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Understanding The Basics of Tokenomics

It was during 2020 when people witnessed most financial markets all over the globe tumble down due to the effects of the Covid-19 pandemic. However, that same year also saw immense growth spurts from the blockchain space, specifically cryptocurrency, as a large number of new investors got introduced to the technology as a profitable alternative investment.

New decentralized finance (DeFi) projects are integrated in the blockchain almost everyday, and in this year — in just a two-year period, answering the question from new investors on which crypto or project is worth investing might eventually lead to major financial loss due to the market’s uncertainty. For newbies with little to no-knowledge-at-all in crypto, the first question commonly asked is what gives a cryptocurrency or a token its value and how it is determined? Well, a project’s tokenomics can give you a pretty good idea of whether you should consider investing in it or not.

What is tokenomics?

The word ‘tokenomics’ is a portmanteau, a term that comes from two separate words: token and economics. So, tokenomics is basically token economics or crypto economics. It is the study of the economics of a crypto token from its qualities to its distribution and production, and much more.

Tokenomics is an important aspect to consider when making investment decisions because ultimately a project that has smart and well-designed incentives to buy and hold tokens for the long haul is more likely to outlast and do better than a project that hasn’t built an ecosystem around its token. A well-built platform often translates into higher demand over time as new investors flock to the project, which, in turn, boosts prices.

Likewise, when launching a project, founding members and developers need to consider the tokenomics of their native cryptocurrency carefully if their project is to attract investment and be successful.

The core features of every tokenomics

The success of tokenomics can be determined by how the founding members incentivize the investors who buy and hold the project’s crypto or token. And just like fiat currencies (Dollars, Euros, Yen, etc.), each crypto or token has its own monetary policy.

Tokenomics determine two things about a crypto economy — the incentives that set out how the token will be distributed and the utility of the tokens that influence its demand. Supply and demand has a huge impact on price, and projects that get the incentives right can surge in value.

The core variables that affect tokenomics that developers and founding members are wary about are:

Mining and Staking

Mining is the core incentive for a decentralized network of computers to validate transactions — applicable for base layer blockchains, like Ethereum 1.0 and Bitcoin. Here, new tokens are given to those who devote their computing power to discovering new blocks, filling them with data and adding them to the blockchain.

In staking, users are rewarded for fulfilling a similar role but by locking away a number of coins in a smart contract instead — this is how blockchains like Tezos operate, and it’s the model that Ethereum is integrating towards its 2.0 upgrade.

Yields

Decentralized finance (DeFi) projects offer high yields to incentivize users to buy and stake tokens in liquidity pools. Liquidity pools are huge pools of cryptocurrencies or tokens that make decentralized exchanges and lending platforms work — similar to how pool funds on banking institutions are managed. The yields are then paid out in the form of new tokens.

Token burns

“Burning” of tokens means permanently removing the excess tokens from circulation to reduce supply and increase demand. Doing this helps to support its price as the remaining tokens in circulation become more scarce.

Limited vs unlimited supplies

The creation of tokenomics will also determine a token’s maximum supply. An example of limited supply is Bitcoin’s tokenomics which states that only 21 million bitcoins can be mined with the last coin expected to enter circulation around the year 2140. On the contrary, Ethereum has unlimited supplies, though its issuance is capped every year. NFT (non-fungible token) projects take ‘limited supply’ to the extreme; an entire collection of NFT might only mint one-of-one for each specific collectible or token.

Token allocations and vesting periods

There are also projects that have a detailed token distribution. In some cases, a certain amount of tokens are reserved for venture capitalists or developers, but the catch is that they can sell those tokens only after a certain time.

That naturally has an effect on the circulating supply of the coin over time. Ideally, a project’s team will have implemented a system where tokens are distributed in such a way that it reduces the impact to the circulating supply and a token’s price as much as possible.

Factors that affect tokenomics

For beginners in the blockchain space, it is a must to understand the elements that will have a major impact on the value of a crypto coin or token.

Token distribution and allocation

Before making investment decisions, it is important to understand how the token will be distributed as most crypto tokens are generated through any of the following ways: either they are released through a fair launch or they are pre-mined.

Fair launch is when a crypto is mined, earned, owned, and regulated by the entire community. Before making the token public, there is no early access or private allocations. Bitcoin, YFI, and Dogecoin are a few examples of this

On the other hand, Pre-mining is when several of the crypto tokens are generated and distributed to a select group of addresses (typically project developers, early investors, and other team members) before they are made public. Nowadays, most projects are pre-mined tokens, which shows credibility and that it cares about its future development.

Token supply

The token supply is the primary component of every tokenomics. Total supply, circulating supply, and max supply are the three types of supply to keep an eye on when investing in a project.

Total supply refers to the number of tokens that have already existed, excluding those that have been burned. The circulating supply refers to the number of tokens that have been issued so far and are presently in circulation, while max supply is the maximum number of tokens that will be ever created.

If the circulating supply of a particular token has been increased by the project developers regularly over time, it is expected that the token’s value will rise in the future. On the contrary, if too many tokens are being released at the same time or very often, the token’s value will drop significantly.

Market capitalization

The token’s market capitalization refers to a metric that measures the relative size of the token. It is calculated by multiplying the present market price of the token with the total number of tokens in circulation. While this may provide some insights into the performance and size, any novice should know that it is not similar to money inflow — therefore, it does not reflect the amount of money in the market. The higher the market cap of a token and the lower its circulating supply, the more valuable that token could be in the future.

Token model

Any user planning to invest in a crypto project must know if the token is inflationary or deflationary. An inflationary token, like fiat money, does not have a max supply and will continue to be produced as time goes on. A deflationary token model is simply the opposite, where there’s a max supply the token is capped at, like Bitcoin’s 21 million. Most proof-of-stake tokens like ETH are inflationary so as to reward the validators and delegators in the network.

Future Readiness

Tokenomics also involves understanding how a crypto token can help address the challenges of the future. Many teams in the crypto space that are responsible for the development of a network do not end up as its rulers. So, developers must accept the fact that what works now for their token projects may not work in the future. The network’s growth and maturity may necessitate changes in the way the token is being governed.

Why is tokenomics important?

Projects can use blockchain technology to create micro-economies. They need to figure out how tokens should work within their ecosystem to become self-sustaining. When it comes to tokens, there is no such thing as a “one-size-fits-all” attitude. Blockchain has opened the door to a wide range of applications and implementations. Tokenomics allows teams to design a new model or adapt an existing one that fits with what the project aims to achieve. If done well, this can create a stable and high-functioning platform.

Tokenomics in an NFT ecosystem

NFTing is set to change the landscape of NFT marketplaces, addressing the shortcomings of existing marketplaces in terms of utility, fees, user experience, and social interactions between like-minded individuals. To sustain this long-term vision, flexibility, strong community giveback, and incentives for all users involved, NFTing has created its own tokenomics which will be the driving force of the entire ecosystem.

The NFTing token is intended to become a non-inflationary token with sufficient numbers, set at a soft cap of 10 billion tokens. This will allow everyone to own some of the token while it becomes a heavily transacted asset used for all things NFT as the platform and ecosystem grows.

NFTing chose block emission as it’s a viable long-term solution for a project with years in the making, better than fixed hard cap (where other projects usually end up changing it midway or outright making new tokens). This way we have more control over the emission, and possibly reduce it. Furthermore, no rug pull or hack of a huge amount of the supply is possible, ensuring the highest level of security for the overall tokenomics.

To know the latest developments of this exciting NFT ecosystem or if you have questions regarding the project, you can follow us on Twitter or add us on Telegram and we will gladly start a meaningful conversation with you!

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