Remember those Economics classes in high school or university that we all had to take? They taught us the relationship between the production and demand of goods and services and money supply. Similar to any other currency, cryptocurrencies are part of an economy where supply and demand govern their value. The token economy is called tokenomics ( catchy name, isn’t it?), and it’s not something you will learn in school ( yet!).
It goes without saying that anyone looking to invest in cryptocurrency, or even those interested in play-to-earn games with crypto rewards, should be well versed in the basics of tokenomics, including the tokenomics of any in-game coins they acquire. So, let’s unravel together all the layers of the token economy, one by one.
First things first - what are tokens?
Crypto tokens or crypto coins are digital assets of a cryptocurrency based on blockchain technology. They have a certain value and can be exchanged with other crypto tokens or sold for real money.
Typically, tokens are used as security tokens,governance, or utility tokens. A security crypto coin gives ownership rights to significant assets, like companies. Token holders of such crypto assets get a percentage of the company's profits. A utility crypto token is used as a service in a payment ecosystem. Governance tokens offer their holders the ability to change the governance system within a blockchain by proposing new features and having a say in how the ecosystem works.
Basic tokenomics principles
Crypto token allocation and distribution
For most crypto tokens, there are two basic ways to generate them: they can either be pre-mined or released through a fair launch. A fair launch happens when the cryptocurrency is mined, earned, owned, and governed by the entire community. There are no private sales or early accesses to the tokens. They become available for everyone at the same time. On the other hand, pre-mining entails distributing a number of coins during a private sale, or to early investors and project developers, before the public sale.
The majority of projects start with pre-minted crypto tokens, but some prefer to start with a fair launch, allowing users an equal opportunity to own their digital currency.
Crypto token supply and demand
One critical aspect of tokenomics is the supply of the cryptocurrency. The coin supply comes in three forms of equal importance: circulating, total, and max supply. Circulating supply refers to the number of tokens that have been issued and are now in circulation. Total token supply refers to how many tokens exist in the world today, excluding any that might have been burned. As for the max supply, it is the maximum number of tokens that can ever be generated. Some tokens, however, have no maximum supply.
As the developers regularly increase the circulating supply of a particular coin, you can assume its worth will increase over time. At the same time, the token’s value can decrease if too many coins are released often or all at once.
Having a fixed supply of a specific cryptocurrency doesn’t mean that it will automatically increase its value over time when it comes to token demand. Other powers at play also affect our perception of its worth. The return on investment of crypto shows how much income a token can generate for you by simply holding it. You can stake your coins and generate more revenue by holding them for a determined amount of time in some situations. With some tokens, you can tap into the earnings of the protocol they represent.
Another method of gaining ROI is through "rebasing," akin to a stock split where you hold a token and stake it, and you keep getting more of it as the protocol expands its supply.
Don’t stop believing
Never underestimate the power of people’s belief in a digital asset. The more people believe in a cryptocurrency and want it, the more its value grows over time. To have a clear image of this aspect, take a look at the community constructed around a token. How active are they on different platforms and channels? How big is the community, and are there users that make the token part of their identity?One of the most potent forces behind demand is the belief that goods and services will become more valuable in the future. This is as true in the general economy as it is in tokenomics.
We’re not talking about actual games but a method of applied mathematics that studies human behavior based on rational decision-making. Game theory is used in economics to study the behavior of businesses, markets, and consumers.
When it comes to crypto, applying the game theory method can help discover what additional elements from the tokenomics design can increase a token’s demand. For example, one such game theory in tokenomics is lockups. The protocol creates an incentive for locking your tokens in a contract, often in the form of more significant rewards.
Market cap is another critical aspect to look into when wondering about the value of a specific token. It shows the total amount of funds that have been invested in a project until that moment. The fully diluted market cap shows the theoretical market capitalization if its max supply would be in circulation. By comparing these two, you can get a pretty good idea of the coin’s future value. The lower a token's circulating supply and the higher its market cap, the more valuable it might become in the future.
A token can be inflationary or deflationary. Fiat money is an example of an inflationary coin that doesn’t have a max supply, continuing to be produced over time. Deflationary tokens have a max supply, at which new coins stop being produced. A famous example, you ask? Look no further than Bitcoin, which will never have more than 21 million tokens created. Tokens that use the proof-of-stake consensus are inflationary as a way to reward the users that validate the new blocks of data into the blockchain.
We don’t know about you guys, but we’ll be the first to admit Economics wasn’t a fan-favorite subject in college. However, when embarking on the new world of crypto, NFTs, and play-to-earn games, it becomes crucial to master these concepts pertaining to the token economy. Good thing you have us as learning buddies and virtual mentors to help you navigate these digital waters on your way to impressive WINnings.
Let’s stay in touch: