TOKENOMICS MODELS
The core team behind each project develops the rules for how tokens are created, or “minted,” and how they are brought into and out of the network. Different projects use different approaches.
Cryptocurrencies are known for their volatility. If there are enough coins in circulation to match supply levels, then market participants are less able to influence volatility. This helps create a stable price for the coin, which encourages people to use the tokens for what they are intended for.
Tokens can be distributed in different ways. Networks reward validators or miners with freshly minted coins, selling a portion of the tokens to potential users as part of an initial coin offering (for example, an ICO). Tokens can be distributed among users through certain actions and behaviors. Augur, for example, rewards people for fact-checking its bookmaker network.
For a crypto project, a token is an important component. With the help of system tokens, users have the opportunity to take part in activities, support the functioning of the project, and receive benefits from participation in the project. Therefore, it is important for a crypto project to be able to distribute tokens to potential users. Often, tokens are an object of interest for various types of investors (holders, traders). In addition to studying the fundamentals of a particular project, a sophisticated investor asks himself a number of questions:
INTRODUCTION
• How many coins or tokens are there currently?
• How many will there be in the future and when will they be created?
• How quickly are tokens released into circulation?
• Does the release rate change over time?
• What is the token distribution structure?
• Is there any information to suggest that a large number of coins were lost, burned, disposed of, or otherwise unusable?
• Are there deflationary pressures such as token burning?
• Are there significant changes in technology that may affect the number of project tokens? For example, Ethereum plans to move from proof of work (PoW) to proof of stake (PoS).
• How many will there be in the future and when will they be created?
• How quickly are tokens released into circulation?
• Does the release rate change over time?
• What is the token distribution structure?
• Is there any information to suggest that a large number of coins were lost, burned, disposed of, or otherwise unusable?
• Are there deflationary pressures such as token burning?
• Are there significant changes in technology that may affect the number of project tokens? For example, Ethereum plans to move from proof of work (PoW) to proof of stake (PoS).
You can get answers to these questions by studying the tokenomics of the project. Tokenomics (token economy) is a set of policies and algorithms for the creation and distribution of project tokens.
Aspects of the token offering:
• Method of issue and distribution of the first coins.
• Initial offer. It involves an assessment of the initially issued coins and the features of their distribution among stakeholders (investors, founders).
• The type of issue outlines the monetary policy governing the release of new coins of a particular crypto asset.
• Supply cap—whether emissions are strictly limited or constant.
• Initial offer. It involves an assessment of the initially issued coins and the features of their distribution among stakeholders (investors, founders).
• The type of issue outlines the monetary policy governing the release of new coins of a particular crypto asset.
• Supply cap—whether emissions are strictly limited or constant.
Token distribution methods
Price stability
Control
Some projects may include tokens held in reserve that can be added to the ecosystem later as a way to drive growth or pay for system maintenance. This method is implemented, for example, in XRP.
At the same time, other projects take a consciously hands-off approach to network operation. For example, Augur developers do not play any role in the operation of the network, they simply maintain the infrastructure.
Most teams building a network won’t be able to dictate its rules. That’s not how decentralization works. Most developers know that what they create now will not necessarily work in the future as originally intended. As the network grows and evolves, the way tokens are managed may need to change. Some projects have developed provisions for how network users can effectively change the way tokens are governed in the ecosystem through consensus.
Future adaptation
Examples of tokenomics in action:
BITCOIN
There will only ever be 21,000,000 Bitcoins, and they are issued at a rate that is halved every four years. Approximately 19,000,000 already exist, so only 2,000,000 more will be produced in the next 120 years.
This means that 90% of the supply is already in circulation, and in 100 years there will only be 10.5% more Bitcoins, so we should not expect significant inflationary pressures reducing the value of the coin.
ETHEREUM
There are approximately 119,000,000 coins in circulation and there is no limit on the amount of ether. But Ethereum’s supply has recently been adjusted through a burning mechanism so that it reaches a stable supply or perhaps even becomes deflationary. Taking this into account, one should not expect much inflationary pressure on ether. It could even be deflation.
DOGECOIN
Dogecoin also has no supply cap and inflation is currently running at around 4% per year . Thus, inflationary tokenomics can be expected to erode the value of Doge more than Bitcoin or Ether.
Why is tokenomics important?
Blockchain technology allows projects to create micro-economies. To become self-sufficient, they need to figure out how tokens should work in their ecosystem.
When it comes to tokens, there is no one size fits all approach. Blockchain has enabled a wide range of use cases and implementations. Tokenomics allows teams to create a new or adapt an existing model that works with what the project wants to achieve. This can create a highly functional and stable platform if done correctly.
TYPES OF TOKEN EMISSION
The most typical example is the NEM (XEM) currency. The entire volume of coins immediately goes into circulation, their further quantity remains unchanged, capitalization is determined by the market rate.
LIMITED ONE-TIME
This type of token emission also involves limiting the maximum number of coins in circulation. The key difference is that the coins are not released all at once, but gradually. It should be noted that there is a specialized mechanism that regulates the process of issuing new coins.
LIMITED GRADUAL (UNTIL MAXIMUM COINS ARE REACHED)
Unlimited emission of tokens implies the endless production of new coins without any serious restrictions. Such assets as Ethereum (ETH), Smooth Love Potion (SLP) operate using a similar model. A rather serious drawback of this approach to issuing new coins is that the unlimited emission of tokens under negative circumstances can cause quite serious inflation.
