus, make it a more usable currency. On the contrary, deflationary tokens have determined the number of their max supply.

For example, it's publicly known that there will only be 21 million BTC produced in total and roughly every four years, the new coins that are produced via the mining process are reduced by half. This process is called Bitcoin "halving", which aims to create scarcity and price stability. This condition is being created in the hope that it will make people compare Bitcoin to gold and think of it as "hard" money. Other than Bitcoin, this system is also used by Bitcoin Cash, Bitcoin SV, and Zcash.

 

4. Market Capitalization

In the context of cryptocurrency, market capitalization refers to the metric used to determine the popularity of a token. It is calculated by multiplying the current market price with the current circulating supply of the token. This can be a good indication of the present and future value of the token. In this case, tokens with larger market caps are usually more reliable.

See also: Top 10 Cryptocurrencies with the Largest Market Cap Today

 

5. Price Stability

Another important thing to consider in tokenomics is the token's price. Cryptocurrencies are commonly known for their high volatility and mostly not for the good part. High volatility increases the risk of investing and might even let giant spenders restrict the network by mass purchasing and selling the tokens. Therefore, make sure to choose a token that has an adequate repository of assets to match the supply levels. This will make the price stable and allow users to utilize the tokens for their intended purposes.

 

Conclusion

Tokenomics might be the essential key that both developers and investors need. For crypto developers, tokenomics provide an understanding of how to make a well-sustained project for the long run. Tokenomics allow them to either build a new system or use an existing one on the blockchain depending on their goals.

On the other hand, tokenomics is also important for investors. Not only shows the token's worth at the moment, but it can also predict the potential value for the long run.

 

By studying tokenomics, you will be able to separate good investments from bad ones and have a better chance of success. However, as explained above, the process is actually not quite simple as there are many factors to take into consideration. Also, keep in mind that the concept is still in its early maturity. At this point, the crypto world is still highly uncertain and generally risky. So before investing, to avoid any fraud, always make sure that the project is legitimate and suitable with your goal.