From: ShazebCNBC reports there are more than 19,000 crypto tokens in circulation. To find a good crypto token that has the potential of getting bigger, you need to understand the tokenomics of tokens. But what does tokenomics mean? Let us understand tokenomics and why does it matter?
What Is Tokenomics?
Tokenomics, a combination of “token” and “economics,” is a catch-all term for the factors that make a particular cryptocurrency valuable and appealing to investors. It is a type of cryptocurrency business plan for a token. To explain further, tokenomics is the study of the supply and demand characteristics of cryptocurrencies.
A cryptocurrency project’s tokenomics are an extremely important factor to consider when determining whether it has future growth potential. Many teams and token creators underestimate the importance of a critical aspect of every blockchain project — token design — when planning the token launch.
Tokenomics encompasses the functionality, goal, allocation policy, and emission schedule of a token. A well-built token often leads to increased demand over time as new investors flock to the project, driving up prices. Understanding tokenomics can help investors separate the wheat from the chaff and avoid projects with no long-term viability.
To understand tokenomics, let us take an example. Bitcoin tokenomics define that the total supply of Bitcoin is limited to 21 million. Until all the Bitcoins are mined the value of existing coins will become half every four years. This leads to the scarcity of the coin and hence an increase in value.
Types of Tokens
To effectively understand tokenomics, let us understand the types of tokens before proceeding ahead for a deeper understanding of the topic.
Layer 1 Token
Layer 1 tokens represent a specific blockchain and are used for a variety of services such as investment, storage, and purchase. Every transaction on their network is settled on their native blockchain. Examples of Layer 1 tokens are Ether, Solana and BNB.
Layer 2 Token
Layer 2 tokens are built on the existing blockchain networks. When launching a token, you do not need to create your blockchain from scratch. Instead, you can use existing blockchains such as Ethereum, Cardano, and Polygon. Layer 2 tokens are intended to aid in the scaling of decentralised applications in a network. Examples of Layer 2 tokens are MATIC, FEES and Avalance.
Other than the above-mentioned classification, the tokens are also classified as fungible & non-fungible and also as security tokens and utility tokens.
What does Tokenomics Cover?
Token Market Capitalization
The total market capitalisation is the product of total coins in supply and the price of a token. A token with higher market capitalization is considered more reliable.
Token allocation is an important aspect to propel the project. The token governance team decides the allocation of tokens for distribution to the investors, future reserves, market development, research and development, salaries of employees etc.
Token Transaction Fees
A token transaction fee is charged for each transaction. The high transaction fee may promote holding the tokens and not selling them frequently while a low fee can help the project ecosystem to promote purchases of its’ ecosystem items. Project team to decide the transaction fees as per the utility of the token.
The economic model of a token can be either inflationary or deflationary. In the inflationary model, there is no upper limit to the number of coins i.e., the number of tokens only increases. In this model, the on-demand minting option is not available and new coins are only minted as per the fixed schedule. Example- ETH, DOT In contrast, the deflationary model puts a limit on the maximum supply of coins. The number of tokens decreases in number. This model uses a token burn mechanism to reduce the number of tokens. Example- BNB, CRO.
The incentive mechanism for a token helps investors to earn from the crypto token. The various incentive mechanism may include staking, liquidity pool and yield farming. These methods ensure a return as APY on the tokens locked in the incentive scheme.