Tokenomics – is one of the most used concepts when investing in crypto, but few understand what it is. A phrase that is easy to understand in theory but very complicated when analyzed in depth.
Therefore, in this article, I will help you understand all the things that we need to know about Tokenomics.
What is Tokennomics?
Tokenomics is a combination of two words Token (Cryptocurrency) and Economics (Economics). Therefore, Tokenomics can be seen as the economy of cryptocurrencies and how they are built and applied to the operating model of that project.
Why is Tokenomics important?
Reading this far, you will probably find it quite boring. A token is also just an asset that is traded on an exchange. So what’s so special about tokenomics? Before answering this question, let’s go through a small quiz to increase the drama!
Take a look at the image below and imagine the crypto market as a multi-party game, including:
Developer: Andre Cronje, Vitalik Buterin,…?
Market Maker: CZ Binance, Sam FTX,…?
Large investment fund: a16z, Multicoin, ParaFi,…?
Retail investors: Most of us (including myself).
So who are the people sitting closest to the chessboard? Who are the game controllers? Looking at the picture above, you will see even Justin Sun can’t access the game; then, it is probably the small investors standing outside the casino listening to the game’s results.
Who controls the crypto game?
Indeed it is; we are playing a game created by Market Makers, Builders/Developers and large investment funds. From trending ICO, IEO, and IDO to NFT, GameFi on ecosystems.
So what factors will they control the game through? That is the token, the thing that you buy and sell and put your trust in it. But tokens are something built by great developers, builders, and market makers. In short, the crypto market is a zero-sum game; everyone wants to make money, so who will lose?
If you want to make money and understand what Market Maker is doing, you need to understand the operation of the Token, or in other words, it is TOKENOMICS.
We will continue to learn about how the tycoons operate Tokenomics!
Elements of a Token and Tokenomics
This part is quite long, but it will have links and support useful Insights for the following sections, don’t miss it. Before diving into the analysis of the application and the value of the token for the project, I will go with you from basic to in-depth, including:
Coin/Token Supply
In the past, Total Supply and Circulating Supply were two frequently used concepts. However, Coingecko and CoinMarketCap have added a new concept called Max Supply – a concept that is easily confused with Total Supply.
I will explain in detail the 3 concepts of Token Supply and give illustrative examples to make it easier for you to understand this section.
- Total Supply is defined as the total amount of coins/tokens in circulation and locked minus the number of coins/tokens that have been burned. Initially, Total Supply will be a number designed by the project development team to match the operating model best.
In more detail, Total Supply will have the following forms:
The fixed total supply is the initial pre-determined amount of coins/tokens and cannot be changed. Example: Total supply of Bitcoin is 21 million BTC, Total supply of Uniswap is 1 billion UNI,…
The total supply is not fixed; the number of coins/tokens can change depending on the activity of the project and is divided into the following groups:
The total supply increases gradually due to more mining. For example, the amount of ETH in the market will depend on the performance of the Ethereum network; CAKE will be minted when users Farm on Pancakeswap,…
Total supply gradually decreased due to burn. For example, Binance Coin has an initial total supply of 200 million BNB and is gradually burned to 100 million BNB,…
The total supply changes continuously due to the Issue-Burn mechanism. For example, mainly Stablecoins like Algorithmic Stablecoin (FEI, AMPL,…), Crypto-backed Stablecoin (DAI, VAI,…), Centralized Stablecoin (USDT, USDC,…).
- Circulating Supply is a concept that refers to the amount of tokens being circulated in the market.
- Max Supply will determine the maximum number of tokens, including those that will be mined or available in the future.
- Read Token Supply
Above are the Token Supply parameters of 3 different coins/tokens:
ETH: Ethereum is a token with no total supply (No Max Supply) and will be minted more when there is a need to use the network. After being minted, ETH will be circulated without being locked by any organization (Circulating Supply = Total Supply).
SRM: Serum is designed with the largest amount of 10 billion SRM (Max Supply). At the present time, the maximum number of SRMs can reach 161 million SRM (Total Supply), but the actual number of circulation is only 50 million SRM (Circulating Supply).
NEAR: Near Protocol’s Token Supply is the most basic and the most common. Total Supply and Initial Design Token Quantity will be equal (Max Supply = Total Supply), gradually unlocked until reaching 1 billion NEAR (Circulating Supply).
