Explaining Tokenomics (With Examples)

If you’ve ever scratched your head trying to understand why some cryptocurrencies skyrocket while others fizzle out, then this leeson on Tokenomics was written especially for you.

Right, let’s get to it.

First things first, it’s important to state that yes, navigating crypto is a bit of a minefield - you’re not alone in feeling that way.

Buzzwords, complex technologies, thousands upon thousands of projects, and if you’ve been to Crypto Twitter… let’s not get started on that chaos.

Fortunately, there’s a secret weapon. 

Tokenomics.

Student, are you ready?

What Is Tokenomics?

Think of tokenomics as the economic engine that drives a cryptocurrency. 

Tokenomics is the set of rules and incentives that determine a token's value and long-term sustainability. It’s a portmanteau of “token” and “economics”, so as you can probably surmise, it’s economics for crypto tokens. 

Here are the three main arms of tokenomics:

• Supply: This refers to the total number of tokens that exist or will ever exist (total supply), as well as the number of tokens currently available for trading (circulating supply). Understanding the supply is crucial because scarcity (or abundance) significantly impacts token price.

  
  

• Distribution: This outlines how the tokens were initially distributed. Were they offered through an Initial Coin Offering (ICO), airdropped to early adopters, mined by users, or allocated as staking rewards? The distribution method can influence the token's ownership and how decentralized it truly is.

  
  

• Incentives: Tokenomics also includes the mechanisms that motivate users to hold, use, or contribute to the network. This could involve staking rewards for securing the network, governance rights for voting on protocol changes, or access to exclusive features within the platform.

  
  

Just like a traditional economy, tokenomics are driven by principles of supply and demand, incentives, and utility. If you can grasp this, you are half-way there.

Why Is Tokenomics Important When Investing in Cryptocurrency?

Understanding tokenomics is literally the most pivotal piece of research anyone looking to invest in a cryptocurrency could ever possibly do. It's the key to separating promising projects from those that are destined to fail. 

Ignoring tokenomics is like taking a wild swing at the piñata.

Here are the key aspects you’ll need to familiarize yourself with:

• Price Determination: The supply and demand dynamics dictated by tokenomics heavily influence a token's price. A token with a limited supply and high demand is likely to appreciate in value, while a token with an unlimited supply and low demand may struggle to maintain its worth.

  
  

• Demand and Scarcity: A well-designed tokenomics model creates either scarcity or abundance. Scarcity, like Bitcoin's limited supply, can drive up demand and value. On the other hand, an inflationary model might be necessary for a project's functionality, but it requires careful management to avoid devaluing the token.

  
  

• Utility: What is the token actually used for? Does it give access to services, provide voting rights in the DAO, or facilitate transactions within the ecosystem? A token with strong utility is more likely to maintain its value over time.

  
  

• Governance: Many cryptocurrencies use governance tokens to give holders a say in the project's future. This decentralizes decision-making and can encourage a stronger sense of community and ownership. It can help things like grants and developments also get a lot of internal support from enthusiasts in the community.

  
  

• Long-Term Viability: Ultimately, a sustainable tokenomics model is crucial for the long-term success and growth of a cryptocurrency project. Without a sound economic foundation, even the most innovative technology is going to struggle or have teething pains. By analyzing tokenomics, you can assess whether a project has the potential to succeed in the long run.

  
  

Let’s move on to some real examples…

Tokenomics Examples: Real-World Applications

From one project to another, no two tokenomics models are the same (in theory they could copy one another, but there are still variables). Each is designed to serve a specific purpose within its own ecosystem, but they all take different approaches to get there.

Here’s what we mean by that: 

Fixed Supply vs. Inflationary Tokens (Bitcoin vs. Ethereum)

Bitcoin ($BTC): Bitcoin boasts a fixed supply of 21 million tokens. This limited supply creates scarcity, contributing to its value proposition as a "digital gold" or store of value.

As demand for Bitcoin increases, its price tends to rise due to this inherent scarcity. This is a deflationary model over time, as the rate of new Bitcoin entering circulation decreases.

Ethereum ($ETH): Ethereum, while initially inflationary, is transitioning towards a more complex model.

