Crypto 101 with Vin: Tokenomics
Tokenomics is a literal amalgamation of ‘token’ and ‘economics’. Think of it as the monetary policy of a blockchain’s native coin or of tokens built on top of a blockchain. Monetary policy normally would be the behavior or actions that a central financial institution adopts to meet a certain end.
Like those financial institutions, or extremely more so, blockchains and protocols are trying to solve some specific problem. That problem could literally be anything from play-to-earn gaming to on-chain banking. The tokenomics are taken into consideration and designed to facilitate actions that solve the problem.
I am not an economist, but I am a programmer who has certain expectations when researching about different cryptocurrencies. I find it easiest to determine what the tokenomics are by getting a brief overview of factors and asking more pointed questions that I think are important to consider before taking a stake in project.
The 3 Most Important Factors of Tokenomics
The primary factors that I think constitute tokenomics are: Supply, Distribution, and Governance. You could consider others, but I believe these 3 have the most direct impact on the value and utility of tokens.
The supply of tokens is just the number of tokens. Although the supply seems to represent one thing, you can actually conjure up several different numbers: Total supply, Max supply, Circulating supply, etc. Some of these numbers could actually be the same, but may be different due to the nuances in how differently blockchains can be implemented.
- How many tokens exist now? (Total Supply)
- How many tokens have been burned?
- Is there a limit to how many tokens can exist? (Max Supply) This makes a token deflationary thus increasing it’s value.
- How much of the existing supply is available to use? (Circulating Supply)
- What is the supply schedule? This is the rate at which tokens are created.
The line chart below illustrates Bitcoin’s maximum supply(21 mil), total/circulating supply at time of writing(under 19 mil), & estimated supply schedule from creation up to 2060. The total and circulating supply are the same since we cannot determine how many Bitcoins are not accessible. These numbers would be different if tokens were being burned.
Tokens need some way to end up in the hands or rather wallets of others. This could be through sales like Initial Coin Offerings(ICO), airdrops for using some service, mining, staking, or a multitude of other methods.
If a project cannot distribute coins, then that means it never reaches potential users and there would be no point to a token that cannot change hands. Often times the distribution of tokens is built into the consensus mechanisms. If you would like a brief overview on that topic, click here.
- How do tokens end up in the hands of users? Some methods are better than others in incentivizing users to use the tokens a certain way.
- How are users incentivized to use the token as intended? Do you get extra for doing certain things; Is there a consequence to doing things harmful to the network? This keeps value in the system instead of tokens simply being held for profit, unless that is the goal of course.
- Are the tokens spread evenly or concentrated among a subset of wallets? This is important when considering the impact or control that whales can have when moving large amounts of a token.
- How many of those tokens are inaccessible? Have users simply lost their wallet’s key phrase or is there lock up period for claiming?
Below is a breakdown of StormX’s(STMX) distribution allocations. It actually gives a good insight on to how exactly the token supply is being split as well as the distribution methods.
The crowd sale is exactly what you might think it is. It is a direct sale to the public meaning exchanges, or individual users. The allocation indicates users of the StormX product are eligible to earn some amount of tokens by doing some actions on the platform. Then the rest is meant to fund the project company and facilitate payments to other partners.
The governance aspect of a token is critical to how a token will operate. Governance is the set of rules indicating many aspects of a project, but in regards to the tokens themselves, it dictates how the minting of tokens should progress as well as the injection of tokens pre-allocated for other purposes into secondary markets. You can think of the injection part such as grants or funding.
Certain projects operate on rules that do not change, or an entity like a company or a group of developers control governance. The democratic option might be Decentralized Autonomous Organizations (DAOs) which may hold votes or act in alignment with pre-set rules before taking actions.
- Does a governance model exist? If so, are the rules for modifying the process of minting or allocating tokens well defined?
- Who controls the creation and allocation of tokens? Other token holders, a company, node operators, or no-one?
Monolithic governance figures like a company or developers could possibly enact changes on a whim, but even they will have set rules so as to maintain trust with token holders, but they are not obliged to maintain that behavior.
DAOs have to act through proposed initiatives and must stick to the rules strictly outlined if possible which is reinforced by the fact it is written in code committed to the blockchain. This makes it so token holders don’t have to trust the governing entity because they are usually part of the decision making process enforced by code.
Why Is Tokenomics Important?
The stronger the correlation between services and the token made for said services, then there will be great utility for the token making it necessary and useful. Essentially usage of a service — or network — increases demand for the token and therefore its intrinsic value.
If supply and demand can be considered as important factors in determining the value of non-tangible assets like stocks and futures to the price of the toilet paper in a pandemic, then the same can be said for crypto-assets.
The next time you’re deciding whether or not to buy a crypto-asset consider the questions discussed and hopefully it helps you make a financial choice you are more comfortable with.
Thanks for reading and check in next time.
Kakavarna.eth — Automation Engineer(9–5), crypto investor, and gamer with opinions