Market Cap & Fully Diluted Valuation
Market Cap is the capitalization of the project with the number of tokens circulating in the market at that time. From the Circulating Supply, we will calculate the Market Cap.
Market Cap = Circulating Supply * Token Price
Fully Diluted Valuation (FDV) is the capitalization of the project but is calculated with the total number of tokens in circulation and not yet unlocked of the project. From Total Supply, we will calculate FDV.
FDV = Total Supply * Token Price
Why does capitalization affect growth potential more than price?
Currently, the price of a token depends on many factors; in addition to Fundamental Analysis, it also depends on the Initial Total Supply of the token. Example of a project with token A with a Market Cap of $10,000,000:
If the project issues 10,000,000 A token ⇒ Each A token = $1.
If the project issues 10,000,000,000 A token ⇒ Each A token = $0.001.
The number of tokens issued can range from tens of thousands to several billion tokens, but capitalization is an important factor affecting the growth of tokens.
Example: Let’s make the case that Aave and Compound are two projects with equal fundamental analysis potential in the field of Lending. Because of that, the Compound can reach Aave’s Market Cap.
In terms of price, each COMP costs more than AAVE, but COMP has higher growth potential because Compound has not reached the “ceiling”. If Compound achieved a Market Cap like Aave, each COMP could reach $735.
Token Governance
Currently, on the market, there are about 10,000 coins and tokens. However, not every token follows the Decentralized mechanism like Bitcoin; there will be tokens/coins that are managed according to the Centralized mechanism. I will divide it into 3 basic types:
Decentralized (Decentralized Tokens) are coins/tokens whose governance is completely decided by the community and is not pressured to govern by any organization. For example, Bitcoin, Ethereum,…
Centralized (Centralized Tokens) are coins/tokens whose governance mechanism is decided by a leading organization; they have the power to influence the nature of the coin or project that the token represents. Usually, these are Full-backed stablecoin projects like Tether and TrueUSD, exchange tokens like Huobi and FTX, or projects with a Centralized governance model like Ripple…
From Centralized to Decentralized: There are also coins/tokens built with the initial governance mechanism Centralized, then gradually decentralized to the community.
For example, the original Binance Coin was fully governed by Binance. However, after a while of launching the Binance Smart Chain and the “Validator Spotlight” program, Binance has gradually decentralized the network of BSC and BNB tokens for users to control.
Token Allocation
Before investing in a token, Token Allocation will help you know if the distribution of tokens among the stakeholder groups (related groups) is reasonable, as well as their impact on the overall project.
- Team
This is the token for the project development team. This will include the number of tokens of members who contribute value to the project, such as founder, developer, marketer, advisor, etc. The ideal number is usually about 20% of the total supply.
If this ratio is too low, the project team will not be motivated to develop the project in the long term.
If this ratio is too high, the community will not have the incentive to hold the token of that project because the token is being dominated by too much of one entity. This causes a number of problems, such as concentration of power and the possibility of being overpriced.
- Foundation Reserve
The reserve is a project’s reserve for future product or feature development. This is a token with no specific amount. Usually, it will account for 20-40% of the total supply.
- Liquidity Mining
Liquidity Mining is an Allocation that has appeared frequently, especially after DeFi projects developed strongly from September 2020 until now. Liquidity Mining is a token that is minted as a reward to users who provide liquidity for DeFi protocols.
- Seed / Private / Public sale
This is the number of tokens for the sale to raise capital for product development. Normally, the project will have three open sales: Seed sale, Private sale and Public sale (details in the Token Sale section).
- Airdrop / Retroactive
For the project to attract initial users, they will often airdrop to users a very small part of the token allocation. Usually will account for about 1-2% of the total supply.
Around 2019 and earlier, to receive the Airdrop, users only need to perform a few simple steps such as Like, Follow, and Retweet posts on their Twitter page.
However, from 2020, the conditions to receive the Airdrop are much more difficult, requiring users to “skin in the game”, and use the product to be able to receive the Airdrop or Retroactive. Some typical Retroactives can be mentioned as Uniswap (UNI), 1Inch Network (1INCH),…
Learn: What is an Airdrop? How to participate in Airdrop effectively
- Other Allocation
Depending on each project, they will have an Allocation section for a specific case: Marketing, Strategic Partnership,… Usually, allocation has a small proportion and can be included in the Foundation Reserve.
