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Tokenomics: 4 Factors That Determine a Crypto’s Success

  1. What is Crypto Tokenomics
  2. The importance of Tokenomics
  3. Tokenomics: 4 Crucial Factors to Consider
  4. 1. Utility
  5. 2. Supply and Price Stability Mechanisms
  6. 3. Distribution
  7. 4. Governance
  8. Tokenomics: a Crucial Concept in Crypto

Tokenomics is an important concept in the cryptocurrency (crypto) field, which is a key factor that can influence the future of the project's token. In this article, BHO Network will explain the definition of Tokenomics and its importance.

What is Crypto Tokenomics

Created from a combination of the terms “token” (cryptocurrency) and “economics,” Tokenomics is an important concept. To understand this term, we first need to understand the definitions of its two components.

Economics is a social science that analyzes how individuals, organizations, governments and states allocate their resources primarily through the production, distribution, and consumption of products and services.

A token is a non-native digital asset based on an existing blockchain (e.g. ETH is the native token of Ethereum, and other projects may launch their own tokens on the ERC-20 standard).

Combining these two definitions, we can conclude that Tokenomics is the economy of the token, how it is adopted, distributed and operated by the project.

The importance of Tokenomics

In the same way that central banks leverage monetary policy; the right design, management, and implementation of tokenomics allows project teams to create an efficient economy that facilitates growth. ecosystem development and token price growth.

For investors, tokenomics is a paramount factor to consider, as it greatly affects the future value of digital assets as well as whether the project is capable of achieving its set goals. out in its development roadmap or not.

Simply put, regardless of the team's expertise and dedication, the potential of the project, and the amount of capital raised from the funding rounds, bad tokenomics can lead to the total failure of the company. a cryptocurrency project.

Tokenomics: 4 Crucial Factors to Consider

So what makes a good tokenomics project? Below, you'll find four key elements to answering this question.

1. Utility

Usability is perhaps the most important factor in the tokenomics of a crypto project. Scarcity has no value if the token has no application. Even if a token has a deflationary model, has the best price stability mechanism, has a decentralized and efficient on-chain governance and distribution mechanism, it will not have much value if it no use value.

So is fiat money, it only has value if the citizens of that country use it, such as to make their daily payments, investments and other transactions. This is also why some central banks have not supported digital assets in the past.

So crypto projects must build apps for their digital assets with functions that benefit the ecosystem and the participants.

Common functions include:

  • Earning opportunities via activities such as staking, mining, yield farming, and revenue-sharing
  • Governance
  • Medium of exchange on a platform or in the whole 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 deployment of dApps and smart contracts. On the other hand, users utilize Bitcoin both as a store of value and a medium of exchange.

In general, the utility of a token is responsible for creating demand, which drives up the digital asset’s value if the supply stays the same or decreases.

2. Supply and Price Stability Mechanisms

Another crucial factor to crypto tokenomics is supply and price. Crypto projects also have to carefully manage the supply of their tokens, as it also has a direct influence on its price in the following ways:

  • If the token’s supply increases while demand stays the same, it will lead to a fall in its price.
  • On the other hand, the coin’s price will increase with the decrease of the supply (while the demand remains unchanged).

For that reason, if a crypto project seeks to facilitate great returns for investors, it can design the token as a deflationary asset that moves a significant portion of the coins out of circulation over time.

One alternative solution is to create an inflationary asset and reduce its rate of inflation gradually. Bitcoin is an excellent example, which halves the new coins that can be mined with each block roughly every four years until it reaches its maximum supply of 21 million BTC in 2140 (Bitcoin Halving).

However, in some cases, inflation or the lack of a maximum supply is necessary for a token to execute its core functionalities due to the nature of a crypto project’s solution. For example, while ETH’s supply doesn’t have a hard cap, the project mints new coins to incentivize validators to maintain the ecosystem.

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

  • By (not) limiting the number of coins that can be issued (maximum supply)
  • By implementing a price stability mechanism that moves coins out of circulation (e.g., coin burnings and buybacks, as well as the halving in BTC’s case)

Overall, before investing in a coin, it’s essential to analyze the dynamics and mechanisms of an asset that directly impact its supply.

