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Tokenomics - Understanding Cryptocurrency

by Kene Ezeaputa 6 months ago in tokens
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Blockchain Economics

Tokenomics is the application of supply and demand factors to preserve and/or increase token value. Tokenomics works to support the underlying blockchain. Strong tokenomics encourages behaviors that strengthen the network, creating positive feedback for the token itself. If the token that represents the underlying blockchain does not have or accrue value, the blockchain will lose functionality.

Great read

Tokenomics is what describes short-term run-ups and long-term sustainability. It is a sub-study of economics—the study of scarce resources.

At the heart of tokenomics is supply and demand. If additional demand is greater than additional supply, economics tells us the token's price will rise. If demand stays constant and supply increases, prices will fall. This increase in supply is called inflation.

When judging cryptocurrency, you want to make sure the inflation rate is low and predictable. Most governments aim for a 2% inflation rate every year. The best cryptocurrencies have followed this model; Bitcoin's inflation rate is at 1.77% and will decrease every 4 years till the supply of bitcoin reaches 21 million. Ethereum's inflation rate is about 4% but will be closer to 1% after its upgrade in late 2022/early 2023 (leading some to believe Ethereum will become deflationary (negative inflation)) and will cap at about 124 million tokens (currently at 120m).

Inflation rates

The questions that must be asked about any cryptocurrency's supply are: 1) How many tokens exist? 2) How many will there be? 3) How quickly will those tokens enter circulation, and 4) What is the token distribution? a few people own a majority of tokens, they can suppress the market in the short term.

Supply factors are only a part of tokenomics; if supply is stable, it doesn't create short-term or long-term demand. Demand is essential and can be broken up into two parts: drivers of short-term demand and drivers of long-term demand. In the short-term, consumer expectations, the number of buyers, income, and taste/preference are the drivers of demand. The only long-term demand driver is the utility of the token.

In the long run, cryptocurrencies are valued at what they are worth: critical understanding.

The question is what unique utilities the token gives access to and how the token captures the value of the network. The most common utility is access to the underlying protocol. Ether lets you transact on the Ethereum blockchain, and Solana and Cardona do the same for their respective blockchains. Demand for blockchain is driven by security (decentralized) and speed.

The value of Ethereum has risen steadily because of the demand for its blockchain.

To process on Ethereum, you need ether (the Ethereum token). The more transactions, the more demand for the blockchain, which increases the demand for ETH. An important way Ethereum accrues value for its token is called EIP 1559, an update to Ethereum that "burns" the tip (the extra amount paid on top of the base price to get your transaction processed faster). "Burning" means to remove from the supply. This creates two positive forces for ETH. Increasing demand for Ethereum's block space will increase demand for ether and reduce supply.

Y-axis -> Supply X-axis -> Time

Other blockchains simply use transaction fees to reward stakers(validators). But because Ethereum competitors like Solana have increased block space to lower transaction fees, they have to issue tokens on top of the transaction fees to incentivize network-supporting behaviors.

It's appropriate to say Ethereum does a better job of accruing value for its naive token than Solana.

Utility can also be governance or access; this is typically the main value proposition for decentralized autonomous organizations (DAOs). The more tokens purchased, the greater the access to the founders and "elite" individuals. With the accumulation of tokens comes voting power, which allows for more influence on how to spend the DAO's treasury and on the direction of the DAO.

Example

The crypto space is vast, and it can seem like the more you learn, the more you realize you do not know. Don't be discouraged by what you have to learn; be encouraged by where you started and where you are now.

In good faith

Kene Ezeaputa

tokens

About the author

Kene Ezeaputa

Trying to do my best

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