The difference between the two cycles:
2017-2018: Public Sale accounted for more than 50%, Insider accounted for little. For example, ADA, ETH, XTZ, ATOM,…
2019 onwards: Public Sale accounts for 20-30%, Insiders account for the largest proportion. For example, NEAR, AVAX, SOL,…
In there:
Public Sale is the amount of tokens that are opened for sale to the community.
Insider includes the development team, investment funds,…
This can be explained because, in the past, the tokens of the projects were not used much in the ecosystem, and they needed capital to be able to develop the project. At the present time, the market has had the appearance of large investment funds and tokens that are widely applied in the platform. Therefore, Insider and Foundation will account for a large number of tokens on the market.
The difference in token allocation of coins/tokens founded before 2018 and after 2018. Source: Messari.
Token Release
Token Release is a plan to distribute tokens to the circulating market of a project. Similar to Token Allocation, Token Release greatly affects the token’s price and the community’s motivation to hold the token. Currently, on the market, there are 2 types of token allocation:
- Allocation of tokens according to a predetermined schedule
Each different project will have a different token release schedule, but we can classify it into the following time periods:
Token release of some popular tokens in the market.
Less than 1 year: Projects with a 100% token release rate of less than 1 year show that the project team is not a long-term companion to the product they build and cannot create much value for the platform and the token. there.
From 3 to 5 years: This is the ideal time to release 100% of tokens because the crypto market has a very fast rate of change. Since being “Mainstream” in 2017 until now, the crypto market has only experienced a period of 5 years.
In each year, the market has seen the shedding of many ineffective projects and the launch of more potential projects. Therefore, 3-5 years is the most ideal number to promote the development motivation of the team, as well as the motivation to hold tokens from the community.
Over 10 years: Except for Bitcoin, projects with a token release schedule of up to 10 years will find it difficult to motivate holders because they suffer from token inflation for up to 10 years, and no one guarantees that the team will be effective during that period.
As such, the number of token releases must be designed to balance the following two factors:
The rights of token holders when holding tokens of that platform.
The value of tokens released per day (inflation).
If the number of tokens released is too fast compared to the performance of the project, the token price will tend to decrease because users are not motivated to hold the token.
- Token allocation according to performance and usage needs
To solve the problem of inflation happening too quickly compared to the original plan. Some projects have chosen to release tokens according to a specific criterion rather than a set time. This is a pretty cool mechanism because it will help stabilize the price of the token if applied properly.
For example, MakerDAO also does not have a specific token replenishment time. Depending on the actual use needs of the platform, the amount of MKR will be allocated appropriately. ⇒ With Lending or Borrowing activities, the new MKR token will be released.
Token Sale
Token sale can be seen as a form of raising capital through the sale of shares, similar to companies in the traditional market. However, in the crypto market, shares will be replaced by tokens.
If traditional companies have about 5 fundraising rounds, projects in Crypto will have about 3 token sales to raise capital. Often the valuation of a company will not be specific to each industry, region and size. However, in Series C, large companies can completely value themselves from $ 100 million or more.
Traditional Company: Pre-seed, Seed, Series A, Series B, Series C.
Crypto Project: Seed Sale, Private Sale, Public Sale.
The average valuation for the crypto market will be lower as it is a relatively new market with a much smaller market cap than the stock markets of some major countries.
- Seed sale
Seed sale is the first token sale of the project. In this sale, most of the projects have not yet completed the product. There are a number of projects that open to sell tokens as a form of capital raising for deployment.
The funds invested in Seed sale are mostly venture capital funds, they accept high risks but will also be rewarded if the project is successful.
- Private sale
If the Seed sale is mainly venture capital funds, the Private sale will have the participation of many larger and more famous investment funds. Usually, at this stage, projects have launched their products and have partially demonstrated their achievements after raising capital in the Seed sale round.
- Public sale
Public sale is an open sale of tokens to the community. The project can launch tokens in the form of ICOs like 2017 or through third parties in the form of IEOs or IDOs.
- Fair token distribution
However, there are also many projects that are not open for sale in any form but will be distributed through activities such as Testnet, Airdrop, Staking, and Liquidity Providing,… This helps the project become “average”. more equal” to the interested community and reach more users.
Some prominent Fairlaunch Projects can be mentioned as Uniswap (UNI), Sushiswap (SUSHI), Yearn Finance (YFI),… They do not open token sales in any form to raise funds first but will distribute. tokens to real users of the platform.
