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| “Positive thought is healthy to the soul.” ― Lailah Gifty Akita |
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In today's issue: Tokenomics are the secret weapon of successful investors.
Understanding the way tokens are created and destroyed within a crypto asset is hugely important. It's literally the rules of the game.
And the rules vary from crypto to crypto.
Today, we've put together the most readable, easy-to-understand overview of tokenomics to date. Read on. |
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| | | Must Read Today's most important story for crypto investors. |
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Japan's Central Bank is set to begin a two-year pilot test of its new Central Bank Digital Currency (CBDC) coordinating with the top three banks and numerous regional financial institutions.
After a two-year stress test to see if the CBDC can hold up in real-life economic conditions, the Bank of Japan will decide whether to formally roll out its CBDC.
Investor takeaway: CBDCs or stablecoins? This is the question for every modern government... Whether to build and launch your own digital currency or simply support a fully functioning stablecoin. Japan is going for the "build" vs. "buy" approach. Stay subscribed to this newsletter for the results. |
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| Your Money is Growing Truth in numbers. |
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| While the skeptics are writing off bitcoin (again), remember BTC has still more than doubled in value over the last three years even at today's prices: |
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| Investor takeaway: BTC is still beating the overall stock market (even sexy stocks like AMZN, NFLX, FB, and GOOG). Ignore the skeptics and keep the faith. |
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A Primer on Tokenomics by Preetam Kaushik |
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Summary: Tokenomics, a combination of "token" and "economics," plays a decisive role in the long-term value of any crypto investment (understanding tokenomics is an investor's secret weapon). Below, we'll explore the basic concepts behind tokenomics and explain how you can analyze them to make great investment decisions.
What are Tokenomics?
Tokenomics is a portmanteau, a combination of “token” and “economics.” In the simplest terms, it's the study of the basic economic principles behind any cryptocurrency.
Put another way, tokenomics are the "rules of the game" on how tokens are created and destroyed. Because crypto is so new, there are no set rules. Each token has its own tokenomics, which can drastically increase or decrease the value of such tokens over time.
When developers launch a new project, they usually publish whitepapers containing detailed explanations of the tokenomics (the policies for minting and burning crypto tokens that will power the underlying blockchain projects).
Beyond the basic rules of how tokens are created or destroyed, tokenomics, like traditional economics, can become quite complex. To simplify, we'll discuss five aspects that are relevant to most crypto projects. |
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Core Tokenomics Variables
Five major variables are central to tokenomics. Think of these as the basic DNA strands of a blockchain project. Just as our DNA decides what we'll look like as adults, the core variables can play a decisive role in the future trajectory of a crypto project’s valuation. |
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1. Token Creation In a regulated economy, a central authority (like a reserve bank) is responsible for printing money. In a decentralized blockchain, one of several consensus mechanisms determines how new tokens are created. The most popular mechanisms (at present) are:
Proof of Work (PoW): Best known for its use in bitcoin, it's where miners ensure network security using high-speed computers and receive new tokens as rewards for their efforts.
Proof of Stake (PoS): Best known for its use in Ethereum 2.0, it rewards those willing to lock up their tokens to assist in validating network transactions. The locked tokens are called “stakes."
In some projects, developers may also create tokens on a blockchain before it launches. This is called pre-mining. Another related process is insta-mining, where a large number of tokens are released immediately after the launch of a blockchain. From an investor standpoint, this is similar to a public company issuing stock shares. Any number of shares can be issued. |
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2. Token Burning Sometimes, it's beneficial to regulate the available supply of a currency or security. Central banks are able to modify money supply to impact inflation and interest rates. They also use steps like directly modifying interest rates and reserve requirements in addition to direct market operations that adjust the amount of money in the economy.
To achieve the same effect on a blockchain, developers can "burn" or destroy tokens. Like deleting rows from a spreadsheet, these tokens are simply removed from circulation.
Burning is usually great for investors. By reducing the supply, this creates a deflationary impact that theoretically increases the price of a crypto (when the pie gets smaller, your percentage of the pie grows larger).
Not all crypto assets burn tokens. Bitcoin is an example of a blockchain without any built-in burning mechanism. Instead, it uses capped supply and decreasing issuance to lower inflationary pressures over time.
Cryptos with unlimited supply like Ethereum have developed burn mechanisms. From an analytical POV, always check if a crypto has a burning mechanism. If yes, see if it has any fixed schedule (burn rates). These burn rates should have a measurable impact on the inflationary aspects of the token. |
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3. Token Supply Rules Bitcoin has become an expensive crypto asset given prices have gone as high as $60,000. Ethereum, on the other hand, had a peak price of just $4,800. This disparity comes largely from the rules of supply behind each crypto asset.
