KEYTAKEAWAYS
- Tokenomics balances token supply and demand to ensure a project’s sustainable growth and stable token value.
- Supply factors like token distribution, inflation rate, and vesting schedules affect market stability and price trends.
- Demand drivers such as utility, value capture, and investor belief play crucial roles in determining long-term token value.
CONTENT
Learn what Tokenomics is, including key aspects of supply and demand, token utility, value capturing ability, and how inflation rates and vesting schedules impact token value.
WHAT IS TOKENOMICS?
Tokenomics is a combination of the words “Token” and “Economics.” Simply put, tokenomics refers to the mechanism by which a project achieves sustainable development through the control of token supply and demand.
The price of a token fluctuates based on changes in supply and demand:
- When demand exceeds supply, the token price rises.
- When supply exceeds demand, the token price falls.
The core of a token economic model lies in managing supply and demand in a balanced way, allowing both the project and token price to develop healthily.
The scope of tokenomics mainly consists of two key components: supply and demand.
>>> More to read: What is a Token Generation Event (TGE)?
TOKENOMICS | SUPPLY
The supply aspect of tokenomics primarily includes four key components: token supply, token distribution, vesting schedule, and inflation rate.
1. Token Supply
Token supply refers to the total number of tokens currently circulating in the market, the token’s market capitalization, and its maximum supply. This information can typically be found on platforms like CoinMarketCap.
When analyzing token supply, there are two important points to keep in mind:
📌 First Point:
You cannot determine whether a token is cheap or expensive solely based on its price.
For example:
- Dogecoin ($DOGE) is priced at $3 per token.
- Bitcoin ($BTC) is priced at $100,000 per token.
At first glance, Dogecoin seems significantly cheaper than Bitcoin. However, because Dogecoin has a much larger circulating supply, its market capitalization is actually only about 40 times smaller than Bitcoin’s.
🔑 “Market capitalization is what truly matters when analyzing a project—not just the token price.”
📌 Second Point:
If the token you’re considering investing in has a high maximum supply—for example, a total of 10 million tokens with only 1 million currently in circulation—you must be prepared for the risk of token dilution in the future.
As more tokens are unlocked and enter the market, the value of existing tokens may decrease due to the increased supply.
We will explore this dilution risk further when discussing the inflation rate later on.
2. Token Distribution
The next aspect is token distribution, which focuses on understanding “how many individuals hold the project’s tokens and whether there are any whales (entities holding a large portion of the tokens).”
If a majority of the project’s tokens are held by a few whales, there is a significant risk that these whales could manipulate the market by selling large amounts of tokens.
This could lead to price crashes, causing losses for regular investors and negatively impacting the project’s future development.
A well-designed distribution model should ensure that tokens are allocated to a large number of holders, with ownership spread out evenly. This reduces the risk of market manipulation by a small group and supports the project’s long-term stability and growth.
3. Vesting Schedule (Token Unlock Period)
The vesting schedule refers to the timeline set by a project for unlocking tokens allocated to early investors or venture capital (VC) funds.
A well-structured vesting schedule ensures long-term price stability by preventing sudden token dumps. At the same time, understanding upcoming unlock events can offer strategic opportunities for informed investors.
🔓 Why Vesting Schedules Matter
Early investors and VC funds typically purchase tokens at significantly discounted prices.
To prevent these investors from selling large amounts of tokens in a short period—causing sharp price drops—projects implement vesting schedules. These schedules generally limit the number of tokens that can be sold within a specific timeframe.
📉 Market Impact of Vesting Schedules
While vesting schedules help stabilize the market by reducing immediate sell pressure, savvy investors often use these unlock periods as indicators.
They may predict potential price declines when large token unlocks are approaching and adjust their trading strategies accordingly.
4. Inflation Rate
In the real world, we often hear about how governments print more money, leading to currency devaluation.
In the crypto space, the inflation rate refers to the decrease in token value caused by token issuance or the increase in value resulting from token burns.
