Every investor, crypto enthusiast, or any crypto bro has at least once seen the term tokenomics. Let’s together get things a bit clearer and discuss what is indeed tokenomics and what are key features of it.
The term “tokenomics” consists of two words – “token” and “economy”. Essentially, tokenomics is based on the general principles of supply and demand for tokens. With a deeper dive into the topic, we can talk about other key parameters of the token – its functions, purpose, and distribution.
Each project decides how to put the tokens into circulation.
For example, some projects distribute their tokens as a reward to miners and validators. Others open the sale of tokens during the ICO – the initial coin offering. Some ecosystems run test programs for their project to monitor and, if necessary, improve the performance of their network. As a result, users participating in testing receive project assets as a reward. Another way to distribute tokens is to reward users who have “frozen” their assets.
The inflationary model of tokens releases more and more batches of tokens without any restrictions. Such a model resembles the scheme used, for example, for the United State dollar (USD). As long as dollars continue to be issued, consumers have reduced purchasing power, and because of this, the token’s value may decrease.
Here the project itself sets a limit on the creation of tokens. Bitcoin, for example, uses a deflationary model as it is capped at 21 million tokens. Every four years, the BTC mining rate decreases (a phenomenon known as “halving”). The limited supply naturally supports the token’s demand, hindering inflation’s growth.
In this case, there are two separate tokens on the blockchain. When a project uses one token as a financial value, the second one is used to achieve the project’s goals. This usually separates the economic component of the project from its services. An example of such a model is MakerDAO. In the MakerDAO ecosystem, the Maker Token (MKR) functions as a governance token, while DAI is a stablecoin pegged to the US dollar.
Such tokens are pegged to other assets and valued based on their exchange rate, usually the dollar exchange rate. These are, for example, BUSD, USDT and USDC.
One of the most widespread anti-inflation events is token burning. Some blockchains or protocols “burn” tokens – permanently remove them from circulation to reduce the number of coins in circulation. According to the laws of supply and demand, a reduction in the supply of a token should help support its price as the remaining tokens in circulation become increasingly scarce (a deflationary model).
For instance, in August 2021, Ethereum began burning some of the tokens sent as transaction fees instead of handing them over to miners. Thus over $5.7 billion in ETH was burnt.