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Crypto Glossary

What is “Tokenomics”, and how does it work?

What is “Tokenomics?”

Firstly, what is tokenomics in crypto? The explanation is simple. It is the economics of tokens. In other words, it is a set of elements for creating, distributing, buying, and selling coins. This set includes all crypto transactions, from creating a token issuance prospectus to the resale of NFTs (Non-Fungible Tokens).

Tokenomics determines what drives investors to invest in crypto, “monitoring” the monetary policy of each issuer, whether they are Shiba Inu or Solana projects, the creators of a stablecoin or a hype coin. Additionally, tokenomics studies the utility of tokens, which directly affects the level of demand.

The main thing a crypto project creator needs to know in understanding tokenomics is that tokenomics gets tied to buyer incentives and the performance of a particular coin, not the marketing of the crypto project.

The significance of tokenomics

You can explain the value of tokenomics in the variables that affect it.

Those variables are mining (which mines Bitcoin) and stacking, which means keeping coins in your account and getting paid for not selling them (which Ethereum, for example, is trying to do now). So let’s talk about staking in a little more detail.

Staking is an alternative to mining, a very successful technology whereby the issuer of a coin reduces the damage that its minting does to the environment. Many altcoins use staking, be it Chainlink or the critiqued by experts SafeMoon. They believe that the technology is the future of the entire cryptocurrency market. And from the analysts’ point of view, this is true because Bitcoin will stop mining sooner or later, and mining as a way of making money (and harming nature) will fall into oblivion.

Another variable is profitability. DeFi-platforms can offer high yields to encourage the purchase of tokens and their placement in liquidity pools. For example, the more tokens you provide to a liquidity pool used for currency stacking, the more coins you get over time. It does not apply to cryptocurrency loans or any other loans – only to stacking.

The variables also include token burning (i.e., a particular and planned reduction in the number of coins in circulation, for which you also get paid!), supply constraints (i.e., the maximum number of tokens on the exchange) and token distribution mechanisms between users. All these variables are an integral part of the tokenomics definition.

How does tokenomics work?

How does tokenomics work

Tokenomics determines how attractive a coin is to investors. It is described in a separate document, which the issuer must provide to the investor. The document also states how the currency works, how it differs from its competitors, and why it is a good investment. The document usually gets posted on the issuer’s website and aggregator portals. Thus, well-designed tokenomics will determine the demand for the coin. However, the surface-level tokenomics model ends there.

Yet, if you study tokenomics deeper, you will find some tokens may be service tokens. That is, they may have a particular purpose beyond paying for something. For example, holders of such coins have the right to vote to change the tokenomics of the main asset of the issuing company or even to change the operation of decentralised cash pools, investors, payments to coin holders, and so on. Of course, according to game theory, no one would vote for a disadvantageous idea, but the market does not always work following theoretical postulates. For example, sometimes tokenomics works against investors, causing inadvisable purchases in the deflationary market.

Altcoin tokenomics

So how does global tokenomics of altcoins work? In the same way as any other tokenomics.

An altcoin (any coin other than BTC, i.e., an alternative cryptocurrency) has a supply. It is the number of coins you can buy in the market. However, it gets limited – for example, if a company burns coins as Algorand does. Or it may be infinite (but there is no example of that – even Bitcoin will run out sometime because only twenty-one million of those coins were issued, nineteen million of which are already in investors’ hands).

Related to the supply are distribution mechanisms – how exactly the coins get to their future owners, who monitors them, and what restrictions on distribution exist. The lack of information in the documents about the distribution of coins is one of the most glaring red flags in tokenomics. For example, suppose a group of investors hold about 25% of an issuer’s coins and that 25% is offered on the market a month after you buy a certain amount of tokens. In that case, the rate of the crypto coin will drop, and you will simply lose your investment. The tokenomics of altcoins is also related to inflation. The depreciation of money causes the value of goods to rise. Dogecoin, for example, has an inflation rate of about 5% per year; the coin has no supply constraint, making it more susceptible to inflation risks.

Demand plays an essential role in the tokenomics formula of altcoins. How attractive is the coin to investors? Will your investment be profitable? You can find this out via the ROI (Return On Investment). It shows the profitability of the investment and its feasibility. You can calculate the figure using a special calculator, which is available almost everywhere on exchanges.

Nevertheless, remember that even seemingly insignificant factors like cryptocurrency memes or tweets about someone wanting to buy a particular coin can affect demand. For example, Elon Musk’s tweets about his company Tesla accepting Dogecoin made the coin very popular among investors. Still, it didn’t last long in the wave of interest, causing the impulsive investors’ sky castles to collapse.

