If you are new to the crypto space, you have probably heard of the term tokenomics but maybe you are not so sure what it is. Tokenomics is a new concept that emerges in parallel with the crypto space and it has received a lot of attention in recent years, especially from investors and crypto traders. This post aims to explain tokenomics by using analogies from stocks and currency from the traditional finance world.

What is tokenomics?

I have read quite many articles and blog posts but nowhere can give a solid and official definition of the term. However, you can understand tokenomics as the design of incentives to control the supply and demand of a token with the goal to get the desired outcome. The outcome here may be to get the token price increase (for example, a DeFi project may want to increase their token price, thus earning profits for token holders), or maybe just to keep the token price stable, as in the case of stablecoins. Thus, depending on the goal of the project, the tokenomics will be designed accordingly to achieve that goal.

Tokenomics is combined by two words: token and economics. This means tokenomics is just a version of real-world economics in the form of tokens. In fact, many practices of tokenomics are adopted from the economics and traditional finance world. Thus, I think it might be a good idea to explain tokenomics in comparison with similar ideas in real-world economics, with crypto projects being a version of companies and tokens being a version of company stocks (or currency, in some particular cases).

Now, let’s dive in on some basic concepts that make up the tokenomics of a project. For each concept, I will use an analogy from stocks or currency concepts in traditional finance to illustrate the idea.

Use case of the project

I would argue that the use case of the project is the most important thing while analyzing tokenomics. If we compare a crypto project with a company, then the use cases of the project would be the company’s services or products. Surely, if a company has good services/products that draw a lot of demand from customers, then the revenue of that company, and eventually the stocks of the company will have a healthy growth.

Applied this principle to the crypto project, we can argue that a project with good use cases will attract a lot of users and eventually can drive the token price up. So when you start researching a project’s tokenomics, ask yourself some questions such as: What are the use cases of this project? Can the team execute all the features well? Are there any other projects which have the same offerings? Take Raydium on Solana for example, it is a DEX that helps users to trade, swap, stake tokens, yield farming, and even launch project (launchpad). You can even take one step further and check if the use case of the project is really in demand by checking the number of active users of the project. You can check this metric on DanteHQ: https://www.dantehq.com/project/raydium?utm_source=reddit&utm_medium=social_media&utm_campaign=blog_tokenomics&utm_id=blog_tokenomics&utm_term=blog_tokenomics&utm_content=blog_tokenomics

Token Utility

The second thing to look at is the token utility. Unlike stocks, which you can only hold or trade and cannot do anything beyond that, tokens can have some very interesting utilities that holders can make use of. The token utility can be a driver of demand for the token. For example, holding BNB (Binance’s token) will allow holders receive discounts when paying for their trading fees on Binance Exchange. Another common use case of tokens is governance. Governance token gives holders voting rights in the development process of the project.

Token Distribution

Token distribution is the method of releasing tokens to the public in the initial stage for early investors as well as later stages for newcomers. The initial release of tokens to the public can be compared to the IPO (Initial Public Offering) of a company. However, unlike IPO, which is well regulated, token distribution is currently not sufficiently monitored. That’s one of the reasons why the 2017 ICO bubble happened.

There are several ways a token is distributed to the public:

1.Mining / Minting tokens

This type of token enters the circulations by being mined (BTC) or minted (e.g., ETH, SOL).

2. ICO (Initial coin offering)

With ICO, the project sells a portion of the token supply to prospective users. This is a common fundraising method for most crypto projects.

3. Private Sale

In this private event, the project sells a portion of the token supply to investors (usually VCs or angel investors) at a discounted price compared to the public price.

4. Airdrop

Airdrop happens when the project sends free tokens en masse to their target or even random users to encourage token adoption.

Economic model

The economic model refers to the control of the supply and demand of that token. This is quite similar to how a company decides on how many shares are issued to the public and how to control the supply and demand of the stocks. There are a few economic models in tokenomics:

1.Deflationary model (BTC, LTC, BNB)

In this model, the maximum supply of the tokens is fixed, thus, the token value is expected to increase if demand stays the same or increases (deflationary). For example, Bitcoin’s supply is capped at around 21 million BTC, and BNB is capped at 200 million tokens.

2. Inflationary (ETH, SOL)

In this model, there is no hard cap on the maximum number of tokens created. New tokens can be created based on demand or on a set schedule. Thus, the price of the token can decrease if more tokens are injected into circulation (inflationary).

3. Asset-backed Model (USDT, USDC)

In this mode, the value of the token is pegged to an underlying asset, usually the US dollar. In this model, the token is not similar to the company’s stocks but similar to a currency. Thus, the goal of the token is to remain stable.

4. Duel-Token Model (VET & VTHO, NEO & GAS)

In a dual-token economic model, two distinct tokens are used in combination on one single blockchain. Usually, one of the tokens is used to store value while the other one is used as a utility token.

Emission Rate

Emission refers to the event where new tokens are created and released. This is similar to additional equity financing of a company (i.e., when the company increases the number of outstanding shares for a company). The emission rate (sometimes called the emission curve, or emission schedule) refers to the speed of emission. This rate can be decided by the protocol right from the beginning. For example, Bitcoin has halving events that make less BTC created as time goes by. However, some tokens do not have a fixed emission rate since they can be created on demand.

Burning mechanism

Some token has a burning mechanism (remove tokens from circulation) to decrease the supply of the token with the aim to drive the price up. This mechanism is actually adopted from the stock repurchase practice in traditional finance, with the aim to decrease the supply of stocks. One example of the burning mechanism in crypto is Binance (BNB). Binance plans to burn 100 million BNB, equal to 50% of the initial token distribution (200 million BNB), using 20% of Binance’s profit for each quarter. The burn rate refers to the speed at which tokens are burnt.

Vesting Schedule

In the early stage of the project, VCs and early investors could purchase a large number of tokens, usually at a discounted price as compared to public sales. To prevent selling before the token gets traction, projects may lock up the tokens of investors and keep tokens in custody until the release schedule. The vesting schedule can affect the token price as more tokens are unlocked and injected into circulation, the value of token will be diluted. This vesting schedule practice in tokenomics is pretty similar to the vesting schedule practice in a startup, where employees are granted equity but can only have the right to that equity after a period of time.

Sources of token value

The last and probably most important aspect: How do tokens get value? Here are some factors that I could think of:

• Value comes from the utility: If the project has a good use case and the token has a utility that supports the use case, then the token has inherent value. I think this is the ideal source of value for tokens and this will be the main driver of token price.
• “Value” comes from hype: Basically, “if other people want it, then I want it”. Hype is not on the inherent value of the token, it is just based on the perceived value of the public, and it could be wrong. Price increase as the result of hype is not sustainable and eventually will burst, leaving investors at a loss.
• Price increase due to burning: As explained, the burning mechanism decreases the supply of tokens. If the demand stays the same or increases, then the price of the token increases, but if there is no demand for the token, then the burning mechanism may have very little effect on the price.