Tokenomics – A Thing to Consider Investing in Crypto

Tokenomics – A Thing to Consider Investing in Crypto

Cryptocurrencies have experienced robust growth in the past decade. Data compiled by CoinGecko shows that there are more than 11,000 cryptocurrencies that have a combined market capitalization of over $2.8 trillion. While Bitcoin and Ethereum have a dominant market share, many others like Binance Smart Chain (BSC) and Solana are growing fast. In this article, we will look at the concept of tokenomics and what you need to know about it when investing in cryptocurrencies.

What is tokenomics?

Tokenomics is a word derived from two words: token and economics. A token refers to a virtual asset that has value in the blockchain industry. Let’s consider a blockchain platform like Ethereum. 

Ethereum is a smart contract platform that provides an environment where developers can build and run applications. It has a vast use case. For example, using Ethereum, developers can build decentralized finance (DeFi) applications such as DEXes and derivatives. Also, one can build other cryptocurrencies like Shiba Inu and Dogecoin. 

A platform like Ethereum is powered by Ether or ETH, which is its native token. This token is used in the ecosystem to do several things, such as ensuring its integrity, liquidity, and governance. 

The same thing can be said about other blockchain projects. Solana has a token known as SOL, while Avalanche has a token known as AVAX. 

Economics, on the other hand, refers to how these tokens derive their value. It involves things like demand and supply and how they impact specific cryptocurrencies. 

The concept of economics in cryptocurrencies is similar to what happens in fiat currencies. Fiat currencies like the US dollar and the euro derive their value from the trust that people have in the specific governments and actions of the central banks. In most cases, a currency like the US dollar will lose its value when the Fed embraces an expansionary policy like low-interest rates and quantitative easing.

A good way to look at tokenomics when it comes to fiat currencies is what happened in Zimbabwe. The country’s currency lost its value after the government embraced a policy of cash printing.

Bitcoin tokenomics

Tokenomics is so important that it is credited for the success of Bitcoin, the first cryptocurrency. In the past decade, Bitcoin has transformed itself from a small cryptocurrency into a $1 trillion juggernaut. This growth is partly because of how Satoshi Nakamoto designed the currency. 

Like many other cryptocurrencies in existence today, Bitcoin is developed through mining. This mining is done by supercomputers that solve complex mathematical calculations. Now, because of how it is designed, the supply limit of Bitcoin has been placed at 21 million. More than 18 million Bitcoins have already been mined.

Therefore, many people believe that the value of Bitcoin is derived from the fact that it has a finite supply. Also, the difficulty of mining rises as more Bitcoins are mined. 

Most cryptocurrencies use a different model on this. For example, while Ethereum has an unlimited supply of Ether, it has an 18 million annual limit.

Burning in cryptocurrency

One of the most common ideas in tokenomics is known as burning. This is an approach that seeks to reduce the number of cryptocurrencies in circulation. It is a popular approach among many newer cryptocurrencies. 

Burning addresses a key challenge in the industry. When left uncontrolled, the minting of new coins can lead to a significant imbalance between demand and supply in the coins. 

Therefore, many blockchain platforms have introduced burning. This is a process that intentionally removes cryptocurrencies from circulation. This is done by the team or foundation behind the cryptocurrency. When burning happens, the cryptocurrency is usually placed in what is known as an “eater address.” The content of this address is available in the blockchain, but it cannot be used. Some of the popular coins that are burnt are Ether, Binance Coin, and LUNA.

Burning is also done in the stablecoin industry. For starters, a stablecoin is a type of cryptocurrency that is backed by a fiat currency or other assets. Examples of these coins are Tether, Binance USD, and Tether USD. When you buy a stablecoin like Tether, an equivalent amount is developed. Burning happens when people convert their stablecoins into fiat currencies.

Other key tokenization concepts you need to know

In addition to the previous concepts, there are other key things on tokenomics that you need to know when investing in cryptocurrencies. You can get this information mostly from the cryptocurrency’s white paper.

First, you need to know how the coins are minted. Most cryptocurrencies are produced using the concept of proof-of-stake (PoS). This is a process where a team known as validators is tasked with confirming blocks using a tamper-proof method. It differs from proof-of-work, where people use computing power to mint new coins. The latter method is known for being expensive, slow, and energy inefficient.

Second, distribution is an important concept in tokenomics. It refers to how coins are distributed in the market and total value locked. In white papers, you will find details about distribution. Many blockchain companies divide the number of available coins in various ways. 

For example, they allocate some of the coins to their foundation and some of them to paying stakers. Other funds go to the development of the ecosystem. For example, Avalanche launched a $100 million program known as Avalanche Rush. The goal is to provide funds to developers building on the platform. These funds come from the tokens.

Finally, you need to look at the governance structure of the blockchain. Governance refers to how the platform is controlled and how holders vote. This is important, especially for DeFi platforms like Aave and Uniswap.

Final thoughts

Tokenomics is an important concept in the blockchain industry. It refers to all factors surrounding token creation, operation, and demand and supply issues. In this article, we have looked at some of the most important concepts in tokenomics and where to find the details.

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