Lesson 3: WHY IS IT IMPORTANT ? &; CORE FEATURES OF TOKENOMICS
Tokenomics is an important concept to consider when making an investment decision because ultimately a project that has smart and well-designed incentives to buy and hold tokens for the long haul is more likely to outlast and do better than a project that hasn’t built an ecosystem around its token. A well-built platform often translates into higher demand over time as new investors flock to the project, which, in turn, boosts prices.
Likewise, when launching a project, founding members and developers need to consider the Tokenomics of their native cryptocurrency carefully if their project is to attract investment and be successful.
Core features of Tokenomics
The structure of a cryptocurrency’s economy determines the incentives that encourage investors to buy and hold a specific coin or token. Just like how fiat currencies are all different, each cryptocurrency has its own monetary policy.
Tokenomics determine two things about a crypto economy – the incentives that set out how the token will be distributed and the utility of the tokens that influence its demand. Supply and demand has a huge impact on price, and projects that get the incentives right can surge in value.
Here are the main variables that developers change that affect tokenomics:
Mining and staking – For base layer blockchains, like Ethereum 1.0 and Bitcoin, mining is the core incentive for a decentralized network of computers to validate transactions. Here, new tokens are given to those who devote their computing power to discovering new blocks, filling them with data and adding them to the blockchain. Staking rewards those who fulfill a similar role but by locking away a number of coins in a smart contract instead – this is how blockchains like Tezos operate, and it’s the model that Ethereum’s moving toward with its 2.0 upgrade.
Token burns – Some blockchains or protocols “burn” tokens – permanently remove them from circulation – to reduce the supply of coins in circulation. According to the laws of supply and demand, reducing a token’s supply should help to support its price as the remaining tokens in circulation become more scarce. In August 2021, Ethereum started to burn a portion of tokens sent as transaction fees instead of sending them to miners.
Limited vs unlimited supplies – Tokenomics determines a token’s maximum supply. Bitcoin’s tokenomics, for instance, dictates that no more than 21 million coins can ever be mined, with the last coin expected to enter circulation around the year 2140. Ethereum, by contrast, has no maximum limit, although its issuance each year is capped. NFT (non-fungible token) projects take scarcity to the extreme; some collections might mint only a single NFT for a piece of art.
Token allocations and vesting periods – Some crypto projects account for a detailed distribution of tokens. Often, a certain number of tokens are reserved for venture capitalists or developers, but the catch is that they can sell those tokens only after a certain time. That naturally has an effect on the circulating supply of the coin over time. Ideally, a project’s team will have implemented a system where tokens are distributed in such a way that it reduces the impact to the circulating supply and a token’s price as much as possible.