What is Tokenomics?Total supply and its demandInitial allocation of tokensDistribution of tokensValue accrualConclusion
Thursday, 23 September, 2021
Have you ever wondered, if we do not add the right pinch of salt to a burger, will it taste good? The answer is no. If the burger ingredients are not in the right mix, the burger will not taste good. Similarly, to create a valuable crypto asset we need to have the right mix of tokenomics. Tokenomics is the recipe to create valuable crypto assets. In a world where thousands of crypto assets exist, tokenomics help us read between the lines and show us the path to make sound investment decisions.
What is Tokenomics?
Tokenomics is the rulebook defining a crypto asset1 monetary policy, from the issuance to the removal of tokens, if any. It uses game theory to design incentives to reward good actors and punish bad ones. Tokenomics also defines the role that the token plays in the ecosystem and how it accrues value.
Total supply and its demand
The first key ingredient in tokenomics is the token supply, whether it is capped or unlimited, and the demand to complement such a supply. Bitcoin is well known for having a capped supply of 21 million bitcoins while Ether supply is unlimited. It is interesting to note that the two most successful blockchains measured by market capitalisation have different monetary policies.
Initial allocation of tokens
A blockchain project needs time and resources to go live. To attract early investors, developers and other talents, tokens are often allocated in advance to this group. If the project goes live and the value of tokens increases, they get rewarded for their effort.
Figure 1: UNI token allocation
Notice that tokens allocated at an early stage are often subject to a vesting period. This is another incentive for early participants to continue supporting the projects in the initial years of its life until it creates a sustainable ecosystem of its own. The vesting period applies predominantly to pre-mined crypto assets, i.e. crypto-assets issued before the project goes live.
Distribution of tokens
Once the allocation is decided, the distribution of tokens may start. We differentiate this between two episodes, the genesis block and the following ones.
The last essential ingredient of tokenomics covers the value accrual of a token.
Tokenomics plays a central role in the functioning of a blockchain or dapp. It uses a set of hard-coded rules and a token to align the behaviour of all actors in a way that benefits the protocol. As we have seen, there is not one good tokenomics model. There are several recipes for good burgers with different ingredients leading to various flavours. For each recipe, the right mix of ingredients is key. Depending on the blockchain services offered, tokenomics are different.
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