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Tokenomics Part 2

By Jaya Bijoor

Last week we did an article on tokens. Now, let’s dive into tokenomics, the overarching term that describes the economics of token based projects.

Tokenomics includes the following variables:

  • Token supply

  • Token allocation and distribution

  • Token utility

  • Incentive mechanisms (covered in next week’s post)

In essence, how the tokenomics are designed for a particular project directly impacts the value of its token.

Let’s get into it further:

Token supply

Token supply refers to the number of tokens that a project issues or releases. Figuring out token supply is incredibly important to the project’s success. For example, a project can have a maximum supply (like Bitcoin’s 21 million), which means only a certain number of tokens will be issued. Tokens can also be inflationary or deflationary. Inflationary tokens are those that have an increasing supply, while deflationary tokens are those that have a decreasing or constant supply.

Can a token be deflationary even if it has an infinite supply?

Yes. For example, ETH has infinite supply and burn mechanisms that remove tokens from the circulating supply, making it deflationary. That means the ETH burned will be higher than the total ETH issued.

Circulating supply is another crucial factor when designing tokenomics. Circulating supply describes the number of tokens available for buying and selling. Many projects have burn, stake, or lock mechanisms that remove tokens from the circulating supply. For example, there are currently 11.5 million ETH staked and locked out of the circulating supply.

Managing the balance of supply and demand is a crucial component of great tokenomics and ensures that a token retains its value under different market conditions.

Token allocation and distribution

The team decides on token allocation and distribution when a project is launched. For example, BTC was launched without private allocations or pre-mining. Other projects choose to reserve tokens for investors, treasury, core team members, or other reasons while allocating the rest of the tokens to the public. Most projects sell the remaining tokens or use them as a reward for early community members. What matters is defining vesting schedules to ensure the supply and demand balance. A vesting schedule defines the time and cadence at which investors or other stakeholders can sell their allocated tokens without creating a supply surplus.

Token utility

Controlling the supply of a token is essential, but the token’s utility drives demand. In crypto, tokens can take on several use cases: governance, transaction fees, membership, payment methods to memes. And although there are many tokens with dubious or no utility thriving in the bull market, only the tokens that have actual utility survive the bear and persist in the market.

What keeps a token-based system in check and functioning as intended?

Beyond the primary factors we just covered, tokenomics must include incentive mechanisms and game theory principles. We will explore game theory and token incentives next week in our third and final part on tokenomics.



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