Tokenomics 101: Token Value Explained
Tokenomics is a compound of the words ‘token’ and ‘economics’. Compared to cryptoeconomics, a practical science studying blockchain design and protocols, tokenomics is a relatively new term denoting the study of the economics of a token.
With exotic, new tokens being created daily and taking on a variety of shape-shifting characteristics, tokenomics can shine some light for investors on understanding the value of their tokens, what drives it, and assess whether the factors supporting the token are indeed sound.
We will go into further detail in a bit. But first know that tokenomics is a useful way for investors to assess a token’s value by analyzing the factors, relationships, and dynamics intersecting with the asset.
Ultimately, tokenomics studies the influences that shape a token’s value, which can be summed up with the following:
What is the total supply of the token?
In microeconomics, the price of a particular good is determined by the law of supply and demand. A low supply but high demand leads to an increase in value, at least, in the short run.
Is the total supply of a token hard-coded such as Bitcoin is to a 21-million cap? Or does it have a runaway supply policy that continually prints tokens? The latter creates an inflation effect that erodes away the value of the token over time. A hard supply cap like Bitcoin guarantees scarcity, which means that its value will only go up when demand increases. See: How Many Bitcoins are There Today?
Conversely, are there measures to reduce the supply over time? To regulate supply, a portion of the tokens may be burned away or sent to an unknown address to create a deflationary effect. For example, Ripple (XRP) is burned away at the rate of 10 drops or 0.00001 XRP per transaction, while 70% of VeChain’s VeThor (VTHO) is destroyed for every transaction. An interesting take on this relationship is COIL’s token model, which features an elastic, self-adjusting supply that rebases itself every 23 hours to resist market manipulation.
Understanding a token’s supply policy will give you a relatively good indication of its potential value.
What is the token used for?
A token can be programmed to take on various functions and uses within a project’s ecosystem. The greater the utility, role and purpose of a token, the higher the perceived value.
Here are some examples of utility:
Coins such as Bitcoin (BTC), Litecoin (LTC) and Monero (XMR) are widely accepted as currency or payment options for goods or services. Bitcoin can be used to pay your taxes in Zug along with buying anything from beer to a car.
Toll or fee
Sometimes called the ‘energy’ or ‘gas’ token of a blockchain, where a small amount of the token is used to perform transactions. Ethereum (ETH) is the leading example of this, and others are Vechain’s VeThor (VTHO) and NEO’s GAS.
Value of exchange
Tokens here are used within an ecosystem in exchange for something else of value. In the case of Sia (SC) and Storj (STORJ), that would be decentralized cloud storage, for Golem, decentralized computing power, and for Basic Attention Token (BAT), user browser attention.
Discount or cashback
Typified by exchanges, tokens in these ecosystems are used to give holders discount benefits or cashbacks if they transact in the token. Examples are Binance (BNB), Huobi (HT), and Crypto.com (CRO), which also has a top-up spend card where you can earn rewards in CRO thus incentivizing usage.
Staking or collateral
Tokens can also be used to give participants a stake in the network and encourage them to hold and create stability, provide liquidity, validate transactions, and earn rewards or interest. An example of this would be Cosmos (ATOM), where top stakers also earn the right to validate transactions and therefore, harvest the transaction fees and block reward. Smaller stakers can delegate their ATOM to the larger stakers and earn some of the rewards based on their staked amount.
A key characteristic of decentralized finance (DeFi) projects, governance tokens bestow on holders the ability to vote on decisions that affect the network, such as adding or removing assets or changing interest rates. Those who hold more tokens yield greater power. Examples include Maker (MKR), Uniswap (UNI) and Universal Market Access (UMA).
The above are just some examples of utility that a token might take on, and often also in a combination of two and more, to provide compelling use cases for adoption.
How is the supply of tokens distributed among the network?
When it comes to distribution, it is better to have a bigger pool of investors rather than a small pool of whales holding a disproportionately large number of tokens. This is reflected in a high Gini coefficient, which is a metric for wealth distribution equality and hence, decentralization.
A wider and more equitable distribution results in a lower Gini score, and means that it is less vulnerable to market manipulation (such as if a whale decides to sell their coins).
It is common practice for token founders to reserve a portion of the supply as a reward for their work, and to incentivize their commitment to improving the product. But they should not hold a disproportionate majority and usually, these tokens are locked away and cannot be sold before a certain date from the project’s ICO.
Token distribution can be done in many ways, including through mining, private and public sales, gifts to partners, advisors and via airdrops, reward for tasks and bounties.
A token with more than 51% of tokens in the hands of several founders should be a red flag, and you should then be asking what the trade-offs with such concentrated centralization are.
Who are the players in the ecosystem?
Lastly, a proper token valuation takes into account its network. This includes its founding leadership, team members, and community. Another way to see this is the relationships between a token’s stakeholders, users, and holders and how each player is incentivized to behave in a way that best benefits the ecosystem as a whole.
A token with a strong community can drive its value up with developers committed to network stability, investors staking and holding and engaged users adding to a network’s credibility and accountability.
When it comes to tokenomics, people will often refer back to Bitcoin as the first reiteration and as the Gold Standard of cryptocurrencies. However, the landscape is fast evolving with features such as smart contracts spawning a constant stream of new tokens. Necessarily, this will dictate the design of novel token models to meet the shifting use cases and demands and the tokenomics behind it.
This content is for informational purposes only and is not investment advice. You should consult a qualified licensed advisor before engaging in any transaction.