Some pros & cons of this mechanism:
Advantages: Tokens are distributed to people who contribute value to the project, reducing deep “dump” because Seed sale and Private sale buyers “discharge” tokens.
Cons: The project “misses” a part of the capital that can be called from the community to develop the project.
- Impact of Token Sale on Tokenomics
There is no set rule or benchmark for the price difference between token sales. For a project, the Public sale price can be twice the Private Sale price, and the Private Sale price can be twice the Seed Sale price. This completely depends on the project.
However, they will keep the spread reasonable. Because if the price difference between each phase is too high, investors who come first will tend to take profits early; on the contrary, investors in the next round will not have the motivation to participate in the sale.
Therefore, projects will apply a token release mechanism to distribute benefits among investors properly. If the price difference of each batch is high, investors who come first have to have a longer lock time. On the contrary, investors who buy at a higher price will be able to unlock the token sooner.
Token Use Case
Token Use Case is the intended use of the token; this is the most important element of tokenomics that helps you to value a token in the market based on the benefits that the token brings to the holder.
Functions of some tokens/coins on the market.
Normally Token will have the following functions:
- Staking
Currently, most projects support Staking for their native tokens. This creates an incentive for users to hold tokens because more tokens are distributed as interest. Without the staking mechanism, token holders will suffer from inflation because every day, a new number of tokens are minted into circulation.
In addition, Staking also has the additional benefit of helping to reduce the number of tokens circulating in the market, which reduces selling pressure and makes it easier for the price to grow. For networks that use Proof-of-Stake, the increased number of tokens staked also makes the network more decentralized and secure.
Example: Cardano (ADA) has been growing from $0.2 to $2 (1,000% growth) since the beginning of 2021. Theoretically, to grow like that, the amount of capitalization poured into Cardano must be 10 times.
However, in reality, that is not the case; the capitalization number poured into Cardano is much lower. What makes Cardano grow so strongly is that 75% of the Cardano in circulation has been staked, which helps to reduce the selling pressure of ADA in the market, creating momentum for ADA growth.
- Liquidity Mining (Farming)
For DeFi tokens, there have been many recent appearances. Users can use them to provide liquidity for DeFi protocols, in return, they will be rewarded with the project’s native token.
Example: Provide liquidity to Uniswap to get UNI, …
- Transaction fee
To make a transaction, users need to pay a fee to the network, more specifically, the Validators for them, to confirm the transaction for them. Each blockchain network will have its own native token used to pay for the network (usually projects operating in the field of blockchain platform). For example:
Ethereum uses ETH.
Binance Smart Chain uses BNB.
Solana uses SOL.
Polygon uses MATIC.
- Governance
In this part I mentioned above, the platforms can be managed under a Centralized or Decentralized mechanism depending on the project developer. However, the majority of current DeFi platforms are governed by a Decentralized mechanism.
This means token holders will be able to propose and vote to make changes to the platform they participate in. Proposals can be related to transaction fees, token release speed, or larger issues, such as proposals for the project development team to expand to the new blockchain.
Prominent DeFi platforms such as Uniswap, Sushiswap, Compound, etc., have all applied the Decentralized Governance mechanism allowing users to participate in governance. However, most of the community only stops at Voting power but cannot create Proposals for the platform because the amount of tokens needed to create Proposals is often very high value.
- Other benefits (Launchpad,…)
This is one of the important factors that help the token to be circulated and creates a great incentive for users to hold the token. Regular Launchpad projects will require users to stake tokens in order to participate in the sale. Or have the right to participate in the NFT prize draw…
For example, Polkastarter requires holding POLS, DAO Maker requires holding DAOS,…
Note: To evaluate a project with growth potential or not, Tokenomics is an important factor. However, the price of the token, as well as the potential of the project, is also evaluated through many other factors. Tokenomics is not the only factor affecting the potential for price growth.
Below I will mention some projects with effective and ineffective t
Summary
I have analyzed the above article specifically to help you understand the structure and role of tokenomics in the market. Here are some important Recaps:
Tokenomics is a collection of many internal factors such as Token Supply, Token Application, Token Sale, Token Release,…
Tokenomics is an important but integral part of the operating model to assess the effectiveness and growth of the token accurately.
Tokenomics can be “varied” with many different designs. But let’s focus on the platform’s revenue and how the project captures value for the token.
