- The term “Tokenomics” is a combination between “Token” and “Economics” and can be translated into Spanish as the Token Economy which evaluates the economy of a token to determine its health and potential.
- Tokenomics aims to create an economic ecosystem that is based on tokens.
- The Token Economy refers to all aspects related to the creation and management of the token, for example, what will be the supply of the token, how will it be issued, how will it be distributed and what will it be used for.
In the traditional economy, a fiat currency can be evaluated economically by the official data of the money supply, that is, the amount of money in circulation in its economy.
In particular, monetary aggregates are used to know the amount of money that is circulating in an economy, where each one is ordered from greater to less liquidity; being M1, M2 and M3. For example, M1 is made up of coins and banknotes in circulation and sight deposits, being the most liquid aggregate.
The relevance of evaluating monetary aggregates in the economy is thatas many will know from their own experience in their countriesthe money supply affects the levels of inflation and economic growth, therefore, just as it is necessary to evaluate the conditions and behavior of fiduciary currencies, the same applies to tokens.
It is necessary to evaluate the economy of a token to determine its health and potential and for this ‘Tokenomics’ works.
Everything you need to know about Tokenomics
Before studying Tokenomics, it is essential to understand what a token is. in a simplified waya token is a digital unit that is used as a specific asset or that represents a particular use in a blockchain.
In general, both tokens and cryptocurrencies have previously established issuance schedules and are created algorithmically. Basically this reduces the uncertainty regarding their offer to zero, that is, we can know precisely how many tokens will be available on a certain date, unlike the fiat money supply.
If you want to learn in more detail what tokens are and how they differ from cryptocurrencies, we invite you to read the guide specially developed for it by Bitcoin Mexico.
What is Tokenomics?
‘Tokenomics’ is a new and essential term in the ecosystem of cryptocurrencies and blockchain technology. As can be seen, the term is a combination between “Token” and “Economics”; that is, it can be translated into Spanish as the Token Economy.
In this way, the Token Economy is a fundamental element of any project belonging to the crypto ecosystem, since its success or failure largely depends on it.
Basically Tokenomics aims to create an economic ecosystem that is based on tokens. In fact, the idea was proposed by BF Skinner, a Harvard psychologist, in 1972 and Tokenomics was considered as the science that studies the economy of tokens.
An ecosystem of this type is supported by the different possible interactions with a given token. Otherwise, basically the token would be useless and, therefore, nobody would use it.
In this way, Token Economy refers to all aspects related to the creation and management of the token; for example, what will be the supply of the token, how will it be issued, how will it be distributed and what use will it have.
When looking at the token economy, you are basically looking for answers as to what gives the token value and what is the probability of success or failure.
Characteristics of Tokenomics
The Tokenomics of a project will define two fundamental aspects: First, the incentives that will determine how the token will be distributed and its utility that will influence demand.
The price of a token is largely determined by its supply and demand. When a token is useful and attractive, investors will increase its demand and since supply is limited, it will put upward pressure on the price. However, the theory also works the other way around: if no one wants the token, the price will most likely crash.
Some of the most important aspects that are included within Tokenomics and that tend to change between projects are:
- Limited supply vs. unlimited: Contrary to popular belief, not all tokens available on the crypto market are in limited supply. This is an aspect to consider between projects, for example, Bitcoin has a maximum supply of 21 million BTC, while Ethereum has no limits on its supply. This feature is especially important in terms of inflation, since, for example, Bitcoin is considered deflationary because the amount of Bitcoin expected to be paid for a product decreases over time.
- Token distribution: Some projects offer a detailed section on how the tokens will be distributed. Ideally, the distribution mechanism and strategy should be such that the impact on the circulating supply and the price of the token is as minimal as possible.
- Will tokens be burned? Considering that supply and demand play a key role in the price of a token, a frequently used strategy is to permanently remove tokens from circulation. For example, BNB, Binance’s crypto, uses an automatic burning system.
