A year ago, when I was just starting in the crypto scene, the one mind-boggling word for me is Tokenomics. There were lots but this one comes up every time we talk about new projects we need to incubate. I read and hear this a lot. Every single project with tokens involved MUST have it in its whitepaper. Of course, we don’t want to be involved in a project whose real purpose is to dupe people out of their money.
I was advised to always study and go over that area of the project to see if it is worth investing in. Do the math. Know the supply and demand. Are there perks? Scrutinize the value accrual. Uhm? For a newbie like me, and not even a fintech specialist, another word like this pops up, and it makes it even harder to understand. But I must find out about these things and learn is what I did.
After numerous research and talking to people who know more about this side of things, here are some key takes on Tokenomics.
But before we move on, let me remind you that I don’t claim to be an expert, but sharing is caring. So, there’s that.
What is NFT?
What is Tokenomics? Simple. It is a combination of two words – token and economics.
A token is a unit of value that is issued by a business, acknowledged by a community, and backed by an existing blockchain. To put it simply, a token is a representation of anything within a particular ecosystem, such as a piece of data that acts as a representation of a fact or right.
Some GameFi protocols even use two tokens – the governance token and the in-game reward tokens, both of which has their own utilities.
Let’s use Axie Infinity as an example.
Moving on the economics side of things, let us start with Supply and Demand.
Source: Axie Infinity
Why are These Indicators Important?
The metrics allow a better understanding of future supply and shortage. Imagine if the circulating supply was just at 40%. This implies the supply will grow by sixty percent. Creating more coins will create the price to fall. Hence, scarcity is good.
Last year, this became a problem for some GameFi protocols where there were too many NFTs minted which overpopulated the market with NFTs, bringing down the price. And for many of them, the price did crash due to more supply.
The economics of a given protocol are also heavily influenced by the practice of token hoarding. It is common for venture capitalists and whales to hold the majority of the tokens in a project. Because of this, they could set the price of tokens and even decide the fate of a protocol, provided that the developers do not have the resources to combat them once they begin dumping tokens.
A dramatic drop in price may result from venture capitalists and other insiders selling their tokens. The team will not be able to prevent that. Once they reach the vesting stage, they are granted permission to sell the tokens. Some people aim to increase the value of their assets, while others only want a rapid return on their money. And it is a normal thing in the industry.
Knowing the numbers and analyzing them will help us in our journey in the crypto world.
Demand influences a person’s desire to acquire something as well as the amount of money they are willing to spend on it. The US Dollar which is the global reserve currency now is in great demand because of its utility despite the fact that inflation is a concern.
The tokens tend to cause speculation without enough utility. A utility token fulfills a particular function inside an ecosystem where users are granted the privilege to carry out certain activities on a particular network by utilizing these tokens. Like gas fees for example. These are fees that must be paid in order to use the network. Want to buy on Open Sea? You need Ethereum for the gas fee.
While cryptocurrencies are a kind of digital money, utility tokens are more accurately described as software. They can be used to transfer value, although that is not their prime objective.
Users may need a particular DEX token to trade tokens on a decentralized exchange (DEX) or to engage in any variety of decentralized finance (DeFi) activities. Alternatively, a token of this kind might be used to reward platform users or to pay interest to individuals who deposit cash that the platform subsequently loans out to borrowers.
For art collectors or GameFi projects, non-fungible tokens (NFTs) also function as a form of a unique utility token. An NFT may be a one-of-a-kind digital work of art, a character, or a weapon in a game, or they may also be used for other things such as music, pictures, licenses, and many more. The demand increases in direct proportion to the degree to which the network or DAPP is used.
We may see a protocol performing faultlessly or producing brand new money seemingly out of thin air. However, investors are not going to take part in any kind of this activity, in any form at all. Some people aren’t interested in governance tokens; they want value instead.
A good example would be the value obtained through participation in Staking. If you stake the token, you will get a proportional share of the platform’s transaction fee revenue. SushiSwap and BabySwap are doing these to attract more investors. The token value rose as a direct consequence of this development. We would need a more extensive article on this topic (e.g., APR, APY, farming, staking)
Human behavior is truly strange. The demand for certain coins or NFTs can go from one extreme to another. Coins CAN pump despite horrible Tokenomics. Sometimes the meme, narratives, and marketing can be THAT strong.
Take Elon Musk’s case last year when he announced that it will be accepting Dogecoin as payment and this made Dogecoin surge by as much as 25 percent. People started buying Dogecoin hoping Elon will keep on pumping the coin, hence more profit for them.
People Buy What They Think Will Make Them Money.
Let us be real. Some protocols have fantastic Tokenomics but terrible value. Possible explanation: everyone is looking for the next big thing to be excited about, thanks to these kinds of stories.
What Should We Look Out For?
Besides looking closely at the numbers, there would be other factors to consider in choosing our investments.
It is essential to have a good understanding of the individuals who are working on any given project. Were they involved in other “rug pull” projects? Are they doxed? Do they have the sound finances to fund their project?
Keep in mind that the Teams have the option of selling their tokens. The sale of tokens generates significant cash for incentive programs. They need to raise funds, so they sell. We tend to forget that they must cover costs like marketing and development in addition to salaries and that they are paid in fiat currency. As a result, the prices of tokens are put under pressure.
They might be able to help the founding team’s attempt to generate value by offering guidance, facilitating distribution, or establishing partnerships. They are given LONG-TERM INCENTIVES as early backers so that they will continue to support the project.
Too Good to be True
To the Moon! I am sure you have heard this phrase a lot. A common misconception that newbies have is that new coins bought at a very cheap price will get them rich. I was once a victim of that thought.
Let’s imagine that we purchase meme coins with supplies of billions, some even have quadrillions, at a price of $.0000000002 each and believe that we will become wealthy once the price reaches one dollar. If we have a better comprehension of market capitalization, then we should already be aware that it’s impossible. Why? Because if it were to reach one dollar, it would be more than the sum of all the money in the world.
If it sounds too good to be true, it probably is (too good to be true and not going to happen).
Tokenomics can help you enhance your crypto investments. And always remember- DYOR. Do your own research. Follow people who know a lot about crypto and read articles but in the end. Decide for yourself. Don’t turn into a troll and blame people for something you have full control of.