What is the importance of tokenomics?
- Supports price stability
- Dictates how coins are made and burned
- Provides incentives for buyers
- Influences future value
Tokenomics is an important concept to consider while you’re deciding on which crypto project to invest in — but what is tokenomics, and why is it so important?
This concept is so crucial to every crypto project. The project’s ecosystem, sustainability, and value depend on it. In this article, we give a rundown on what tokenomics are, what they mean for a project, and why this concept is so important to a cryptocurrency’s success.
What is tokenomics?
The term is a portmanteau of “token” and “economics,” which already gives you a good idea of what it means. Tokenomics is a catch-all for all the elements concerning a cryptocurrency’s value. This includes everything from its supply, how it’s minted, what it can be used for, et cetera.
Simply put, tokenomics is the science of a particular project’s economy. Beyond that, tokenomics can also influence the psychological or behavioral forces that could affect a cryptocurrency’s value long term.
Because it plays a huge role in its short-term and long-term value, tokenomics is one aspect that many seasoned investors look out for. Projects with well-designed tokenomics are thus more likely to succeed in the long term because they can attract more investors and create a sustainable economy.
Likewise, projects with poor tokenomics have the odds stacked against them — even if they were somewhat profitable at the start — because investors are more likely to abandon ship at the first sign of trouble.
If you’re thinking of whether or not a new project would be profitable, then understanding their tokenomics is one of the first things you should do. Here are the different elements that tokenomics will affect a project:
Supports price stability
Cryptocurrencies are notorious for being extremely volatile — one attractive token might just plummet in value overnight, seemingly for no reason. This volatility scares many investors. Any fluctuations can push them to buy and sell en masse, which can prove disastrous to the project.
Tokenomics can help a project overcome this by ensuring there are enough tokens to match the levels of supply and demand. This creates stability for the project and encourages investors to hold onto the tokens they have and use them for what they’re made for.
Dictates how coins are made and burned
Tokenomics sets the rules on how each token is made (or “minted”), allocated, and later taken out of circulation. While investors must be able to buy from a supply or make new tokens, this presents a problem: inflation.
Much like real-world money, cryptocurrencies become worthless if too many tokens are minted. If the supply outstrips the demand, then inflation is inevitable. Big fluctuations in price are a common outcome when a crypto project lacks tokenomics protocols to outpace inflation.
This is where “burning” mechanisms come into play. The tokenomics of a project should also include how the tokens are removed from circulation to reduce the total supply. This increases the currency’s price, benefits investors, and helps the project avoid inflation.
Some tokenomics protocols can also dictate whether or not coins are held in reserve. This means that they are later added back into the economy, which may be needed to promote growth or help with system maintenance.
Provides incentives for buyers
Tokens don’t just have a monetary value — they can also have utility. This feature makes a token even more attractive to a potential investor, as it provides incentives. The better the utilities, the more they want to buy and hold the token, which creates demand.
Here are the some of the main variables that developers use for their tokenomics:
- Staking – Some projects allow staking, which is when you lock away tokens (that you either worked for or bought) into a smart contract. It operates similar to a high-yield savings account and generates passive income for the staker.
- Yields – Similar to staking, but the tokens are put into liquidity pools. These power things like decentralized exchanges and lending platforms. Investors lend or borrow crypto on such platforms, and later earn rewards in return for their services
- Token allocations and vesting periods – Some crypto projects use a distribution system for their tokens. For example, tokens may be reserved for venture capitalists or developers, but they can only sell those tokens after a set period. Token allocation guidelines create a system wherein the tokens are distributed in such a way that it benefits the token’s price or stability as much as possible.
Influences future value
Tokenomics lays the groundwork for how tokens work within a project’s ecosystem. But, it also introduces something called “game theory” to the project. Tokenomics can introduce any kind of game theory the project would like.
It’s an economic concept that assumes investors are rational and will put money into the optimal choice — i.e., the project that gives them incentives, such as staking or yield rewards.
Thus, tokenomics also introduces any additional elements in the project’s design that might help increase the demand for the token in the long run.
Who decides what the tokenomics for a project are?
All of these decisions are made at the protocol level — so they’re dictated by its developers and written into their project’s computer code.
Before a cryptocurrency is released, its tokenomics are often outlined in the project’s whitepaper. This is an in-depth document that not only covers what their project aims to do but also explains how the underlying ecosystem will function, including its economy.
This part of a project’s whitepaper is especially important for GameFi projects, as this particular sector of the cryptoverse struggles with inflation and diminished investor returns over time.
But, the era of GameFi 2.0 is approaching with new projects like Imperium Empires. As the premier AAA space metaverse game on the market, we take pride in being the pioneer in many aspects of GameFi — including tokenomics. Read all about how we overcome the prevalent problems in GameFi and how our tokenomics benefits our players in our whitepaper.
Knowing what tokenomics is, and how it affects a crypto project should give you a good idea of how to better evaluate any potential investment opportunity that comes your way. By reading up on a project’s tokenomics, you should gain some insight into how the cryptocurrency will be managed, how it can be used, and how its demand and supply will be driven in the future.