What are tokenomics?
Tokenomics demonstrates the problem and governance dynamics behind each crypto asset. It covers everything about how the asset works, as well as the behavioral theory that affects the value of the token in the long term. In short, Tokenomics describes the supply and demand of a crypto asset.
In the traditional economy, economists oversee the issuance of a currency using official money supply data. The numbers they report are often referred to as M1, M2, and – depending on the country – M3 or M4. The in-depth explanation of the four types of M lies beyond this Tokenomics analysis: just know that M1 is the measurement of the most liquid units, M2 is less liquid,… These numbers help to monitor different aspects of providing a more transparent currency.
These numbers are important because, throughout history, kings, queens, and governments have maintained the creation of additional money in their countries. It turns out that running a country or fighting can be very expensive, and it’s not always easy to increase revenue or balance the budget, which means that generating more money will be politically advantageous.
In the modern world, things like bank bailouts and pandemic responses have required governments around the world to create large amounts of new currencies very quickly. The creation of additional currencies can cause a decrease in the value of the existing amount. We call this decline “inflation” and it is most visible when the price of the things we buy increases every year.
In contrast to this process, cryptocurrencies and tokens built on blockchains have a schedule of releases, created according to pre-established algorithms. This means that we can quite accurately predict the number of coins that will be created on a given date over time. While most cryptocurrencies can change this release schedule, it will normally require the consent of many people and is difficult to implement. This brings certain comfort and security to owners, because they know to what extent their assets will be created in a way that is much more predictable than the government generating money.
What is the maximum total money supply?
In total, only 21 million Bitcoins will be created. The entire production process will end around 2140. Between now and then, the number of new coins created through the mining process will halve in every four years. This is called halving Bitcoin and is designed to create what economists call scarcity, thus creating upward pressure on prices.
While 21 million may sound like a huge number, when compared to the roughly 8 billion people on earth, it’s clear that this number is incredibly small. It is this imbalance that has led many to compare Bitcoin to gold and consider it a “solid” currency.
As the first cryptocurrency to be created, the process of issuing and developing Bitcoin has led the way for other currencies. For example, Bitcoin Cash, Bitcoin SV and Zcash also have a hard limit of 21 million coins. However, there are coins that have very different schedules. For example, both Dogecoin and Grin have identical issuances for every newly created block infinitely, meaning that the token supply of these coins is basically unlimited. Grin’s founders hope that this feature will make it easier to maintain a more stable price and thus become a more easy-to-use currency. It will take years to understand whether this is really going to happen or not.
Between Dogecoin and Grin there are a lot of coins and tokens operating on Ethereum that have maximum issuance levels in place, but that number is very high. For example, Tron has a Total Supply limited to more than 100 billion.
There are also cases where the number of coins or tokens will decrease. Some projects have created rules in which a certain number will be burned – meaning they will be transferred to a wallet that cannot be retrieved – at set intervals. Combustion usually involves operating fees, so the more assets are used, the faster its token is burned.
Why are tokenomics so important when it comes to investing in cryptocurrencies?
In his famous book on investing, Margin of Safety, value investing legend Seth Klarman explains that “In short-term investing, supply and demand determine market prices.” If we believe that is true and applies to cryptocurrencies that use Blockchain technology as well as the stock market, then understanding the factors that will impact supply or demand is important for both speculators and investors.
In that case, there are a number of factors to consider. Perhaps the most important thing is to understand how to use digital currencies. Is there a connection between the use of the platform or service being built and the content? If so, it is very likely that a growing service will cause an increased demand for buying and using cryptocurrencies to increase the price of that coin. If not, what can the token be used for?
Other important questions to answer include:
- How many coins or tokens currently exist?
- How many will survive in the future and when will they be created?
- Who owns these coins? Are there any plans to be released in the future to developers?
- Is there any information that suggests that a large number of coins have been lost, burned, deleted, or somehow unusable?
Tokenomics are useful in guiding understanding the value of an asset in the future. For example, many new users of cryptocurrencies will think things like “If this coin becomes as valuable as Bitcoin, then one day…” In fact, that may never happen. For example, check out the two coins mentioned above, Bitcoin Cash and Tron. Bitcoin Cash has the same total supply as Bitcoin, so the thought that one coin could become as valuable as the other in time to have some legitimacy – that’s entirely possible. However, with over 100 billion Trons available, for a coin to be worth thousands of dollars, Tron will need to become the most valuable business in the history of the world – is that likely to happen?
While answering these questions will be quite complicated, they will provide an additional way of looking at cryptocurrencies and help you understand whether this cryptocurrency in the future will be more developed than other cryptocurrencies.