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Written by Robert Steinadler a month ago

What are tokenomics in crypto?

You might have already heard of the term tokenomics if you are interested in crypto projects that often do not rely on their own blockchain but rather on other driving factors. The term has become quite popular in the last few years and basically describes the incentive structure that is underlying a blockchain protocol and its token.

If the tokenomics are well formulated a token may thrive and increase in value. Hype and market sentiment is a factor that drives value in the short term. The tokenomics on the other hand focus on the long-term value and are therefore more important to investors rather than traders who are looking to realize profits in a very short amount of time.

How are tokenomics working and how do they define the value of a token?

Utility tokens and token economy

Tokenomics is essentially a combination of the words token and economics. A cryptocurrency like Bitcoin does not rely on some sort of tokenized economy but instead provides a currency that functions on its own and holds value because of that fact.

A utility token on the other hand relies on the economy that is created around the token. That is why most utility tokens have no use for their own blockchain nor are they designed as a currency. It is the incentive to buy, hold or spend a token that defines its usefulness and therefore its value. Interestingly enough there are a couple of driving factors that are proven to increase the value but then again tokenomics is not limited to these basic ideas. Anything could play a role. Some tokens became incredibly valuable because they allow holders to take part in governance.

If you take a look at Yearn you will find that the tokens were worth more than Bitcoin at certain points in time. Its use case is that token holders have the right to vote in Yearn’s governance system. The reason why it became so valuable is simple. Holders can vote on how the protocol distributes rewards and incentives. Since Yearn is a multi-billion-dollar aggregator these voting rights became incredibly valuable.

Value does not lie in the token, it is added

It is easy to see that utility tokens hold no or little intrinsic value. Value is always added by external factors. Tokenomics is a way to get a better grasp of the idea of how and from where this value is derived. While it is true that basically anything could add value to a token there are several metrics that come into play as an important factor when considering the tokenomics:

  • Supply and emission: Usually creators of a token will use inflation to increase the circulating supply until a cap is reached. The supply and emission metrics tell you several things when it comes down to future projections of the token’s value, e.g. how much market share is needed to reach a certain market capitalization.
  • Distribution of tokens: Tokens are usually distributed between certain parties and for certain purposes. A percentage is often given to seed investors, another share is for the team who builds the protocol, and often times there is also some sort of treasury to use tokens to fund marketing or other things that help the token to thrive.
  • Lock-up periods: These periods define the time frame in which parties can tap into their allocations. Typically, early investors have to wait a year or longer until their tokens become available and can be sold on the secondary market.

The metrics described above are adding value by controlling the available supply and the distribution between interest groups and their options to sell their share at a later point in time. But there are also metrics that are important which often come into play once a project is providing services or products on the blockchain:

  • Burn rate: Many tokens make use of some sort of buy-back-and-burn program. Meaning that revenue is used to buy back tokens from the secondary market and destroy them to shrink the supply or at least reduce inflation that is caused by the emission.
  • Staking and ROI: It is also very common to add value by staking or reinvesting tokens in some form. This allows investors to earn passive income that is often financed by the emission rate of the token.
  • Community: Many tokens depend on the community who is flocking around the products or services. In some cases, the whole token is about the community itself. Think of meme tokens, they don’t offer utility but rather affiliation to the meme. In other cases, the community is the most vital part of the utility token. ApeCoin is such an example where holding the token allows the community to participate in the NFT ecosystem of the BAYC.

FAQ Tokenomics

Are utility tokens the only tokens that are dependent on tokenomics?

No, but there is no strict distinction. An NFT can have tokenomics, too. Think of STEPN or ApeCoin. But in both cases, there is some sort of utility added even if the tokenomics apply partially to NFTs. Tokens that are considered to be securities are also driven by tokenomics.

What metrics will guarantee the success of a token?

There is no such thing as a formula that will guarantee the success of a project. The same tokenomics that will lead project A to a huge success might fail if they are just copied or applied by project B.

Are tokenomics the only factor that is important?

No, a project can thrive because of its tokenomics but it doesn’t have to. One example is the Omicron token. When the term became popular bots bought the token and the price exploded for a very short time. As you can see from this example hype or market sentiment might be a driving factor while tokenomics play little or no role in a token’s success. Long-term success on the other hand is often connected to tokenomics and is more important than factors that are causing a short-term effect.

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