Jul 4, 20223 min read

Understanding tokenomics and its influence on the success of a project

Updated: Jul 12, 2022

Tokenomics, put simply, is the science of token economy. It involves analyzing multiple factors that determine a project’s success and influence its future. In other words, it allows investors to differentiate between good and bad actors in the cryptosphere.

Let’s take a deep dive into tokenomics and how it’s closely linked to a crypto project’s roadmap and growth potential.

Crypto tokenomics: The basics

The term tokenomics, a portmanteau of the words ‘token’ and ‘economics,’ was first used in a 2017 Medium article written by William Mougayar. It has since evolved into a science that explores the core features of a token’s economy, which could include essential factors like utility, usage, and value. While tokenomics is still an evolving concept, it has helped many investors weed out bad crypto projects and has been used to tell what the outlook of a token’s future is.

By understanding a project’s tokenomics, investors can make more informed, confident decisions. Likewise, developers looking to launch a token project can carefully assess their native currency’s tokenomics to become successful and attract investment.

Tokenomics: 4 Core Success Factors

The success of a cryptocurrency project can be attributed to the following core features:

Utility

Of all the factors in tokenomics, utility is perhaps the most important. Regardless if the token scores in other factors like price stability mechanisms, distribution, and governance, it will likely fail if it’s not used for anything. Consider fiat currency. It remains useful so long as a nation’s citizens use it for everyday transactions and investments. Tokens, on the other hand, primarily exist within the ecosystem and its participants.

That said, tokens remain useful so long as it has buy-in from its participants. However, more successful native currencies have empowered their users by creating multiple functionalities or use cases that are responsible for driving up demand and value, even if the supply stays the same or decreases. For example, Ethereum’s (ETH) is primarily used to pay transaction fees to deploy smart contracts and dApps, while Bitcoin (BTC) is mostly used as a medium of exchange and a store of value.

Here are examples of successful token functionalities:

Medium of exchange in the whole ecosystem or on a platform
Earning opportunities through mining, yield farming, staking, and revenue-sharing
Collateral for other assets in the ecosystem (i.e., stablecoins)
Governance (as in governance tokens in exchange for a stake or voting rights in DAOs)

Price Stability Mechanisms

A token’s supply and price is also a crucial factor to tokenomics. Essentially, crypto projects have a supply-driven price stability mechanism, which means that supply has a direct influence on the token’s price. For example, if a token’s supply increases but its demand stays the same, it will likely result in a price drop. Meanwhile, a coin’s price will increase if the supply decreases, while the demand stays the same.

Many crypto projects design their token as a deflationary asset, either by moving a big chunk of the supply out of circulation over time, putting a hard cap on the number of coins to be minted, or holding out the rest of the supply and releasing it incrementally over a specified timeline.

Price stability dynamics and mechanisms tend to vary widely across crypto projects, which investors should carefully analyze before investing in a coin.

Distribution

Distribution in crypto projects occurs in many different ways, making it another crucial feature of tokenomics to consider. In a nutshell, users won’t be able to use a project's network if the project fails to distribute coins to its users. After all, tokens power these platforms. Projects must then explore efficient and effective ways to introduce their tokens to the market.

In some cases, projects would reward team members and early investors more, while others would distribute tokens to the community to facilitate a fair launch. It’s important to take note that a project’s distribution model can tell you a lot about its history, giving you insight into its future.

Governance

The last (but not the least) key element of tokenomics is governance. This factor may not be important to some projects, but it is a crucial element for tokens that have governance as their primary functionality.

Governance basically refers to how the core team of developers governs the project. For some users, it can be a big deciding factor whether or not the governance model is fully decentralized or occurs on the chain or off the chain. Investors would also consider the core team’s skills, experience, and background. But the main considerations are integrity, transparency, and cooperation.

Tokenomics is one way to assess a project’s future growth potential. While it may not be set in stone or it doesn’t always go as planned, they allow investors to navigate the cryptosphere and identify which ones are worth investing in.

About AlgoBlocks