What Is Tokenomics? 6 Key Features of Tokenomics Explained
Reading Time: 4 minutesBefore you invest in a crypto, make sure you check the tokenomics.
It is common knowledge that trading and investing in cryptocurrencies is risky and quite challenging, making it important to have enough information before committing your money. One of the key things to consider when trying to gather information about a crypto is its tokenomics, that is, its economic value and proposition.
Considering various factors influencing tokenomics may help you know how well crypto is likely to fare.
What Exactly Is Tokenomics?
Tokenomics, a portmanteau of ‘token economics,’ refers to the value and important functions of a specific cryptocurrency. An experienced investor will consider a token’s economy and how it is run before investing in it.
A crypto project with unclear tokenomics rules will likely not thrive since it doesn’t contain important factors that assist investors in their decision-making process. The content of tokenomics can make a crypto project appealing or displeasing to investors.
The 6 Key Elements of Tokenomics
Below are some of the key elements of tokenomics.
1. The Token Supply
Investors consider the circulating supply of a coin, the number of coins currently in circulation, and the maximum supply of crypto coins, that is, the number of coins that will ever exist.
A token’s supply says a lot about how scarce or surplus it is likely to be. Investors can use this to predict what will happen in the future. For example, tokens in high demand but scarce due to limited supply will likely grow in price faster in the short term than those with an unlimited supply.
Some coins have been coded not to exceed a particular supply. For example, the maximum supply of Bitcoin (BTC) is 21 million tokens, and the last coin is planned to be mined in the year 2140, whereas the maximum supply of Solana (SOL) is 508 million tokens. On the other hand, some tokens, like Ether (ETH), do not have a maximum supply. Instead, the supply of ETH increases as demand increases.
Therefore, understanding a token’s supply will help you know the number of tokens currently available and how it plans to create more in the future. The result can help determine if a project is valuable based on your investment goals.
2. The Consensus Mechanism
A consensus mechanism is a process through which blockchain transactions and cryptocurrencies are secured and validated. The popular consensus mechanisms are proof-of-work (PoW) and proof-of-stake (PoS).
PoW requires crypto to be mined using specialized computers to create new cryptocurrencies and validate blockchain transactions. Transactions executed on proof-of-work networks are verified by miners that solve complex calculations using specialized computers. A miner who successfully matches the hash adds a block to the blockchain and receives the block reward (plus transaction fees). This reward incentivizes miners to create more crypto coins and validate blockchain transactions.
Under the proof-of-stake system, cryptocurrencies are not mined. Rather, validators verify transactions and propose new blocks. Hence, validators must lock up their crypto assets in a smart contract to validate cryptocurrency transactions and get rewarded with additional tokens. This process is referred to as staking.
Stakers who lock up their crypto assets are always randomly selected to validate transactions, even though validators with the highest deposits have the chance of being selected earlier. Moreso, validators are guided by rules to ensure compliance, and if anyone breaks them, they can be suspended and have their funds removed.
3. Yield Farming
Yield farming is another incentive mechanism embedded in tokenomics. It is also referred to as liquidity mining. Yield farming is how crypto investors lend out crypto assets to generate more rewards.
Typically, investors are allowed to add funds to the smart contract liquidity pool, and the reward for adding funds is given in the form of new tokens.
4. Token Distribution and Allocation
Another key feature of tokenomics is understanding how a token is to be distributed. Tokens can be distributed either through a fair launch or free mining.
Fair launch distribution is when tokens are not privately allocated to a certain number of people before they are launched to the public. In contrast, ‘free mining’ is when there is an early private allocation of some tokens to a certain number of people before their launch into the crypto society.
Crypto projects will choose how to distribute tokens so supply won’t exceed demand. Investors stand a chance of being allocated tokens in several investment rounds. Early investors benefit from larger token allocations in the case of an initial coin offering (ICO).
5. Token Burns
A token burn is the permanent removal of tokens from circulation. It is done to maintain a balanced token supply and ensure its increased value. To do this, tokens are sent to a wallet with an invalid address. The bottom line is that when the number of coins in circulation is low, the value of each coin will increase.
Token burns help tokens balance supply and demand, helping curb inflation or deflation. So, when there are fewer tokens, the value of each token increases, and at the same time, the amount of money invested increases.
6. Token Utility
Token utility explains the functions and uses of a particular cryptocurrency. The uses of crypto tokens differ and are sometimes peculiar.
Stablecoins, for example, have their price pegged to a specific price point, such as one US dollar, to ensure price stability. In that, they possess a similar value to fiat currencies. USDT and USDC, for example, represent the United States dollar. A token’s use cases can reveal a lot about how valuable it will be in the future.
Why Are Tokenomics Important?
Tokenomics helps crypto enthusiasts understand how various tokens have been programmed. Therefore, it is a useful resource to analyze before selecting tokens in which to invest.
Also, a proper understanding of tokenomics gives you an idea of what you are putting your money into. Combined with other factors, tokenomics can help you predict the future of the token you’re investing in. For example, by looking at the tokenomics of a coin, you will see its supply and how it will be controlled in the event of inflation.
Another benefit of tokenomics is that it helps build long-term trust and credibility in a project while also helping you weed out crypto projects created by bad actors and scammers.
Always Check the Tokenomics
Tokenomics knowledge will help you understand a token’s current and future value. As a result, new investors must read it before making any investments, as it could save you big bucks in the long run.
Reference: https://www.makeuseof.com/what-is-tokenomics/
Ref: makeuseof
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