evaluating tokenomics đȘ
the economics of crypto - exploring the supply and demand drivers for tokens. 1020 words.
The basis for DAOs and really a lot of other projects in web3 revolve around positioning value transactions and exchanges to provide the most utility and value. Thinking about the value that is generated and captured from different project - where does this value go?
Letâs take DeFi as an example. Charging a small fee for DeFi exchanges is a direct way for DeFi protocols like Aave and Pancakeswap to generate cash flow.
Comparing trading volume and revenue generated from fees only takes us so far. Whatâs more interesting is exploring how revenue flows differently across different protocols since itâs really up to the protocol to determine how it should be distributed amongst all of the parties involved with the creation and maintenance of the protocol (like liquidity providers, the DAO or the team supporting the protocol, holders of the native token, etc.).
Tokenomics is fundamentally how we incentivize these parties to collectively run a successful decentralized exchange. The process of incentivizing and aligning involved parties can turn a wavering project or exchange into a steady means of generating revenue.
In the context of decentralized exchanges, the most notable model used by Uniswap doesnât extract value from its traders outside of the process of swapping. Transacting tokens is just an exchange between liquidity providers and traders that pay a small fee (as an incentivization mechanism) to these providers. With this system, the holders of the protocolâs token or the team are economically rewarded.
How does the protocol work then? The lack of incentivized pools with Uniswapsâs token mitigates the selling pressure - UNI is not easily rewarded. Because of its scarcity, Uniswap doesnât actively incentivize it as a means of providing liquidity to its pool with the main token.
Uniswap is just one example. When assessing different projects, how do we understand the tokenomics and incentivization mechanisms that allow the project to run? Tokeconomics canât really be assessed through whitepapers and roadmaps.
What can we use instead?
Think about the dollar currency. How many dollars are in circulation right now? How many are printed but not being circulated right now? When we think about the ideas behind inflation and the value of the dollar, these concerns arise and cryptocurrencies present many of the same concerns.
The biggest factor when analyzing crypto tokenomics is the allocation and distribution of tokens. Most crypto tokens are either released through a fair launch or pre-mined.
A fair launch means thereâs no early access or private allocations. Pre-mining is when several of the crypto tokens are generated and distributed to a group of addresses (usually project developers, investors, or other early team members) before they are even made public.
If thereâs a wallet that has a considerable percentage of the circulating token supply, thereâs a high chance that as soon as the holdings are dumbed the price of the token will drop. You can assume a project is credible if it distributes its tokens to as many members as possible.
As with economics, the supply is a huge part of understanding the tokenomics of a project.
Pictured Above: Supply Numbers for Bitcoin, Ethereum, and Cardano
From the numbers:
Bitcoin and Cardano have max supplies.
Ethereum does not have any max supply.
Cardano does not have all its issued coins in circulation.
Bitcoin has 90% of its max supply in circulation.
These numbers are indicators for analyzing supply and demand.
If an asset is scarce and there is a high demand for it, it can increase its price (this factor can essentially determine whether a token is inflationary or deflationary)
No max supply can lead to an abundance of the coin in the market and a decrease in the price (not necessarily).
Once locked-up coins are released to the market, they can affect the price.
Some crypto tokens have a dual token model, where one token is used as security to raise funds and the other is used for utility inside the network. MakerDAO and Axie Infinity both function in this way.
Burning is also a significant part of crypto as it helps to decrease coins in the circulation, adjust supply and demand, and make an asset less inflationary
The general idea behind the burning process is to make the coin more demanding and less inflationary.
There is no unique approach that all projects follow to burn their tokens. Some burn on scheduled intervals. Some other burn part of the transaction fees. Surprisingly enough, some projects burn tokens randomly and without notice.
Ether burn occurs in every transaction on Ethereum. When users pay for their transactions, the minimum gas fee gets destroyed by the protocol. This means that Ethereum burning occurs at the transaction fee level.
Burning can tell you a lot about the supply of the coins, inflation/deflation, and the mechanisms applied for adjusting prices by projects.
In economics, something known as monetary policy (printing money out of thin air) exists. As the primary entities in charge of fiat money, governments and central banks moderate supply and demand.
In the crypto world, âmonetary policyâ is related to two things: whether the coin is inflationary or deflationary and the roadmap for the coins issued in the future.
The primary source of info for checking monetary policy is the Consensus mechanisms of the projects. Reviewing this data can give you valuable info about how coins are extracted, the inflation and deflation rates of the coins, and the rates the new coins will be introduced into the market.
In crypto, the âmonetary policyâ should ideally be automatized by code.
Reviewing the tokenomics of different projects helps to understand the financial incentives behind the different parties involved in the management and success of the project. Like in economics, tokenomics can help users make better decisions when looking to invest or even contribute to different projects in the crypto ecosystem.
Whatâs more exciting is being able to understand fundamental incentivization mechanisms to apply to different (even non-crypto) related projects. Exploring how tokenomics plays out in different projects and how it affects roadmaps and community outlook and engagement is interesting to see where the future of specific ecosystems may lie.
Learn more đ
Incentivizes structures
Tokenomics resources
Iâm learning by writing about ideas in web3, blockchain, crypto, etc. If you find errors in my understanding or would just like to talk, reach out @_anyasingh