Tokenomics: 4 Factors Determining the Success of a Crypto

Tokenomics is an important concept in the field of cryptocurrency that analyses a variety of fundamental factors that can affect the future of a project token. Let's take a look at what factors determine the success of crypto.

What is Crypto Tokenomics?

Created from the combination of the terms "token" and "economy", tokenomics is a very important concept. However, it lacks a universally accepted definition in the cryptocurrency space. However, the words 'token' and 'economy' are excellent starting points for a better understanding of the topic. Economics is a social science that analyses how individuals, organisations, governments and states allocate their resources, primarily through the production, distribution and consumption of goods and services. On the other hand, a token refers to a non-native digital asset based on an existing blockchain (for example, ETH is the native cryptocurrency of Ethereum, while projects can launch their own fungible tokens through the ERC-20 standard). Combining these two definitions, we can conclude that tokenomics is the science that studies all the fundamental parts of a token economy, including important factors such as utility, supply, price stability, distribution and governance.

Why does tokenomics matter in crypto?

Just as central banks use monetary policy in relation to their fiat currencies, the proper design, management and execution of tokenomics allows project teams to build an efficient economy around their solutions, facilitating the growth of the ecosystem and the price of the token. From an investor's perspective, tokenomics is a critical factor to consider as it has a huge impact on the future price of a digital asset and whether the project can achieve the goals outlined in its roadmap. Simply put, regardless of the expertise and dedication of the team, the potential of the concept and the amount of funds raised from early investors and venture capitalists, poor tokenomics will likely lead to the ultimate failure of a crypto project.

Tokenomics: 4 Important Factors to Consider

Now that you have learnt the basics, let's see when we can say that a project has good tokenomics. Below you will find four important factors to answer this question.

1. Utility

Utility is probably the most important factor in the tokenomics of a crypto project. Even if a token is deflationary, even if it has the best price stabilisation mechanisms, distribution and decentralised and highly efficient on-chain governance process, it will not be worth much if it is not used for anything. The same is true of fiat currency, because it only has value if the country's citizens use it, for example, to make their daily payments, investments and other transactions. This is why some central banks have cracked down on digital assets in the past. To avoid the scenario described above, crypto project teams need to equip their digital assets with multiple functionalities that benefit the ecosystem and its participants. Examples include:

• Gaining opportunities through activities such as staking, mining, yield farming and revenue sharing.
• Governance.
• Exchange intermediary on a platform or in an entire ecosystem.
• Collateral for other assets in the ecosystem (e.g. stablecoins)

For example, ETH's primary utility is to cover transaction fees as well as the distribution of dApps and smart contracts. On the other hand, users use Bitcoin both as a store of value and as a medium of exchange.

Overall, the utility of a token is responsible for creating demand, which increases the value of the digital asset if the supply remains the same or decreases.

2. Supply and Price Stabilisation Mechanisms

Another important factor for crypto tokenomics is supply and price. Crypto projects must also carefully manage the supply of their tokens, as it has a direct impact on its price in the following ways:

1. If the supply of the coin increases while demand remains the same, it will lead to a fall in its price.
2. On the other hand, if the supply decreases (while demand remains unchanged), the price of the coin will increase.

Therefore, if a crypto project aims to generate large returns for investors, it could design the token as a deflationary asset that takes a significant portion of coins out of circulation over time.

An alternative solution is to create an inflationary asset and gradually reduce the inflation rate. Bitcoin is a perfect example, halving the number of new coins that can be issued with each block every four years until it reaches a maximum supply of 21 million BTC in 2140.

However, in some cases, due to the nature of a crypto project's solution, inflation or lack of maximum supply is necessary for a token to fulfil its core functions. For example, although the supply of ETH has no fixed limit, project validators mint new coins to incentivise the ecosystem to preserve it.

Basically, crypto projects can control the supply of their tokens in two main ways:

• By limiting (not) the number of coins that can be issued (maximum supply)
• By implementing a price stabilisation mechanism that takes coins out of circulation (e.g. halving in the case of BTC by burning and buying back coins)

In general, before investing in a coin, it is very important to analyse the dynamics and mechanisms of an asset that directly affect its supply. While some coins can sustain long-term growth with minimal increase in demand due to deflationary processes, there are others that experience inflation-induced price declines even after attracting record numbers of new capital and buyers.

