Tokenomics : Part I

Why did the token economist cross the road? To get to the other side chain!

In recent years, tokenomics has become an increasingly important topic within the cryptocurrency and blockchain industry. With the rise of initial coin offerings (ICOs) and other token-based fundraising models, many organizations have turned to digital tokens as a way to finance and grow their projects.

The tokenomics series consists of 3 modules discussing many different approaches to tokenomics, and the specific design of a tokenomic system depending on the goals and needs of the organization or project.

The first module will be an introduction to tokenomics, it’s behaviour and dependencies and a look at some famous cryptocurrencies.

What is Tokenomics?

Tokenomics refers to the economics & incentives surrounding tokens. The logic and incentives that control crypto assets are referred to as “tokenomics” in recent years. It covers every aspect of the asset’s operation as well as any psychological or behavioral factors that might have a long-term impact on its value. Long-term success is considerably more likely for projects with well-designed tokenomics since they have done an excellent job of rewarding, purchasing, and retaining their tokens. Poor tokenomics dooms projects to failure since investors will dump their tokens as soon as there is an issue.

Understanding tokenomics is one of the most useful initial steps you can do to make a solid decision if you’re debating whether or not to purchase a crypto asset.

It’s a broad term that covers:

• How the token works
• Supply & Demand
• The mechanisms that govern it
• Incentives, psychology & behavioural aspects
• Game Theory & a lot more

Emissions, inflation, and supply-side distribution

Since it’s a little simpler to understand, let’s start with the supply side. You’re mostly attempting to determine: Should I anticipate this token’s value to hold or grow based solely on supply? Or will someone pump that value up?

A token’s value will rise on the supply side if there are fewer of those tokens available; this is known as deflation. If there are more tokens, their value will decline; this is inflation. You don’t have to consider things like whether the token has any utility or will bring in money for its owners when analysing the supply side. Actually, all you’re doing is considering the supply and how it will evolve over time.

The inquiries you should make are:

• How many of these tokens are there currently?
• What number will there ever be?
• How quickly do new ones come out?

Case Studies

1. Bitcoin

A straightforward supply curve that emits over a period of 140 years was used to develop Bitcoin. Only 21,000,000 bitcoins will ever be issued, and the rate at which they are distributed is roughly cut in half every four years. There are only 2,000,000 more to be released over the next 120 years because there are now about 19,000,000.

Since there will only be 10.5% more bitcoin in 100 years, 90% of the supply is already in circulation, so you shouldn’t anticipate any significant inflationary pressure to drive down the value of the coin.

Mt. Gox Case: In a 2011 cyberattack, the Japanese-based exchange Mt. Gox lost about 850,000 Bitcoins. Ten years later, in November 2021, the exchange published a “Rehabilitation Plan” to give investors back about 137,000 BTC. According to several cryptocurrency analysts, the release of 137,000 BTC could result in increased sell pressure that could drive the price of Bitcoin below the $10,000 threshold.

2. Ethereum

In September 2022, the Ethereum network underwent the “Merge,” which symbolized the switch from proof-of-work to proof-of-stake.

Pre Merge (Historical):

• Before moving to proof-of-stake, miners received about 13,000 ETH each day.
• Based on the approximately 14 million ETH that has been staked, holders receive about 1,700 ETH per day.
• Depending on the overall amount of staked ETH, the precise staking issuance changes.

Post Merge (Present Day):

• Since The Merge, there has been an 88% decrease in the total fresh ETH issuance, leaving only 1,700 ETH/day.

● The burn: Taking tokens out of circulation is known as burning. It’s similar to a company buying back shares. ETH gas fees are split into a tip to the miner & base fee. The base fee is burnt. The burning happens in many ways. It increases scarcity & drives up value. This varies based on network demand. The 1,700 ETH that is provided to validators is effectively neutralised by an average gas price of at least 16 Gwei, bringing the net ETH inflation for that day to zero or less.

Previously, new ETH was issued from two sources: the execution layer (i.e. Mainnet) and the consensus layer (i.e. Beacon Chain). Since The Merge, there has been zero issuance on the execution layer.

Interesting Speculation: You won’t be able to immediately unstake if you have already staked to the beacon chain. If you stake your ETH right away, it will likely be locked for at least another six to nine months, and even then, there will be a trigger to unstake, so you can’t just do it right away; it might take a little longer. When people are able to unstake, that will be a part of the shanghai update, which is most likely the next upgrade to arrive following the merge. Another thing to keep in mind is that the market should be affected when Ethereum may be unstaked, or at least that is my assumption. (Again, this is not financial advice:D) Since all of this ETH is being staked and locked for the next six to nine months and cannot be removed, the supply will be lower in those intervals. Supply will return to the market once you can unlock all of that. It will be fascinating to see what happens after this because all of the staking rewards and interest that people have been earning on staked ETH will be available for them to sell.

Counteract Proposed: Only six validators may quit per epoch (every 6.4 minutes, or 1350 per day, or only 43,200 ETH per day out of over 10 million ETH invested) since full validator exits are rate regulated by the protocol. This rate cap avoids a large-scale money migration and varies based on the total amount of ETH staked. Additionally, it stops a potential attacker from utilizing their stake to commit a slashable offense and then withdrawing their entire stake before the protocol can impose the slashing punishment in the same epoch. When withdrawals are enabled, validators will leave at a rate set by the protocol if the rate is too low. This will gradually increase everyone's APR who is still participating, bringing in new or recurring stakes once more.

3. Dogecoin

It also has no supply limit, and it is now growing at a rate of about 5% annually. Therefore, among the three, we should anticipate that Doge will lose value faster than Bitcoin or Ethereum as a result of inflationary tokenomics.

In the next module, we will see the lessons that we can learn from these case studies.