There are thousands of cryptocurrencies in the market and each has different utility and market demand. All of them also have different supply mechanisms, minting or mining processes, and applicability from where their demand is generated.
While the performance of a cryptocurrency depends on its supply and demand dynamics, it must be handled coherently for a sustaining token ecosystem. This is where the concept of tokenomics comes into play. The supply of cryptocurrency is the most fundamental aspect of generating its market demand which is done by forming a credible tokenomics.
In this article, we will go through cryptocurrency tokenomics and understand what are the different methods of designing tokenomics.
What is Tokenomics?
Tokenomics is a method used to manage the supply of a cryptocurrency. The term is derived from the combination of “token” and “economies” which refers to the economy of the cryptocurrency token. It could be elaborated on when and how new tokens will be added to the circulating supply.
In other words, tokenomics is a strategic methodology that helps provide economic value to a cryptocurrency token. The crypto project’s success varies on the token supply in the market liquidity. Without a proper design of tokenomics, a cryptocurrency would find it hard to create strong market demand. This usually results in project failure. Hence, tokenomics is the building block of a cryptocurrency and it is highly influential on a particular cryptocurrency market.
Investors mostly study the tokenomics of the cryptocurrency project before deciding on whether they want to invest or not. If the token distribution plan does not provide a solid forecast of future prices, investors will not risk their money.
What a cryptocurrency project requires to attain long-term success is high market demand and a sustained ecosystem. Both of these are achieved by a sophisticated token distribution that addresses sufficient demand while creating scarcity in the cryptocurrency market. This is enabled by locking, minting, or burning cryptocurrency tokens by the project developers.
To better understand what is tokenomics, here is an example of the leading cryptocurrency Solana (SOL);
Solana has emerged as the recent most popular cryptocurrency after Ethereum and Bitcoin. The design of Solana tokenomics is one of the best that has led it to be among the top 5 cryptocurrency projects in a short period. The company allocated nearly 40% token supply to the community and approximately 24% to the team and foundation. They allocated different portions for sale when the project was seeking funding in the initial phase.
How to design Tokenomics?
Designing tokenomics for a cryptocurrency requires a thorough understanding of the crypto landscape and market motives. The right placement combined with novel tokenomics models could lead to building a perfect cryptocurrency project. This could unlock the maximum advantage for the overall market sentiment for a cryptocurrency’s ecosystem as well.
The following are the components that are looked into while designing tokenomics for a cryptocurrency;
- Supply: Supply refers to the number of cryptocurrency tokens currently available in the market. It generally falls under two main categories: total supply and circulating supply.
- Allocation: Allocation is the portion of cryptocurrency token supply that is provided for specific uses – such as ecosystem funds and staking rewards – or to entities such as developer teams an investors.
- Vesting: Vesting refers to the gradual release of new cryptocurrency tokens, usually in monthly periods.
- Cliff: Cliff is the period where no tokens are vested. It puts a halt in between the cryptocurrency releasing time. For example, releasing of 100 million tokens after a two-month cliff.
- TGE: It is the acronym for token generation event. This is where a new cryptocurrency token is minted on the blockchain and its initial distribution starts.
Project developers are required to allocate tokens for several uses and curate a strong foundation. The allocation could be based on different segments such as equity, token sale, development fund, community rewards, validator rewards, future allocation, etc. Among all allocations, developers often give priority to assigning the most funds for the development and growth of cryptocurrency projects.
What does Ideal Tokenomics look like?
As mentioned earlier, cryptocurrency tokenomics should be designed to meet sufficient market demand while giving some space to scarcity. A novel tokenomics will have a long-term vision and a clear projection for the future. The utility of cryptocurrency matters the most rather than it being traded on live markets. So tokenomics needs to be focused on cryptocurrency utility and how it will flourish the project ecosystem.
So we know what is tokenomics, now let’s understand models of tokenomics.
Inflationary Cryptocurrency Tokenomics
In the inflationary model, cryptocurrency token supply is increased by releasing new tokens regularly. This means that the circulating supply of the token sees a steady increment over time. Cryptocurrencies that follow the inflationary tokenomics model generally have unlimited supply.
The method of releasing new tokens depends on the consensus of cryptocurrency. Most of the time it consists of staking which requires users to lock some amount of existing tokens and receive daily or monthly rewards on it. The new tokens are unlocked from the system as a reward for network participants such as node operators and validators.
A prime example of inflationary cryptocurrency is Dogecoin. It is a memecoin that follows Bitcoin’s footprint without any practical application. Dogecoin has proof of work (PoW) consensus to release new tokens in the market. The supply of Dogecoin is continually increased via the block mining process.
Deflationary Cryptocurrency Tokenomics
The deflationary cryptocurrency tokenomics model has a gradual decrease in cryptocurrency market supply. Most of the deflationary cryptocurrencies have a fixed total supply or max supply as Bitcoin. This supply is released into the market via different approaches such as mining.
Similar to Bitcoin, Litecoin (LTC) is another example of a deflationary cryptocurrency. Litecoin has a max supply of 84 million and Bitcoin has 21 million.
Ethereum has also become a deflationary after the Merge upgrade. It used to be an inflationary cryptocurrency and its circulating supply was increasing with ETH mining. However, with the Merge upgrade, Ethereum now has transited to the proof-of-stake (PoS) consensus mechanism where unlocking new ETH supply is significantly decreased.
The token supply of deflationary cryptocurrency is usually controlled using two methods;
- Fixed total supply, which is releasing tokens gradually into the market until total supply is out.
- Burning mechanism, where a portion of the circulating supply is burned to streamline demand for that cryptocurrency token. Cryptocurrency burning is a method in which tokens are deducted from the circulating supply by sending it to a non-recoverable or dead address.
Conclusion
Every cryptocurrency has a tokenomics and it is a fascinating subject for developers. A well-shaped token economic model could lead the cryptocurrency project to reach its long-term goals while its neglected importance might fail the project. Tokenomics is most important when it comes to the success of cryptocurrency which majorly depends on the supply dynamics
