Tokenomics refers to the logic and incentives that govern crypto assets. It includes all aspects of the asset's operation and any psychological or behavioral characteristics that could affect its long-term value. Tokenomics is the science of valuing cryptocurrencies and determining their worth before investing.
Long-term success is considerably more likely for projects with well-designed tokenomics. They've done a great job of motivating people to buy and hold their coins.
People quickly sell tokens at the first indication of problems, so projects with terrible tokenomics are doomed to fail. For example, the Terra Eco-system, which lost the handle and suffered billion-dollar damages, is a good illustration.
Understanding tokenomics is one of the most useful initial steps you can take to make a sound decision if you're considering whether or not to buy a crypto asset.
Supply and Demand
As explained in the first part series, Tokenomics I, supply and demand are crucial in tokenomics as the crypto market is like any other.
Supply: Emissions, inflation, and distribution
On the supply side, deflation raises the value of a token as the number of tokens accessible drops. When more tokens are produced, the value of a token depreciates. When considering the supply side, you don't have to worry about whether the token has any utility or whether it will generate money for its holders. You're merely considering the supply and how it will evolve.
The following are the questions you should ask:
1. How many of these tokens are currently available?
2. Supply limit of the token
3. Minting and mining rates
Demand: Return on Investment and Game Theory
Having a limited supply does not automatically make something valuable. People must also believe that it has worth and will continue to have value in the future.
Return on investment (ROI) and game theory are two factors to consider when determining if a token will have demand-side value in the future.
Return on Investment
In this situation, the return on investment is not determined by how much you believe the token price will rise. The amount of money or cash flow the token can bring you just by owning it.
For example, if you own Ether, you can stake it to assist in safeguarding the network once Proof of Stake is implemented. In exchange for staking your ETH, you will be paid extra ETH at around 5%.
You can use some tokens to access the earnings of the protocol they represent. If you own SUSHI, you can stake it to get a piece of the Sushi protocol's earnings, presently trading at around 10.5 percent APR.
Another form of ROI is "rebasing," which works similarly to a stock split in that by keeping a token and staking it, you will continue to get more of that token as the protocol's supply grows. The inflation rate isn't necessarily negative because you can keep your protocol share.
Consider what additional components in the tokenomics design can boost token demand, as Game Theory suggests. This part is where tokenomics can become very complicated.
On the other hand, Lockups are a popular variant of good tokenomics game theory. The protocol encourages you to lock your tokens in a contract by offering bigger rewards.
Performing Your Self-Assessment
This article should provide you with a good place to start when considering any new project. You should be able to obtain a fair idea of how the supply of the coins will be managed and what forces will drive demand for the token or cryptocurrency by reading the documentation or whitepaper.
And the question to ask yourself isn't "will this appreciate against the dollar?" but rather "will this appreciate versus (BTC, ETH, SOL, whatever you prefer)?" Most crypto assets are very connected and move in lockstep, so if you're holding anything other than the large foundational coins, you should have some faith in its tokenomics and incentives to outperform the base currencies on which it's based.
That's all for now folks. Stay tuned for more crypto informative articles to keep you ahead of the pack. Happy trading!