Bitcoin has a limited supply of just 21 million tokens. Its scarcity gives it the same properties as a precious commodity like gold. By contrast, the Ethereum blockchain can create an unlimited supply of tokens, which is expected to have an inflationary effect throughout its lifetime.
The supply variables of a crypto can have massive implications for its long-term price and market value. There are three main variables worth watching:
Maximum Supply: Is there a hard cap on the total number of tokens that can be created?
Circulating Supply: How many tokens are currently available on the blockchain?
Total Supply: Are there any “locked” tokens besides the known circulating supply?
Developers can lock away some quantity of tokens for future purposes. If these exist, keep in mind they may eventually go "live" on the blockchain and possibly have negative impacts on prices.
Another important aspect is the rate at which new tokens are being mined. Since new tokens have inflationary effects, a high rate of mining could negatively affect the prices of the tokens in the long run. |
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4. Governance Systems In blockchains like Ethereum, future upgrades of the blockchain are decided by developers. In recent years, however, several projects have given out governance rights to people who own tokens of the project on the blockchain.
Owners of these governance tokens get to vote for changes to important aspects of a blockchain including core features, user interface, fee structure, rewards, and more. The majority of governance tokens have emerged in the DeFi space.
For example, Aave is a blockchain-based platform that offers staking, borrowing, and lending opportunities using crypto. Its native token, AAVE, gives its holders a say in the future of the platform.
There's also DAI, the popular stablecoin, which has a separate governance token called MKR. Owning MKR gives you the ability to vote on important governance proposals (like shareholder votes).
Having a governance token is not essential for the success of a project. Ethereum and bitcoin have nothing of the sort, but it can add further value to a project. Ownership of governance tokens can also be a future investment if the project gains traction. Like activist shareholders, you can even affect the future direction of the protocol. |
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5. Token Allocation and Vesting Periods Before the initial coin offering (ICO) of a crypto project, developers will often set aside a percentage of the token supply. These tokens are earmarked for the dev team, the early backers of the project, and other employees as a measure of reward or gratitude.
The allocated coins are locked away, with smart contracts set to release them after specific periods or when certain conditions are met. This is called vesting. Up to 25% of a coin’s total supply can be set aside through vesting.
While such allocations are perfectly fair, you should keep a close eye on them. If the developers are allocating excessive amounts for themselves, that may be a red flag. You should also try finding out the vesting period of the tokens, as they could affect future prices when they're released into the open market. |
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Why are Crypto Tokenomics Important for Investors?
Analyzing crypto tokenomics is a basic part of due diligence for crypto value investors (our Blockchain Investor Scorecard has a whole section devoted to it). Tokenomics can tell you a lot about the stability, viability, and future potential of a new blockchain project.
A tokenomics analysis can show the following things: How will the token be distributed? Will the distribution be fair, or will insiders reap most of the rewards? Is the system capable of scaling with growth? Will the long-term outlook be inflationary or deflationary? What future events might affect the price of the token?
If you can't get clear answers on tokenomics, that investment probably isn't worth your attention. Tokenomics are just code, and code can be changed. Look for projects that have the tokenomics clearly spelled out in writing. |
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Quick quiz: Is this token inflationary, deflationary, or fixed?
Investor Takeaway
Tokenomics is the secret weapon of successful crypto investors. Rather than treating all crypto investments equally, tokenomics allows you to anticipate the future supply of a particular crypto asset. There are three possibilities:
Inflationary: The more tokens are minted, the bigger the pie, and the smaller your proportional slice. This doesn't mean you'll lose money (the price of each token could still go up), but it does mean you'll own less of the overall project.
Fixed: Conversely, investments with fixed token supplies mean your slice of the pie stays the same. This doesn't mean the value stays the same (the token price could still go up or down), but you still own the same percentage of the "company."
Deflationary: Investments with shrinking token supplies mean your slice of the pie gets larger. Again, this doesn't mean you make money (the token price could go down), but you retain a proportionally larger percentage of the project.
Knowing how your token works (inflationary, fixed, or deflationary) is the secret weapon for successful crypto investors. Use it wisely. |
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Bitcoin Market Journal is a daily newsletter that makes you a better crypto investor. It's created by John Hargrave, Nick Marinoff, Steve Walters, Anatol Antonovici, Ben Burn, Preetam Kaushik, and Daniel Joel.
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