Tokenomics is the science of a token. Combining ‘tokens’, digital assets, with ‘economics’, which explores the production, distribution and consumption of goods and services, tokenomics examines the essential parts of a token’s economy — in particular, what drives demand for tokens.
Let’s look at Supply and Demand
Supply and demand influence market prices. In the real world, diamonds and luxury goods are expensive precisely because there is more demand than supply. The principle of scarcity is at play here. Crypto is no different.
1. Supply: Allocation and Distribution
We often hear about private sales or tokens being reserved for project owners or investors. This is one way that initial distribution occurs. Other projects hold a fair launch — a term that means everyone has equal chances.
For example, Solana’s (SOL) sees more than 40% being owned by insiders at launch. On the other hand, ApolloX native token APX was a fair launch, with no investor allocation, team allocation or pre-mining.
In theory, having too many insiders could cause a token dump and price crash. So why doesn’t every project conduct a fair launch? Well, insiders can help to generate value for the project, whether by providing funds, counsel or connections.
More importantly, you should understand whether these insiders, if any, are incentivized to support the project long-term. Some questions to consider:
- Who are the investors or insiders?
- What value do these investors provide to the project?
- What is the vesting schedule for tokens?
2. Supply: Inflationary vs Deflationary Tokens
Inflationary tokens have no cap on their maximum supply. The number of tokens increases over time with continuous mining activity. Examples include ETH and DOGE. In contrast, supply for deflationary tokens decreases year by year. Many projects also buy back and burn tokens to decrease the total supply. APX is an example of a deflationary token with its 1% burn tax for each transaction.
Again, in theory, a deflationary token generates more demand than supply, thus creating scarcity which drives the token value up.
ETH itself will transition from an inflationary token after The Merge and EIP-1559 hard fork — ETH issuance will drop 90% and a base fee will be burned with each Ethereum transaction, turning the token fully deflationary.
Credit: Glassnode
Useful terms to know:
- Max supply: The maximum number of tokens that will ever exist
- Total supply: Max supply - burned tokens
- Circulating supply: Total supply - locked tokens
- Market capitalization: Circulating supply * current price
3. Demand: Utility
A token needs to have utility to be in demand by traders and to be successful. Understanding toknemics requires a good grasp on a token’s short and long-term usage and benefits.
Token utility can look like
- Gas fee payments: For participation on the blockchain/project’s ecosystem
- Governance: For proposal voting; community management
- Real-world usage: Payments to real-life merchants; added to balance sheets
- Long-term value: Locking to get more voting power; staking; rebasing
But what about memecoins like Dogecoin? Dogecoin has little utility and is an inflationary token, so why is its price soaring to new highs?
It’s a mix of human psychology and star power. If you’ve noticed, Dogecoin price spikes every time Tesla CEO Elon Musk references it. Traders buy Dogecoin hoping that the price will pump, even with its lacklustre tokenomics. Same reason why it rallied again after Musk bought Twitter. People recall Musk’s liking of DOGE and his previous words about making DOGE a payment method on Twitter Blue.
Why is tokenomics important?
If a coin or token is the backbone of a blockchain ecosystem, tokenomics are the force that oil the wheels.
Digital assets are used to create new products, incentivize members and govern the community. Figuring out tokenomics of these assets can help projects to create sustainable micro-economies and stay relevant.
For investors, understanding tokenomics helps you to evaluate a project’s potential value and inform your trading strategy.
The views expressed in this article are the author's alone and do not necessarily represent the views of ApolloX.
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Risk Reminder: Crypto trading carries a risk. All trading activities are done at your discretion and at your own risk. The information here should not be regarded as financial or investment advice from ApolloX. ApolloX will not be liable for any loss that might arise from your use of any financial product.
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