In blockchain, we always talk about tokens and sometimes, it gets hard to understand what exactly it is. Especially, if it all seems new to you.
Tokens are essentially assets or digital units of cryptocurrency used to represent a particular asset on the blockchain. These tokens are commonly used for governance, utility, privacy, asset, securities and in recent years, gaming.
Cryptocurrencies and tokens built on blockchain have a predefined, algorithmically generated release schedule, that has been encoded. This means we can accurately predict how many coins will be generated on a given day in time because of their mechanisms.
CLASSIFICATIONS OF TOKENS
Utility tokens, asset tokens,privacy tokens are all under the TWO classifications of tokens. These are:
Fungible tokens are assets that are identical replicas of themselves in value circulating in supply. Examples of this include Ethereum, Cardano (ADA), Solana (SOL).
-Non-Fungible Tokens (NFTs):
These are assets that are non fungible, meaning, they are unique in attributes and value. This also means there is only one of the unique token on the blockchain.
In recent times, it has been a trend especially as art and jpegs. But the introduction of NFTs in tokenization of assets like real estate, art, and real world assets gives a new direction to non fungible tokens.
Over the years, since the emergence of bitcoin, the amount of bitcoin to ever exist has remained constant, 21million. As at the last time heard in 2022, the 19th million bitcoin had just been mined. The last block of bitcoin has been calculated to be mined in 2140, which seems far and impossible given we’re already in the 19th million right? No. That’s why halving was introduced.
Bitcoin halving is a process that happens every 4 years, where the number of coins mined will be decreased by half. This was introduced to create scarcity, which in turn increases demand and prices.
Tokens like bitcoin are called deflationary tokens and also undergo their own type of halving through burning (sending funds to a dead wallet to decrease supply), or any mechanism employed to reduce the number of circulating supply of the tokens.
There are other tokens that have unlimited circulating supply like Dogecoin, which at the time of the article has 132.67 billion in supply. There are also terra (UST) and tether(USDT) having an increasing circulating supply because they arguably aim for being used as stable coins, therefore increasing it’s usage.
They are all said to be tokens with inflationary supply.
Tokenomics is a portmanteau word made up from token and economics, simply referring to the economy of the said token or cryptocurrency asset.
Tokenomics gives attention to addressing questions about the features of the said token and why it should be invested in or bought.
The entire documentation, objectives, features, token allocations and functionality is detailed in a document called the whitepaper. This is a very important document for every cryptocurrency or blockchain project to have, as it shows professionalism and reputability (for a well written and documented whitepaper).
FEATURES OF THE WHITE PAPER
The white paper answers various questions that everyone wants an answer to;
- Why was it created?
It gives a clear picture of the what the motivation was in creating the project, problems they wish to solve in the market, and how it is different from existing solutions, if any.
- What is it’s utility?
Blockchain has made it easy with implementations and applications that can be attached to tokens. These utilities give more value to the token by having more functionality than just being a cryptocurrency.
The utility can be in form of governance of projects, GameFi projects, yielding and staking.
- How does it generate consensus?
In blockchain, one of the most important things to find out is how a network validates it’s transactions to be true or false between their nodes. This simply shows us how it achieves its decentralization, level of security and scalability. The most popular over the years, have been proof of work and proof of stake, though we have further derivatives now.
- How are the tokens to be allocated?
Finding out percentages allocated for different purposes in a project, and the total number of token supply in circulation is essential (so as to identify a rugpull). More questions about the token should be answered like;
-do they have plans to create more tokens in the future
-do they have an allocation locked somewhere for their team or developers.
-who is the team behind the project? Are they doxxed or not?
(easily identifiable by their government name)
-are there any plans for reducing or burning their tokens in the future.
IMPORTANCE OF TOKENOMICS
Token economics helps us plan or see where said token will be in the future. For example, we know through tokenomics that a token like dogecoin cannot be as valuable as bitcoin. This is because dogecoin does not have a hard cap like bitcoin, therefore is not scarce and value remains less. Presently, doge coin produces 10000 dogecoin per block in one minute while bitcoin produces 6.25BTC per block every 10 minutes (900BTC in a day), so we can see why BTC is more valuable.
Token economics also helps teams tailor the functioning of their token according to their projects, in cases of utility tokens or security tokens or non fungible tokens in governance, shares or bonds. If these are implemented properly, we’ll have a high functioning platform. In the words of Seth Klarman in his book, Margin of Safety,
“In the short run supply and demand alone determine market prices.”
If we believe that to be true and that it applies to crypto assets using blockchain technology, then there are a number of factors to consider when looking at cryptocurrency tokenomics. Perhaps the most important thing is understanding how digital currencies are used. Is there a clear relationship/link between the use of the platform or service being created and the contents? If so, chances are growing services are likely to require purchases and usage, causing the final price to go up.
In essence, token economics is the most important part of a project to be considered before vesting your money or assets into a “lovely” project promising to moon and incentivize their community.