THE GOOD, THE BAD AND THE UGLY OF TOKENOMICS
By Rishi Randhawa
Head of Metaverse Innovation @ Enjinstarter
Whether you are building a game, a blockchain, a Metaverse, or a cryptocurrency, the ultimate success of any project relies on value creation. There are countless moving parts, yes, but product comes first.
Once you have the utility, then it’s time for the next integral part of your project and ecosystem: tokenomics. Although in this article I will be speaking of fungible tokens, some of the same observations stand for NFTS, for increasingly communities are built using both.
Why are tokenomics important?
I’ve narrowed down the importance of tokenomics into four main points. By no means are these the only reasons good tokenomics are vital to success — and I’ll discuss others at a later date — but they are the pillars of what I look for in a project.
Firstly, in a trustless web3 world, investor confidence is gained via proof of planning, strategy and utility. Good tokenomics are evidence you understand your project, goals, limitations and value proposition. Well defined tokenomics demonstrate an understanding of how tokens flow within your ecosystem, the fluctuations and pressure points, when and how prices could rise and fall and how to accommodate these changes.
Secondly, good tokenomics give projects the mechanics necessary to stabilize token price, as well as the courage and confidence to execute on roadmaps and strategy.
The third reason good tokenomics are important is the clarity and depth of thought required to execute. Good tokenomics demonstrate capability in your field, as well teamwork, the ability to incorporate mental models, high level financial literacy, an understanding of the markets and human behaviour and many more traits which build trust in investors and community.
Finally, good tokenomics allow you to manage supply and demand from the beginning, removing uncertainty and allowing the team to carry through on the roadmap with confidence.
The Hallmark of Good Tokenomics
Now we know why tokenomics are important, we are going to look at two projects which have got their tokenomics right, and two which haven’t. But before I get to that, let’s go through the hallmarks of good tokenomics and examine three ways you can improve them.
- Without them the ecosystem would not be able to function optimally.
- They are not prone to inflation and mechanics are built in to burn excess supply.
- Fluidity. Tokens can be sent easily between people and don’t require multiple wallets or intermediaries for large volume transfer.
- The token utility goes beyond the core ecosystem.
- The token has multiple motivational values to buy, hold and use — staking, voting, airdrops etc.
- It is clear what the token can and can’t be used for.
- Taxes that go above 2% cause an imbalance in marketplace dynamics. Stay below 2%.
- Even token distribution amongst users.
Three ways to improve your tokenomics
First and foremost, the best way to make your tokenomics better — and one I have already alluded to — is to improve utility. Make your value offering count. Whether it’s gameplay, governance, security, rewards, staking or transaction fees, improve utility and you improve the tokenomics of your project.
Secondly, understand community and stakeholders want a voice. Web3 and blockchain technology has the means to give that voice. If the roadmap is still taking shape and the project isn’t ready to transform to a DAO, add a governance mechanic for a proposal and voting system.
Finally, have a burn mechanism system to manage inflation. Increase the price indirectly by decreasing the supply. A good example of this is Huobi Global who, due to record growth in 2021, burned 2.69 million Huobi Tokens worth $35m.
Two projects with good tokenomics
Helium (HNT)
The telecommunication networks we use to interact with cryptocurrency are centralized, the top five providers accounting for the majority of traffic. This is where Helium, a decentralized wireless network for IOT devices, powered by cryptocurrency, comes in.
The Helium network is made up of internet hotspots which owners can buy, or build themselves. These hotspots are peer-to-peer 5G compatible. You now know my feelings regarding utility, and Helium has it in spades. The project has real-world usage that goes far beyond speculation. By making the networks we rely on decentralized, Helium could change the world.
Like everything in crypto this isn’t guaranteed — due to the competitive nature of the infrastructure it is trying to change, Helium may face tough times ahead. However, the tokenomics which drive the network are an example of what great tokenomics look like.
HNT is the native currency of the Helium blockchain. The maximum supply is 223 million and there was no pre-mine or ICO. 120 million HNT were minted in the first two years and there is a halving every two years, regulating supply to the market.
