Tokenomics

In the world of cryptocurrencies and decentralized finance, tokenomics is the key to understanding how the economics of digital assets work.

Tokenomics is an acronym for “token” and “economics,” which refers to the economic mechanisms that govern the creation, distribution and use of tokens within a blockchain or cryptocurrency ecosystem.

Utility

Something fundamental for a token and that will largely determine its value is its usefulness. A token can be useful within an ecosystem in different ways.

Medium of exchange

Some tokens, such as Bitcoin, are primarily designed to serve as a decentralized medium of exchange. Users can transfer value around the world without relying on traditional banking systems.

Another example is stablecoins, which provide the stability needed for everyday transactions, making them an ideal choice for people looking to navigate the cryptocurrency space without exposing themselves to extreme price fluctuations.

Access to platform features

Many tokens grant users access to specific functionalities within decentralized applications or perks. For example, in Ethereum-based projects, users might need platform-specific tokens to execute Smart contracts or participate in governance.

These advantages could be discounts on the fees they have to pay for a service. For example, on a lending platform, having that platform’s utility token may mean paying lower fees than users who do not have the token.

Other tokens offer their holders the ability to lock their assets in a liquidity pool or participate in farming. In return, users get additional tokens as a form of passive income.

Governance rights

Governance tokens exercise the same role as shares in a company. Users with governance tokens can vote on the future of the company and what is done with the company’s profits and capital.

For example, MKR holders in MakerDAO participate in the governance of the protocol by influencing decisions related to stability fees, collateral types and risk parameters.

Token supply

The total supply of a token represents the maximum amount that will exist. The circulating supply, on the other hand, refers to the tokens currently in circulation.

A company’s tokenomics often include mechanisms such as mining, staking or token burning to control and distribute the supply of tokens.

Scarcity as a value driver

The supply of tokens is something very important because it is one of the factors that determines the value of the token although not the only one. If a protocol is constantly issuing tokens it is very likely that it is constantly reducing the value of the tokens and vice versa.

Many cryptocurrencies, such as Bitcoin, introduce scarcity into their tokenomics by limiting the total supply. In this way, they mimic the scarcity of precious metals such as gold, which aims to increase the perceived value of the digital asset.

Linked to this are inflationary or deflationary token models.

Inflationary models introduce new tokens into circulation over time, while deflationary models may involve burning tokens, reducing the overall supply.

It is also quite normal to find companies that combine token issuance and token burning. On the one hand to reward certain agents in their ecosystem or community and on the other hand to keep the supply more or less constant.

As we can see utility and scarcity are key to the intrinsic value of a token.

While scarcity adds perceived value per token unit, utility ensures that the token serves a purpose within its ecosystem. Striking the right balance between these elements is essential to the long-term success of a token.