In answering the question, what is Tokenomics, we would consider the approach utilized in the traditional economy. In this case, economists use official money supply data to track the issuance of a currency. The numbers they report are called M1, M2, and, depending on the country, M3 or M4. A detailed description of the four M categories is beyond the scope of this tokenomics analysis; suffice it to say that M1 is a measure of the most liquid currencies, M2 is less liquid, and so on. These figures aid in the transparency and monitoring of several aspects of a currency's supply.
The topic of tokenomics examines how cryptocurrencies function within a larger ecosystem. It includes token distribution and how developers may utilize them to reward good network behavior. A popular crypto project is Augur, which compensates users for validating facts on its wagering network. Tokenomics is the study of the supply and demand aspects of cryptocurrencies.
B.F. Skinner, a Harvard psychologist, proposed the token economy for the first time in 1972. He claimed that a token economic model could be used to manage behavior. Giving some recognizable unit of worth would incentivize positive behavior and vice versa.
Token and Blockchain
Before we go further, let's define a vital keyword, "Token." A token is a digital unit of a cryptocurrency used to represent a specific item or use on the blockchain. Tokens can be used for various purposes, the most prevalent of which are security, utility, and governance tokens.
Blockchain-based cryptocurrencies and tokens have pre-set algorithmically generated issuance schedules. It implies that we can estimate with certain precision how many coins will have been made by a specific date in time with a high degree of accuracy. Though most crypto assets can have their issuance schedule changed, it usually requires the approval of many people and is quite challenging to implement. The implication of this is that it gives owners some peace of mind through the understanding of tokenomics and the extent to which their assets will be created considerably more predictable than governments producing money. Tron, for example, is controlled at several levels to decentralize the decision process while being practical. Automated procedures govern how Tron tokens are added to the network to guarantee that there are enough in circulation while keeping the price consistent. If this fails, the community can determine whether to increase or decrease the amount.
Tokenomics and Crypto
Tokenomics is one feature many seasoned investors look for because it significantly influences its short-term and long-term worth. Crypto projects with well-designed tokenomics have a better chance of long-term success because they can attract more investors and develop a sustainable economy. Designing tokenomics for crypto projects is now essential more than ever.
Similarly, any project with bad tokenomics is bound to struggle in the market, even if initially profitable, because investors are more inclined to abandon ship at the first hint of difficulties.
If you're wondering whether a new project will be profitable, one of the first things you should do is learn about its tokenomics.
Importance of Tokenomics
The following are the several aspects of tokenomics that will have an impact on a project:
Aids in price stability
Cryptocurrencies are renowned for being incredibly volatile - one appealing token's value might drop dramatically overnight, seemingly for no reason. Volatility is a significant concern for investors, which often dictates their attitude towards a particular cryptocurrency. Any swings can cause them to buy or sell in large quantities, which can be terrible for the project.
Tokenomics can assist a project in overcoming this problem by guaranteeing that there are enough tokens to meet the levels of supply and demand. It provides stability to the project and encourages investors to keep their tokens and use them for their intended purpose.
Directs the manufacture and burning of Coins
Tokenomics governs how each token is created (or "minted"), allocated, and eventually removed from circulation. While investors must be able to purchase tokens from a supply or create new tokens, there is a problem: inflation.
Cryptocurrencies, like real money, lose value when an excessive number of tokens are issued. When supply exceeds demand, inflation is unavoidable. Price swings are common when a crypto project lacks tokenomics methods to keep up with inflation.
The term "burning" is a mechanism utilized to reduce the oversupply of cryptocurrency. A project's tokenomics should also describe how tokens are removed from circulation to lower the overall supply. Removal of cryptocurrency from circulation raises the value of the cryptocurrency. It benefits investors and helps the enterprise avoid inflation. For instance, in October 2018, Tether 'burned' tokens to drive down the circulation, thereby regulating the coin's value in the marketplace. Burning is achieved by sending a cryptocurrency to an unknown wallet address.
Some tokenomics protocols also specify whether coins would be maintained in reserve. This means they are later reintroduced into the economy, which may be required to stimulate growth or maintain the system. An example of a crypto project that does this is RIPPLE.
Tokens might be helpful in addition to having monetary worth. This feature makes a coin more appealing to a potential investment by providing incentives. The higher the utility, the more people want to acquire and retain the token, creating demand.
Here are some of the incentives that tokenomics developers use:
1. Staking: Some projects offer storing tokens (either earned or purchased) in a smart contract. It functions similarly to a high-yield savings account, generating passive income for the investor.
2. Yields: Similar to staking, except the tokens are placed in liquidity pools; these fuel decentralized exchanges and lending services. On such platforms, investors lend or borrow cryptocurrency in exchange for benefits.
3. Token distribution and vesting periods: Some cryptocurrency initiatives use a token distribution scheme. For example, tokens may be reserved for venture capitalists or developers. Still, they may only be sold after a certain amount of time. Token allocation rules provide a method in which tokens are distributed so that the token's price or stability benefits as much as appropriate.
Impacts future value
Tokenomics sets the framework for how tokens function within the context of a project's ecosystem. However, it also introduces a term called "game theory." Tokenomics can incorporate whatever type of game theory the project desires.
Game theory is an economic concept based on psychology. It rests on the assumption that investors (human beings) are logical and will invest in the best option. For example, a project that offers them incentives, such as staking or yield rewards.
As a result, tokenomics incorporates any additional factors into the project's architecture that may help enhance the token's demand in the long run. And suppose you are a user looking forward to harnessing the potential in tokenomics.
Understanding what tokenomics is and the role it plays in a crypto project can help you analyze every future investment opportunity that comes your way. Leveraging the information provided about a project's tokenomics should give insight into how the cryptocurrency will be controlled, how users may utilize it, and how developers will drive its future demand and supply.