The Helium team has demonstrated many of the hallmarks of good tokenomics. HNT is used as an incentive for mining and building network coverage with hotspots. Each year the algorithm automatically adjusts the distribution of the tokens to the hotspots. The more the hotspot is used, the more compensation the owner of the tokens get. HNT is also used to stake and validate the network.
TERRA
Founded in 2018, Terra is a dual-token, open-source ecosystem of stablecoins collateralized by LUNA and controlled by stakeholders. The tokenomics of Terra are certainly very sophisticated compared to more traditional single token systems which tend to act as a replacement for FIAT.
Firstly, by decoupling certain utilities from the LUNA coin, Terra allows users to choose where the network works for them. If investors are looking for utility outside of the Luna network they can swap LUNA for Terra (UST) and vice versa. To further control coin flow to the market, the trading utility of Terra incorporates the burning mechanism.
To mint USDT (or any of the stable coins in the Terra network) an equivalent amount of LUNA is burnt — with a small fee going to the community treasury for Terra development.
As and when the utility of USDT expands, increasing demand and causing it to unpeg from the dollar value, the process works in reverse. USDT is burnt to create the equivalent value of LUNA — it allows for a self-sustained system where demand and supply is always working to keep the stablecoins pegged, whilst increasing the value of LUNA.
Two projects with bad (and possibly ugly) tokenomics
SAFEMOON
SafeMoon labels itself as “a human-focused technology and innovation business expanding blockchain technologies for a brighter tomorrow.”
With 777 trillion coins, Safemoon needed to get their tokenomics right. To begin, they included a 10% transaction fee to reward hodlers. This high tax rate was to mitigate volatility and incentivize long term investing of SAFEMOON. 50% of the transaction fee (5%) was paid as a dividend to investors in the form of ‘reflections’ (based on the amount of SAFEMOON held), the other 50% was added to the liquidity pool, including a portion to the Safemoon burner wallet to get that 777 trillion down.
Interestingly, the burn wallet was itself a holder (with 42% of supply) and received the highest ‘reflection’ reward.
Alongside the questionable tokenomics, the use case for Safemoon was, in my opinion, weak. As a wallet, it didn’t have a competitive advantage against existing platforms. While this might not have been the ultimate downfall of SAFEMOON it was part of a wider issue that the project could offer much to investors beyond the transaction tax.
Last, but not least, the top exchanges didn’t list SAFEMOON so it was very difficult to buy, and when you could get hold of it, no vendors accepted it as payment.
In December 2021, Safemoon released Version 2 with an updated version of the Safemoon contract.
IRON / TITANIUM
Mark Cuban insists his losses from the controversial Iron Titanium crash in 2021 were not substantial. With an estimated $10 million lost, it only accounted for a small percent of his total portfolio. Mark Cuban got out before the real pain was inflicted. Many others were not so lucky.
TITAN was created to back IRON, a stablecoin pegged to the US dollar via USDC (75%) and TITAN (25%). Initially it was a success story, the tokenomics allowing holders to earn incredible returns on their investment (Up to 2,000,000%+ APY). The price increased rapidly.
The story started to unfold when TITAN hit $65, before retracing down to $60. This price drop saw whales start selling their holdings, flooding the market with TITAN. This put selling pressure on smaller holders, caused the depegging of the TITAN/IRON pair and triggered an almighty rush for the exit.
The problem with the Titan tokenomics was that holders could swap their IRON for TITAN. And they did. As TITAN was crashing, the number of tokens increased, further exacerbating the problem. The supply continued to rise as the price continued to fall. Within a few hours, TITAN was, for all intent and purposes, at zero. Today it is trading at $0.0000001737
Titan’s crash highlighted the dangers of bad tokenomics and what can happen when you get caught in the crossfire.
When a few whales selling their holdings can cause billions of dollars to be wiped from the market and cause the investment of hundreds to go to zero, there is something fundamentally wrong with the basics.
Hopefully I have given you an idea of what to look for, and perhaps what not to look for when it comes to tokenomics.
Disclaimer: This is not financial advice, it is meant purely as educational material. Seek professional guidance when investing in any market, and realize any investment could go to zero.
