What is Tokenomics? A Complete Guide

Welcome to Tokenomics 101. My colleague Bob and I are tired of seeing people new to the crypto space get obliterated, often ending in salt and a vow to never invest their $200 in a dog or moon coin again. Many people are looking for a way out of the crab bucket and to see them crawl back to fiat is a shame. Crypto trading is THE wild west and that is a feature, not a bug. Follow this scrawl and you might survive, the reader ignores these words at their own peril.

How does Tokenomics work?

The following is a concise and basic instruction on identifying the moon token you’re investing in is probably a scam and worthless. Conversely, it is also a concise and basic instruction on why good tokens remain good tokens.

Demand

We’re in this caper for the number to go up, not to stare at 0.1% gains and losses. The first step in analyzing a token’s economics is to assess its demand. A few cursory questions can save time, which is the most valuable resource in crypto research. Questions being: Do people want to buy this token? Will they want to buy this token in the future? Does this token provide value to the holder? Is there a dog on this token?

Generally, the answers should be ‘yes’ across the board and theoretically this is enough to submit an order. Checking Crypto Twitter is not enough unfortunately, and it is wise to check the blockchain explorer for token holder composition. Good signs are a diverse set of wallets and balances. Bad signs are a high concentration of tokens in a few wallets. Get familiar with your token’s explorer, it is the only honest source of information available.

Answering ‘no’ is not necessarily a bad thing either and in some cases is enough to submit an order. Meme potential cannot be underestimated. The GameStop short squeeze is one example in the traditional finance space, in crypto, there are dog coins. Once upon a time, Bob and I bought tokens to justify Ninja Turtle memes in our signal chats but crypto is a serious business and the boss isn’t going to accept spicy memes as an investment thesis. Dig deeper, there are layers to this number-go-up game.

Supply

A token’s supply is less abstract in nature than demand. The key concepts of scarcity and inflation give a token its monetary properties. A scarce asset means there is less to go around and therefore it is valued more. Inflation and deflation indicate whether supply will increase or decrease. Scarcity determines if the token is worthy of value. Inflation determines the token’s ability to hold that value; whether it is to be held like gold or traded like oil.

Inflation

Inflation is when the circulating supply increases. This type of number-go-up is often unwelcome but in cryptocurrencies, it is a good incentive for holders to interact with the protocol. For example, proof-of-work consensus inflates the circulating supply by rewarding miners with newly minted tokens and in turn increases the supply. Though it is true inflation devalues a currency, it is also true it can be a powerful incentive model if demand is high enough.

Another example of inflation is emissions, fees paid in the token to users who provide a service to the protocol such as providing liquidity or staking tokens to further secure the protocol.

While inflation can be a force of good when measured and regulated, it can also be a terrible force of evil. Understand that crypto trading is a player vs. player game and wallets with a massive percentage of the supply wield immense power to move a market drastically at their pleasure. The same can be said of many wallets holding small amounts of the token. Any large amount of tokens added to a supply suddenly and violently can tank the value of the token. Unrealized gains become very realized and stinging losses.

Deflation

The opposite effect known as deflation removes tokens from circulation. These tokens are ‘burned’ and removed from circulation, never to be used again. Thrown out like yesterday’s jam. Another common deflationary effect is through staking tokens, tokens locked in a smart contract usually immobilized by a set unlocking period similar to vested schedules.

A quick note on burning tokens: When tokens are burned, they are not destroyed but rather moved to a locked smart contract in the protocol. These tokens are impossible to access unless through unscrupulous means easily detected by inspecting the smart contract. If this is the case, do not buy this token or tread very carefully, despite what the anime people tell you, there is no honor amongst traders.

Understand the distinct differences in the following metrics, there are no jokes in this section. Numbers are not funny, not since 7 8 9.

Max Supply indicates the maximum amount of tokens that will exist in the network, this includes tokens that will be mined or made available through vesting. For example, BTC has a max supply of 21,000,000 BTC but notice that the circulating supply is lower than this number. Max supply will always be greater or equal to the circulating supply.

Circulating Supply indicates the number of tokens currently tradeable through the network. This number includes dead wallets (e.g., lost seed phrase) and coins not accounted for by a centralized exchange. This number does not include burned tokens and is protocol wide.

Total Supply is the number of tokens removed from supply due to network effects (e.g., burned tokens) subtracted from the maximum supply.

A keen understanding of the above numbers allows for some math-fu of the following data:

Market Capitalization or Market Cap indicates how valuable a protocol is and allows for comparing value between any given pair (or more) of tokens. Higher market caps typically indicate healthy tokenomics or a less volatile token as there is more money invested in the circulating supply of a token. Be careful with higher market cap tokens as there is less room for your investment to multiply if you’re into that kind of thing. A lower market cap indicates the opposite and is generally more volatile depending on the tokenomics but they are the bread and butter of the degenerate trader.

Market cap can be calculated as follows:

Circ. Supply * Current Price

Fully Diluted Valuation indicates the value of a token once all tokens are in circulation. A decent indicator of the potential for a token’s value. It can be calculated as follows:

Max Supply * Current Price

There are two fundamental token distribution models: Fair launch and Pre-mine launch. There have been other attempts to solve for a truly fair launch, but they are generally based on one of these.

Supply and demand are indicators of a token’s incentive structure, the basis of trusted monetary policy, but they only provide a snapshot of the token. An investment thesis demands yet a deeper dig. The road to meme town is not far.

Sound money can only be effective when it is believed in and used. The beauty of a public ledger is certain pieces of information cannot be hidden. As stated before, the token’s blockchain explorer is the most honest source of information available. It is the monetary policy as seen in the wild. Every transaction, every fee paid, and every wallet listed. To make an informed decision, it is important to know how the tokens are distributed.

Fair Launch

This model gives everyone a chance to acquire tokens and does not discriminate. It is fair in the truest sense of the word: Equal opportunity by any means at the user’s disposal. The best example again is the proof-of-work rewards for mining a block. The user solves the hash, and the user gets the reward. Some users run hundreds or thousands of ASICs to improve their odds, some users have one ASIC and hope for the best or join a hash pool. No one is given their reward, it is earned.

Pre-mine Launch

A pre-mine launch gives tokens to the people building the project and sells tokens to seed investors at a heavy discount to the public launch price. It is a method of fundraising: the team gets paid and investors 10x their investment while still giving the public a chance to multiply their investment. If the fair launch is a gladiator’s fight to the death, then the pre-mine is Caesar and his patricians watching the fight. Yes, they are watching a vicious blood sport from the safety of their cushioned bleachers but without them, the fight does not happen.

Token Allocation

Though pre-mine seems unfair, and they are, good projects often design their token allocation in a way where most of the supply is given to the community. Seed round tokens are locked and given an unlocking schedule. This is referred to as vesting. Remembering that any sudden and violent addition to circulating supply will tank a token: a robust vesting schedule allows for a good project to flourish, seed investors to get their returns, and disincentivizes whale wallets suddenly dumping their bags on the retail market.

You may only submit your thesis and place a buy order once:

• Demand is identified
• Supply is accounted for
• Inflation deemed healthy
• Deflation is practical
• The project team is vetted
• Investors properly leashed

The best way to learn crypto trading is to take part in the market. Even after following this article, a token may still tank completely, that is OK, everyone gets tagged in this game. The goal is to learn and improve upon your previous theses. As Bob always says: “There’s always more reading to be done”.