While some coins can maintain long-term growth with minimal increase in demand due to deflationary processes, there are others that experience inflation-induced price crashes even after attracting a record number of new capital and buyers.

3. Distribution

If a project fails to distribute tokens to their users in one way or another, no one will be able to use their network. For example, Ethereum will have no users if no one owns ETH to participate in the network and build Dapps.

Projects can distribute tokens in a variety of ways. Some choose to distribute more to the development team and early investors. Others, usually projects using the fair launch model, choose to distribute tokens to the community more.

For example, coin distribution occurred in the following ways at the below crypto projects:

  • Ethereum kicked off with a crowd sale in which participants contributed 31,000 BTC. For that reason, crowdsale contributors received 60 million (83%) of the initial 72 million ETH, with the remaining 12 million ETH (17%) going to be distributed to the original contributors and Ethereum Foundation. After that, new ETH was created and sent to the miners as a reward for developing the ecosystem.
  • There is debate in the community about whether Bitcoin creator Satoshi Nakamoto pre-mint the first few Bitcoins or bought them as a regular miner (since he was the first to mine BTC), we have can conclude that Bitcoin has a fair launch model in its initial distribution terms. Regardless of whether it is pre-mint or not, Satoshi's 1.1 million BTC is still in place, not a single Bitcoin of which is in circulation. That said, the remaining funds have been distributed among Bitcoin “miners” (just like in the case of ETH).
  • Ethereum-based Uniswap has a completely different distribution model, combining the fair launch model and the ICO period of 2017 (the latter, the project team, investors and advisors benefit the most). After the September 2020 release, the initial supply of 1 billion UNIs is allocated as follows: 15% airdrop to the community, 2% to liquidity mining, 43% to admin fund, 21.51% to development team, 17.8% for investors and 0.69% for advisors (all of which have a vesting period of 4 years except for the part for airdrops and liquidity mining).

The distribution model of a token greatly affects whether a crypto project has the necessary funding to achieve its goal in the roadmap, and whether its business model is sustainable. It also affects the investor's view of the project.

Since decentralization and transparency are two qualities that are valued in the crypto space, the community generally prefers the fair launch model. Assuming most of the money is distributed among development team members and investment funds, the community may feel suspicious. However, this model helps ensure developers and ecosystem participants have access to the resources needed to make their vision a reality.

But, to be fair, it is safer to distribute tokens equitably among (tens of) thousands of users rather than a few initial whales or large investors, as it greatly reduces the risk of such as price manipulation, project sabotage, or centralization of governance processes.

4. Governance

The last factor that determines the success of tokenomics and that project is governance. While it has an indirect effect on the future success of a crypto project and the project's token price, it is also an equally important factor, especially for tokens with administrative function.

Just like the impact a government has on a country's economy, a project's core development team or committees and governing bodies have a significant influence on a project's future and token price.

Furthermore, the governance process itself is also important. Regarding the governance model, here are some key highlights that investors should consider:

  • The level of centralization (the core team has the ultimate authority vs. a fully decentralized community governance process)
  • Whether governance occurs on the chain or off the chain (although, off-chain governance can still be decentralized)
  • How accessible is the governance process for the average user (e.g., how easy it is to create a proposal and vote on it)
  • The minimum share of votes required to approve a proposal
  • The core team’s background, skills, and experience if they are highly involved in the project’s governance

Overall, while decentralization is highly valued in crypto, it doesn’t mean that all projects featuring decentralized governance are better than ones that are either fully or partly centralized. Transparency, integrity, cooperation via an efficient process, and a professional team (whether they are core developers or elected community members) matter more in this field.

Tokenomics: a Crucial Concept in Crypto

Tokenomics has a significant impact on the future of the project and the price of its digital assets. For that reason, this is an important concept that everyone in the crypto space should know.

Project development teams can design their tokenomics to achieve their goals and achieve their vision faster. Investors can study tokenomics to assess whether a digital asset is worth the investment and its potential risks and returns.

Published on May 24, 2022

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