Tokenomics, short for ‘token economics,’ refers to the usage of tokens in a web3 project. It is a sort of monetary policy that lays out how tokens will be allocated and distributed. Tokenomics is the centerpiece of any web3 project as it outlines a major portion of the business model. These outlines can be hard-coded into the project or left to be more flexible as the project grows. 

What is a token?

A token is a certificate of a digital asset recorded on a blockchain. The certificate provides the owner with certain rights, the provenance of value, access and types of utility within a web3 project. 

It is important to distinguish the terms ‘coin’ and ‘token’ in cryptocurrency; they are two distinct digital assets. 

Tokenomics meaning

Cryptocurrency is divided into two categories: tokens and altcoins (any crypto coin that is not Bitcoin). Tokens are differentiated by their use and regulation within a project and there are some different types that investors can hold.

1. Utility tokens

   • Utility tokens grant access to products or services for holders. 

2. Security tokens

   • Security tokens are tied to the value of external assets and therefore act like a share of stock. 

3. Layer 1 tokens

   • These are connected to a particular service and settle network transactions.  

   • Bitcoin, Ethereum and BNB Chain are examples of Layer 1 tokens.

4. Layer 2 tokens

   • These are meant to assist dApps as they scale by supplanting assets that otherwise would not exist before a new feature of the project is released. 

   • Lightning Network is a Layer 2 token because it runs on top of Bitcoin.

5. Fungible

   • These assets can be exchanged for another asset of like kind or equal value.

6. Non-fungible

   • These assets cannot be exchanged for any other asset. A non-fungible token (NFT) is wholly unique and its ownership is provable on the blockchain.

   • Governance tokens are also non-fungible as they provide the holder with voting power in the decisions made in a project or DAO. 

Analyzing tokenomics

There are five major aspects to tokenomics that investors study:

1. Model

   • There are two distinct token models:

     • Inflationary – Tokens which do not have a maximum (“capped”) supply. These typically incentivize the token’s community to mine and validate on the network.

     • Deflationary – Tokens with a capped supply. These are known to sustain market volatility and evade circulating unsold tokens.

2. Distribution and allocation

   • How a token is distributed to investors is crucial for the success and reputation of any web3 project. 

   • There are two main ways to generate tokens: 

     • Pre-mining – Creating (“mining”) tokens that are distributed privately to founders and other whitelisted investors before mining is made available to the public.

     • Fair launch – A token that is mined, earned, owned and governed by the associated community.

3. Token supply 

   • Three types of token supply exist for every token project:

     • Circulating supply – The number of publicly-issued tokens that are currently in circulation.

     • Total supply – All tokens that currently exist, minus the number of tokens that have been burned (permanently removed from circulation). 

     • Max supply – The maximum number of tokens that can ever be mined. 

4. Market capitalization

   • The total market value of a token. 

   • It is calculated as the product of the current market price of a single token with the circulating supply.

5. Price stability 

   • The high volatility in the cryptocurrency markets can lead to smaller profit yields when lending interest rates are diminished. 

   • To combat extreme fluctuation, reputable web3 projects have enough tokens to match the supply level that can be mined and traded.

Cryptocurrency investing

It is vital for any investor to understand the importance of tokenomics in any web3 project they buy into. Like a business model, tokenomics spells out the processes and goals of a project. For example, the NFT collection Degods allows token holders to earn the $DUST coin by staking their token.

Savvy investors must not only understand the tokenomics of a given project but also be able to interpret the results and form solid conclusions. Web3 projects that ignore tokenomics fundamentals will almost certainly be doomed, along with their community. It is incumbent upon founders to disclose to investors their stated goals, roadmap, supply levels, and other factors in order to maintain a good reputation.