What is Tokenomics? A beginner's guide

DYOR (Do Your Own Research) is our Web3 word of the day. Everybody keeps saying that, but how to DYOR in crypto? If you wonder which tokens are worth investing when scrolling through the long list of tokens in Arctic Wallet, this article is for you! Researching the project tokenomics is a significant part of it.

Source: Arctic Wallet

Key points addressed:

• tokenomics explained;
• what to pay attention to in crypto project tokenomics;
• tokenomics terms to know: supply, market cap, burning, vesting, cliff.

What does the term Tokenomics mean?

Tokenomics is literally coined of two words — token & economics — and is defined as the economics behind the cryptocurrency. It is a popular term that describes the internal dynamics of crypto projects and gives an idea of how their native assets operate.

Tokenomics is a key element to analyze while considering investment into a crypto project to evaluate major risks. Projects with bad tokenomics often tend to fail.

Tokenomics markers

Improper token mechanics could signal future problems. That's why it's crucial to understand it thoroughly. There are 4 key points to analyze in any crypto project's tokenomics: supply, market capitalization, token model, and distribution.

I. Token supply

Supply and demand have a deep impact on token value.

Here are two token supply types to know:

• Circulating supply is the number of tokens currently circulating in the crypto market.
• Total supply is the total amount of tokens that will ever be in existence.

Let's illustrate with an example:

• 92% of Bitcoins are already in circulation.
• Bitcoin's total supply is designed to be not more than 21 billion BTCs to ever be released to the market.

Source: CoinMarketCap

II. Market cap of a token

• Market capitalization is the total value of tokens currently in circulation in dollars. In other words, how much value the currency has: token price its circulating supply.

The same calculation is done to the total value to get a fully diluted market cap of any token.

• Fully diluted market capitalization is the total value in dollars of the total supply.

Source: CoinMarketCap

Market cap gives the idea of the size. The smaller the market cap is, the more volatile the asset is likely to be.

III. Monetary policy

Tokenomics model determines the release of tokens over time - token emissions. It is set in the code of the token, hence, pretty much transparent and informative.

Tokenomics Model

Tokenomics is considered deflationary when the maximum supply of the token is limited, like in Bitcoin with its 21b coins. Scarcity of supply increases the demand and, consequently, the price of a token.

Some coins have no maximum supply. In this case, we talk about inflationary cryptocurrency.

The inflationary tokenomics model in blockchain is similar to that of fiat money as Central Banks keep printing more currency to satisfy the demand and not to overflood the market.

Generally, Proof-of-Stake (PoS) - based tokens do not have a max supply set. However, these tokens can still function as deflationary assets. Let's take Ethereum as an example.

The ETH token has no limited supply in its code, yet, they keep burning a percentage of tokens in circulation to maintain the scarcity and keep the asset price up.

Source: CoinMarketCap

Emission of the token

The planned speed of emissions can tell a lot about the trajectory of the token's economy. Billions of coins flooding the market in a short period of time could have a negative impact on the currency's price. The price of a token with a small circulating supply (or if the growth of token supply is slowed down) is likely to fall unless there's a huge increase in demand.

Slow and steady release of tokens over time with no spikes and sharp increases is a good sign.

For example, a Serum token emission is gradually stretched to seven years:

Serum (SRM) Tokenomics / Source: ProjectSerum.com

The fully diluted market cap value way bigger than the current market cap means more tokens will be issued later, which may potentially have a downward effect on a token price in the future.

IV. Token distribution

Token emission is tightly connected to allocations of assets for development, to project members and community, namely:

• the core team behind the project;
• advisors and early investors;
• general public through a public sale (ICO);
• ecosystem (including staking & yield farming rewards, airdrops and other payouts to incentivize the usage and adoption);
• liquidity for exchanges;
• marketing budget;
• treasury (day-to-day expenses).

There is arguably no ideal token distribution model, but some points are essential to consider.

For instance, if the project can't fund its development, investors can run into problems.

Team members, developers, private investors, and advisors usually get their tokens in the presale phase — token sales prior to letting the token go public, commonly at early prices.

The few parties owning a large percentage is concerning, as they may sell everything (dump the holdings) when the token price appreciates in price. Therefore, the less share angel/VC investors and team get, the safer other parties may feel.

Source: Messari

Vesting and Cliff in tokenomics

After the public release, if the parties listed above get their share of tokens all at once, they would make 5-10x on their initial investment, sell everything (dump), and kill the value of a token along the way. Therefore, cliff and vesting are the next markers to consider.

Not to let the dump happen, the locking and release schedule of the token called vesting is added to tokenomics. It defines how much time it will take to let participants receive bought tokens.

Cliff is the period of time before vesting actually begins, and investors can claim tokens allocated to them.

The chart below, illustrating 1inch token distribution, shows that assets unlocking for core contributors and investors happened one year after the launch. In other words, a one-year cliff takes place.

The vesting itself will run for four years, meaning planned amounts of tokens will be gradually distributed within this period.

1inch Token Unlock Schedule / Source: 1inch

A slow steady release of tokens over the course of not less than 12 months looks more decent and safe. The longer the vesting period is, the better it is for the price.

Tokenomics analysis importance

Project due diligence includes researching many different aspects of it, including the roadmap, accomplishments, the team, transparency, safety, and so on. Understanding tokenomics is helpful in deciding if the project is worth your further attention.

Cryptocurrency is tricky and risky, so always remember to DYOR… And keep following our blog for more blockchain tech and DeFi guides!