Historically, Ethereum has had no fixed supply, with new $ETH being issued to reward miners and stakers.

However, the introduction of EIP-1559 introduced a mechanism for burning transaction fees, effectively reducing the circulating supply and potentially leading to a deflationary effect under certain network conditions.

This flexible approach allows Ethereum to adapt to the needs of its growing ecosystem.

Deflationary Tokens ($BNB Token Burns)

Binance Coin ($BNB): Binance, the world's largest cryptocurrency exchange, uses BNB as its native token. A key feature of BNB's tokenomics is the periodic "token burns."

Binance regularly buys back and permanently removes $BNB tokens from circulation, reducing the total supply. This process is designed to increase the value of the remaining $BNB tokens by making them scarcer.

The burns are funded by Binance's profits, linking the value of $BNB to the success of the exchange.

Staking and Reward Mechanisms (Solana's Staking Model)

Solana ($SOL): Solana utilizes a Proof-of-Stake (PoS) consensus mechanism, which allows $SOL holders to stake their tokens to help secure the network. In return for staking, users receive rewards in the form of additional $SOL tokens.

This incentivizes participation in the network and reduces the circulating supply of $SOL, as the staked tokens are locked up and unavailable for trading.

Governance Tokens (Uniswap's $UNI)

Uniswap ($UNI): Uniswap, a decentralized exchange (DEX), uses $UNI as its governance token. $UNI holders can vote on proposals to change the Uniswap protocol, such as adding new features, adjusting fees, or allocating funds from the treasury.

This gives the community a direct voice in the platform's development and direction, giving them a sense of ownership and skin in the game.

Now we’ve seen some of the different approaches, some of you might be asking…

“How Can Tokenomics Make Me a Better Trader?”

There’s a misconception that looking into tokenomics is for VCs, business analysts, or long-term investors.

Nope.

It’s a powerful tool for all traders. When you analyze a cryptocurrency’s tokenomics, you have an advantage over those who didn’t. You get insights into potential price movements and overall market behaviour.

Once you’ve got some experience analyzing tokenomics, this habit will help you assess the risk-reward ratio of a particular cryptocurrency.

Are there upcoming token unlocks that could flood the market and depress prices? Is the token's utility increasing, potentially driving up demand? These are the kinds of questions that tokenomics can help you answer.

One of the best advantages that being a skilled tokenomics reader gives you is that you can start to see red flags.

There will be moments in your crypto journey where friends, influencers, or peers may write off a project. On the surface you think the project looks good, so, what have they seen?

They may have identified an unsustainable incentives model, questionable distribution practices, or even a setup for a rug pull. 

TLDR; reduce your risk, improve your trading outcomes, make informed decisions, don’t just follow the hype.

How to Learn Tokenomics

We always suggest that you DYOR, so now here are some resources to help you on your way!

• Investopia is a great place to start. This is arguably the best library of content surrounding investment on the internet, so start with this crypto evaluation guide.

  
  

• Udemy has courses of all types, including tokenomics. If you want higher level knowledge and are willing to pay a small fee for a course that will give you top-tier knowledge, go here.

  
  

• CoinTelegraph does more than just share the latest crypto news - it also offers in-depth guides, for free, such as this complimentary guide to tokenomics

  
  

• BlockSurvey has a number of excellent resources all about tokenomics and tokenomists - give it a go here.

  
  

• YouTube boasts over 11,000 videos about tokenomics, so get comfy and jump into a tokenomic rabbit hole

  
  

You may also want to look for specific tokenomics guides for the chain you are building on, such as this guide to Solana tokenomics. You can find these guides by searching “tokenomics + guide + [blockchain] on Google. 

Final Thoughts on Tokenomics

Understanding tokenomics is no longer optional.

You’ll need to embrace tokenomics to navigate the complexities of the cryptocurrency market.

Once you grasp the principles of supply, distribution, and incentives, you can make smarter investment decisions and (be better equipped to) avoid costly mistakes.

If, however, you don’t have the time and you want an epic bot to help automate your trading, perhaps you really did come to the right website.

Check out BONKbot for a user-friendly Telegram trading experience.

Good luck, and happy trading!