- Mining or Staking: This aspect has to do with how the tokens are issued and the transactions are validated, the usefulness of the token will largely depend on it. For example, in mining, transactions are validated by a computer, while staking offers a reward to those who lock a certain number of tokens on the network. It is basically the difference between Bitcoin and Solana.
What should be evaluated?
So, once we know what are the characteristics that can change in Tokenomics from one project to another. Understanding how to assess the economics of a token is critical.
As previously mentioned, the interaction between the supply and demand of the token is essential to determine the chances of its success. Therefore, the following elements that affect supply and demand must be evaluated.
Token Supply
The supply of the token refers to its supply and, like fiat currencies, this is made up of the Circulating Supply, the Maximum Supply and the Total Supply.
What difference do they have from each other? Well, the circulating supply refers to the number of tokens that circulate in the market, the maximum supply is the possible limit number of tokens that can exist and the total supply is the number of tokens that have been issued so far but not necessarily are in circulation.
According to CoinMarketCap, there are 19,079,387 BTC in circulation, with a total supply of 19,079,475 and a maximum supply of 21,000,000 BTC. Therefore, there are 88 BTC that are not circulating although they have been issued.
The reason why it is essential to study how the supply of a token is is that it will provide us with answers about how its supply and demand behaves.. If it is concluded that an asset is scarce and there is a high demand for it, upward pressures on the price will be generated. Also, knowing that a token has a maximum verifiable supply increases the chances that the price will increase, as long as the demand remains or increases.
There may be tokens or cryptocurrencies that do not have a maximum supply, as is the case with Bitcoin. Does this mean that they will have no potential in the future? Not necessarily. Analyzing the supply of a token is not a sufficient indicator to conclude on its potential.
Some tokens or cryptocurrencies use burning mechanisms to adjust supply to demand and thereby make the asset less inflationary.
There is no single approach, some do it through burns at scheduled intervals and others burn part of the transaction fees. Regardless, the result is the same: reduce supply.
Monetary policy, relevant in crypto projects
The concept of monetary politics it is particularly known at the macroeconomic level of the countries. Essentially It is a discipline of economic policy that seeks to control monetary factors to try to guarantee price stability and economic growth.
Basically it seeks to control the amount of money to achieve these objectives. To do this, in the case of the national economy, this is essentially achieved through two mechanisms: changing the interest rate and carrying out open market operations.
Now how does this apply for crypto projects? Well, when evaluating the economics of a token it is relevant to determine if it is inflationary or deflationary and, of course, what are the plans for the issuance of tokens in the future.
How are the tokens distributed?
The fact of how a project distributes the tokens is important because a banner of the cryptocurrency market is decentralization. Projects that allocate a significant percentage of the tokens to a group of people may not be ideal.
Particularly when a large number of tokens are allocated to a certain small group of people, there is a chance that they will cooperate to sell and drive the price of the token to zero.
Then, the following must be determined.
- How were the tokens originally distributed?
- How many tokens are assigned to the people behind the project?
- Is there a number of tokens locked to be distributed in the future? If so, what are the plans to distribute them? How do you plan that it does not affect the price?
final thoughts
The relevance of Tokenomics is that it allows the creation of self-sufficient economic systems based on blockchain technology.but to do so, a project must figure out how tokens should work within its ecosystem.
All projects must create a new model or adapt one that works for the ecosystem they are creating, and consequently, they must have extensive documentation that relates their objectives, governance aspects and must detail all the information regarding the token.
In this way, before investing in any token, it is a mandatory task for everyone to read such project documentation. Basically, this will provide information regarding the seriousness of the project, its objectives, purposes, how it plans to get where it wants to go, technical details of the economy of its token, etc.
The main question to keep in mind is: Is there a high possibility that this token will appreciate against the US dollar? Or, on the contrary, does the documentation indicate that this token has no added value to offer?
Also, this documentation should reveal important information about who the founders are, their team and who advises them, with this information, investors can reduce their risk to a certain extent.
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