Nevertheless, Dogecoin is still in some demand. Much of this phenomenon gets attributed to memes outside the cryptocurrency segment featuring the same Doge character. The memes thereby popularise the coin with the general public, even though it emerged after the first meme and not before!

Mining vs Tokenomics

How is mining different from tokenomics? Mining is part of tokenomics, it is the process of mining Bitcoin, which gets embedded in the tokenomics of this project. Tokenomics describes how a cryptocurrency works, including its mining process, distribution, issuance volume and other similar information. Comparing tokenomics and mining is incorrect, as they are not equivalent processes.

Examples of tokenomics

Examples of tokenomics

What is the crypto with the best tokenomics?

1. Polkadot (DOT)

There are two functions within the project at once. The first is the Parachains platform, which is responsible for tools for developers of blockchain solutions. You can create your own blockchain project on the site, but first, pitch your idea to the platform’s authors. The number of developer slots is limited, and they get allocated in an auction format – the highest bidder will get the opportunity to develop their project. The developer slot only gets rented for a while. Then, the auction gets repeated, and the price can be increased or decreased depending on the results.

The second feature is the use of Polkadot coins in the ecosystem of the same name. For example, coin holders can participate in the governance of the Polkadot network, vote on various decisions, participate in staking and earn money by holding DOT coins in their wallets. Moreover, you can make a fair amount of money. For instance, Polkadot offers about 13% for not selling their coins, i.e. keeping them. Coin holders can also participate in crowdlending, giving collective loans to other users who have bought Polkadots. The loans get offered via a quite traditional instrument for investors on stock exchanges – bonds. It protects lenders from fraud and gives projects a real opportunity to borrow for their business.

2. Helium (HNT)

The eponymously titled Helium is the Helium Network’s cryptocurrency. The Helium network is decentralised and provides coverage for IoT devices. In simple words, IoT is the Internet of things and all the technological innovations that work with it, from smart refrigerators that can chart wholesome food to cameras that record movement in every nook and cranny of a property. The coverage gets compensated by the network’s cryptocurrency of the same name, the Helium token. Network hosts mine tokens when creating a point of coverage and maintaining the network. Companies and developers can use the network to create their own applications and connect devices to them. Transactions on the network (and more often informational than monetary) get paid for with service tokens tied to the US dollar exchange rate. They appear after burning HNT coins. The hosts of the coverage points receive tokens as a reward.

3. Ethereum (ETH)

Ethereum is a coin with excellent tokenomics. In the ETH network, there are either users (token holders and developers) or validators (miners who verify transactions and are rewarded for conducting transactions in an internal coin, the “gas.” Ethereum now wants to switch to staking, abandoning mining, which makes its tokenomics even more attractive. But the project is interesting without that. That’s because, inside Ethereum, you can create apps, smart contracts, and your altcoins. While the number of coins is unlimited, the ecosystem does not issue them in billions.

The tokenomics of altcoins, of course, may not be particularly good. Below we highlight a few of the not-so-best projects whose tokenomics are generally considered not particularly outstanding.

  • SafeMoon (SAFEMOON)

SafeMoon is a coin that supports the development of a wallet and exchange of the same name. You must pay 10% of the transaction amount per transaction every time. That is a considerable amount, which is not particularly justified. Experts point out that the project does not have a unique value proposition and that the wallet does not differ from competitors. Moreover, the exchange repeats solutions you can find with many market players.

  • IRON Titanium Token (TITAN)

The coin is based on a project that exchanges tokens between different blockchains and automatically mines liquidity. Two cryptocurrencies got introduced within the project: TITAN as the main one, and IRON as a utility stablecoin tied to the value of TITAN. Unfortunately, IRON was floored and poorly designed, causing investors to lose their investment in both coins after TITAN collapsed in June 2021.

  • Dogecoin (DOGE)

Dogecoin is a meme token based on Bitcoin. From the meme point of view, the coin is perfect. Still, its tokenomics are screwed up: the coin does not differ much from BTC, it almost wholly copies Bitcoin, does not allow the creation of smart contracts and applications on its blockchain, and is not limited by supply restrictions. There are now one hundred and thirty billion DOGE coins on the market. Moreover, five billion new coins get produced yearly, making the cryptocurrency’s value inevitably fall (because there is so much of it that any demand will be met). Also, the project hasn’t changed since 2013 because its creators abandoned it.

Moreover, one of its developers, Billy Marcus, once called the coin’s design “absurd.” Admittedly, the already mentioned Elon Musk paid no attention to this when he deliberately boosted the popularity of Dogecoin and invested in the currency himself. Nevertheless, this example shows that sometimes short investments in coins with poor tokenomics can be the basis for large profits. Therefore, it is essential to withdraw funds in time to more stable assets – this rule works for the entire cryptocurrency market.