📈 Positive Inflation Rate
A positive inflation rate leads to inflation, typically caused by the issuance of new tokens. This is quite common in the crypto market, especially in projects that use the PoS (Proof of Stake) consensus mechanism.
Such projects often need to issue new tokens to reward validators who help maintain the blockchain.
🔍 Examples:
- In Polkadot ($DOT), the inflation rate adjusts based on the total amount of DOT staked on the Polkadot network. This mechanism allows Polkadot to balance blockchain security with inflation.
- In the DeFi space, protocols like Uniswap often set high inflation rates during the early stages to attract users with high APY rewards. However, this strategy can lead to severe dilution of the token’s value in the short term.
📉 Negative Inflation Rate
A negative inflation rate results in deflation, typically caused by token burns that reduce the circulating supply.
🔍 Example:
Ethereum ($ETH) implemented the EIP-1559 proposal, which introduced a mechanism that automatically burns a portion of transaction fees.
Although Ethereum continues to issue new tokens, the burn rate has sometimes exceeded the issuance rate, leading to a negative inflation rate.
This reduction in circulating supply helps increase Ethereum’s long-term value.
⚡ Key Takeaways:
- Positive inflation rates incentivize ecosystem participation but may dilute token value.
- Negative inflation rates can enhance token value but must be balanced with ecosystem growth needs.
Understanding the inflation rate is crucial for analyzing a token’s long-term value and assessing potential risks.
>>> More to read: What is Token Unlock in Crypto? A Complete Guide
TOKENOMICS | DEMAND ASPECT
The demand aspect of Tokenomics explains why investors are motivated to buy or hold a token, representing the buying pressure in the market.
This section can be broken down into three key components: token utility, value capturing ability, and belief.
1. Token Utility
Token utility refers to the practical use cases of a token within its ecosystem, typically involving either generating returns or enabling access to specific services.
🔍 Example:
- Holding Ethereum ($ETH) allows you to stake it on the Ethereum blockchain to earn interest or use it as a transaction fee when interacting with various protocols within the Ethereum ecosystem.
The standard for evaluating utility varies depending on the token’s sector. The more essential and versatile the utility, the higher the token’s market demand.
2. Value Capturing Ability
Value capturing ability measures how well a token can capture the value generated by its underlying project, essentially reflecting the relationship between a project’s success and the token’s price.
🔍 Example Comparison:
- Cosmos ($ATOM): Cosmos provides an Inter-Blockchain Communication (IBC) protocol, enabling cross-chain interactions. However, using this protocol doesn’t necessarily require the Cosmos blockchain itself.
- Polkadot ($DOT): In contrast, Polkadot’s cross-chain operations must pass through the Polkadot main chain, requiring DOT tokens for transaction fees.
Since Polkadot’s cross-chain functionality depends directly on DOT, its value capturing ability is stronger than Cosmos’s ATOM, which isn’t essential for cross-chain communication within its ecosystem.
📌 How to Evaluate?
Assessing a token’s value capture potential requires a deep understanding of how the token functions within the project and when it is utilized. The project’s whitepaper is often a great starting point for this analysis.
3. Belief
Belief refers to the confidence investors have in a token’s long-term value. This factor can significantly influence market demand, even without direct utility or yield generation.
🔍 Examples:
- Bitcoin ($BTC): Bitcoin cannot be staked on a blockchain to generate yield. Yet, many investors hold it because they believe it represents the digital gold of the future. This widespread belief contributes significantly to Bitcoin’s value.
- Dogecoin ($DOGE): Despite risks such as high inflation, unlimited supply, and potential whale sell-offs, Dogecoin’s popularity—fueled by its meme status and Elon Musk’s vocal support—creates substantial market demand purely based on belief.
Understanding these three core demand drivers allows investors to assess a token’s long-term potential and market strength more comprehensively.
>>> More to read: What is Bitcoin Strategic Reserve & How It Works
