Tokenomics: A New Branch of Economics?
As cryptocurrencies become more widespread, they are used more and more in daily life. We buy products and services with them and even use them to play at a Canadian online casino. But a new cryptocurrency is released almost every day, and whether you’re dealing with them for investment or any other purpose, it can be difficult to figure out which ones to focus on. Tokenomics can help you: this interesting term actually lets you learn everything you need to know about a cryptocurrency.
Whitepapers are not enough anymore
Every new project needs a business plan. This plan lists what the project is aiming for, along with the required budgets and time limits, and any investor can get an idea of exactly what to expect from the project by looking at it. Whitepapers have been doing this for cryptocurrencies until now.
Even Bitcoin, the first cryptocurrency, had a whitepaper. This document simply explained what this currency was intended for, how it would work, and what it could be used for. The problem was that most of the whitepapers were filled with too much technical information: it was impossible for those without knowledge and experience in crypto technologies to understand what they were talking about. In addition, whitepapers often acted as a kind of manifesto. Yes, they were explaining what cryptocurrency is and its purpose, but they were also advocating for a particular political idea. If you read the Bitcoin whitepaper, you’ll see that it’s a kind of manifesto of “techno libertarianism”.
Cryptocurrencies became widespread over time, began to appeal to ordinary end users and turned into an investment tool. They are now in most investment portfolios and have to explain more clearly what exactly they are aiming for. Otherwise, it is impossible for them to attract attention: a new crypto is released almost every day, and if it wants to increase its value, it must first attract attention. The easiest way to do this is to prepare a kind of business plan: you can think of it as a simpler version of whitepapers.
Token + economics = tokenomics
To put it simply, a cryptocurrency has to determine which business model it chooses on certain issues before it is released and announce it clearly: this is called tokenomics, that is, the “economic blueprint” of that currency. The term is also used to make an overall analysis of the economic market that cryptocurrencies constitute, but in any case, it takes the same factors into account. These factors are as such:
- Creation and Distribution. Tokenomics first answers the question of how tokens will be created and distributed. These can be done in different ways. Traditional cryptos like Bitcoin use the “mining” technique and basically allow miners to earn coins. Modern cryptos enable those who take roles such as validators to earn coins. Staking can be another way to earn coins as a reward. It should also be determined in advance whether a new coin will hold an ICO (initial coin offering). Tokenomics first determines how all these will happen: the answers to these questions help to understand how popular the cryptocurrency will become.
- Price Stability. Tokenomics second determines how volatile the crypto will be. Most traditional cryptos (Bitcoin and Ethereum, for example) are incredibly volatile, meaning their prices can change radically up or down within seconds. Modern cryptos, on the other hand, mostly prefer to fix their prices on a stable asset (for example, USD). Depending on which of these models is preferred, it is possible to predict how volatile the token price will be. In addition, the measures taken by the project against buying and selling in bulk will also give an idea of what the price stability will be.
- Token Burn. The vast majority of crypto projects periodically burn tokens, i.e., completely eliminate them. You can think of it simply as “deleting”. This process is done in order to regulate the number of coins in circulation and naturally determines what the price will be. For example, it is possible to expect an increase in the price of a burned coin. When and under what conditions the burn will be made is a good way to predict the price changes of the coin and has an important place in tokenomics.
- Supply Control. Another question tokenomics has to answer is whether the supply should be limited or unlimited. The first cryptos to be released had a certain limit to curb inflation. For example, there may only be 21 million Bitcoins – once this number is reached (this is not expected before 2140), it will not be possible to create any more Bitcoins. Second-generation cryptos have different techniques to fight inflation and do not have any supply limits. Ethereum, for example, can be created an infinite number of times. Investors predominantly prefer supply-limited cryptos because the price of a product with a limited supply will always rise.
The project owners (developers) decide all these, namely what the main factors of tokenomics will be. Before a new crypto is released, what the tokenomics will be is published in a separate document. As we mentioned above, this document is called a “whitepaper”, but tokenomics factors are prepared in a much simpler and more understandable way than traditional whitepapers.