3. Distribution

Distribution is a crucial element not only in tokenomics, but also in the history of a token. If a project cannot distribute coins to its users in one way or another, no one can use its network, as the community will not have access to the asset that powers the platform.

There are many ways for projects to introduce their tokens to the market. Some methods reward team members and early investors more, while others, mostly fair launch models, are designed to benefit the community.

For example, in the following crypto projects, coin distribution took place in the following ways:

• Ethereum began its history with a crowdsale in which participants contributed 31,000 BTC. Therefore, crowdsale contributors received 60 million (83%) of the initial 72 million ETH, and the remaining 12 million ETH (17%) was distributed between early contributors and the Ethereum Foundation. After that, the new supply of ETH was sent to miners as a reward for securing the ecosystem.

• While there is a debate in the community whether Bitcoin creator Satoshi Nakamoto pre-mined the first few coins or acquired them as a regular miner (since he was the first to mine BTC), we can conclude that the cryptocurrency has a fair launch model. Whether or not pre-mining was involved, Satoshi's stash of approximately 1.1 million BTC was left untouched without any coins circulating in the market. However, the remaining coins were distributed among Bitcoin miners (just like in the case of ETH).

• On the other hand, the Ethereum-based AMM Uniswap has a very different distribution model, somewhere between a fair launch and a 2017-style ICO model (in the latter, the project team, investors and advisors benefit the most). After its launch in September 2020, the 1 billion UNI genesis supply was allocated as follows: 15% in community airdrop, 2% for liquidity mining, 43% to the management treasury, 21.51% to the team, 17.8% to investors and 0.69% to advisors (everything except tokens allocated for airdrop and liquidity mining comes with a vesting period of 4 years).

While the distribution model of a token has a major impact on whether a crypto project has the necessary funding to achieve its goal on the roadmap and whether the business model is sustainable, it also has an impact on how the public perceives the solution.

On the one hand, a completely fair launch model facilitates trust. However, let's assume that the majority of the coins are distributed to team members and private investors. In this case, the community could become sceptical. Still, such a strategy could ensure that developers and ecosystem participants have access to the necessary resources to turn their visions into reality.

However, since decentralisation and transparency are two highly valued qualities in crypto, the community generally prefers a fair launch model.

Moreover, it is often safer to distribute coins fairly among (tens of thousands of) users rather than a dozen whales or large early investors, as it significantly reduces risks such as price manipulation, malicious activities or centralisation of the governance process.

4. Governance

The last thing to consider in terms of tokens is governance.

While it has an indirect impact on the future success of a crypto project and the price of its native token, it is as important a factor as any of the others we listed earlier, especially for coins that have governance among their primary functions.

Just like a government's influence on a country's economy, the governing committees and bodies elected by a project's core development team or community members through decentralised governance have a significant impact on the future of a crypto solution (and thus the price of its native token).

Furthermore, the process itself that allows the team or community to govern the project is also important here. In terms of the governance model, here are some key points to consider:

• Level of centralisation (core team has ultimate authority over a fully decentralised community governance process)
• Whether governance takes place on-chain or off-chain (off-chain governance can still be decentralised)
• How accessible the governance process is for the average user (e.g. how easy it is to create and vote on a proposal)
• The minimum number of votes required to approve a proposal
• The core team's background, skills and experience if they are highly involved in the governance of the project

In general, while decentralisation is very valuable in crypto, it does not mean that all projects with decentralised governance are better than fully or partially centralised ones. Transparency, honesty, collaboration through an efficient process, and a professional team (whether they are core developers or elected community members) are more important in this space.

Tokenomics: A Very Important Concept in Crypto

Although there is no universal definition, tokenomics explores the most important parts of a token economy that significantly influence the future of the project and the price of its native digital asset.

Therefore, tokenomics is a very important concept that everyone in the cryptocurrency space should know.

Project teams can use it to design their tokens in a way that will allow them to reach their goals and achieve their vision faster, while investors can use it to assess whether a digital asset is worth investing in, its risks and potential returns..