INFINITE EMISSION
An important advantage of a limited one-time token issue is that digital money that uses a similar approach experiences virtually no negative impact from inflation. This is due to the fact that since new coins are not mined, a drop in their quotations due to supply exceeding demand is almost completely eliminated. Cryptocurrencies that use this approach are popular among investors, since if you purchase coins at the initial stage, you can get a fairly high income due to the growth of their quotes. Under other favorable conditions (in-demand product, strong team), the asset will increase in price.
Examples of such currencies are XRP, Cardano, NEM and others. The creators of XRP initially “froze” 53.6 billion coins out of the total supply (100 billion), and then gradually brought them to the market. This approach made it possible to create an artificial shortage of crypto assets, and the developers received a reserve of time for the development and popularization of the project.
A typical example is Bitcoin (BTC) and its forks. Coins are constantly mined through mining, where the difficulty of the task increases with each block, and the reward gradually decreases (halving). It implies a smooth increase in the number of coins in circulation to the upper limit and, theoretically, a stable increase in their market value. For Bitcoin, there is a maximum limit on the number of coins in circulation, which is 21 million. After the specified volume of coins has been mined, the mining of new digital money will stop.
Regulation of the production of new Bitcoin coins is carried out by constantly complicating the mining process. It should be noted that the difficulty of mining new blocks is further adjusted depending on the total capacity of the equipment involved in this process.
Among the key features of this approach to issuing coins, it should be noted that at the initial stage there is a probability of inflation, which gradually decreases. The more coins mined at the current time, the lower the likelihood of inflation. An important advantage of digital money that uses a similar approach to issuing coins is that their quotes can be predicted with a fairly high level of accuracy.
Most popular digital currencies (Bitcoin, Litecoin, Dash) work on this principle.
In the case of ETH, developers are deliberately looking for ways to solve the problem by introducing algorithms for burning coins (for example, gas for smart contracts), as well as by increasing the complexity of the system and improving the platform.
Despite the fact that coins using a one-time token issue are more attractive in the eyes of potential investors, most digital money developers prefer not to use such an approach.
This is due to the fact that this approach to issuing coins gives digital money developers only one chance to attract the necessary amount of investment capital to bring their own project to life. In addition, with this approach, there is practically no feedback mechanism between investors who purchased coins and the project developers.
When working with such projects, there is a possibility that after the sale of all issued coins, the developers may lose incentive to further develop the project. Thus, a situation may arise when, after an ICO, developers stop working on improving the created platform. As a result, due to the shortcomings of the platform, users may completely lose interest in it, which will result in a decrease in the value of coins, and investors will lose part of their invested capital. Ideally, developers should receive capital in part, with a certain frequency, regularly proving their expertise and the benefits of the product.
The degree of attractiveness of a particular asset depends on the type of its issue. Thus, in tokens with a limited controlled release, the total volume is predetermined. Moreover, the system contains several regulatory algorithms that will prevent the uncontrolled release of tokens to the market, which means there will be no sudden inflation. Therefore, tokens with limited emission are best predictable.
For coins with unlimited emission, the situation is the opposite. They are initially released onto the market in large volumes, creating a predominance of supply over demand. It is more difficult to calculate what value a token will have on the market after a certain time.
As for coins with a one-time issue, the situation with them is even more complicated. On the one hand, the total volume is known, which already allows for at least some analysis. In addition, following the example of XRP, one can resort to “freezing” part of the assets in order to regulate their withdrawal into circulation. On the other hand, such coins have centralized control, which not all crypto users like. It will not be possible to increase their popularity by attracting miners, because they are simply not needed. And even the success of the payment system does not guarantee impressive profits (take the same XRP, which is 4th in capitalization, but at the price of one coin is not even in the TOP 20). Thus, it is unlikely that you will be able to get rich dramatically from these cryptocurrencies (like those who bought bitcoins in 2013–2015), and this is not the most attractive prospect.
TOKENOMICS MODELS
INFLATIONARY TOKENOMICS
The inflation token has no maximum supply and will be issued over time. There are many options for inflationary token models. Some limit the annual creation of tokens, others are based on a set schedule for the release of new tokens. An example of an inflation token is the CAKE token of the decentralized cryptocurrency exchange PancakeSwap. The CAKE token has an inflationary model and has no maximum circulation limit; in each new block, new tokens are “printed”, some of which are subsequently burned. The developers separately explain the release of new tokens by the need to encourage users to provide liquidity, which is reasonable, since the presence of liquidity is the key to the performance of any exchange.
DEFLATIONARY TOKENOMICS
If the total number of tokens in circulation is limited to a predetermined quantity, the token is called deflationary. Some projects may choose a deflationary token model as this can help increase the value of each token (the fewer tokens, the more valuable each token becomes). This reduction in the supply of tokens can be achieved in various ways: by buying back or burning tokens. The main advantage of such models is that they prevent the market from being flooded with too many tokens. Bitcoin sets the industry standard for the deflationary token model. In this model, a certain number of tokens will be created and the limit will never increase. This creates a deflationary currency, even if demand increases, there will be no supply.
PRINCIPLES FOR REGULATING THE ISSUE OF NEW COINS
The more money supply governments and central banks pour into the economy of a particular country, the more inflation swings. But cryptocurrencies are issued according to a specific plan, which is regulated by pre-approved algorithms:
Blocking of some coins and gradual introduction to the market . The method is used in projects with a one-time issue. Developers create an artificial shortage of assets and receive a reserve to attract new investors.
Increasing mining difficulty . New crypto coins are created on the network at a certain time interval. For Bitcoin it is 10 minutes, for Ethereum it is 14.2 seconds. The time remains the same regardless of the number of miners and attracted capacity. The difficulty of mining crypto coins is gradually increasing: in the Bitcoin network – every 2016 blocks (about once every 2 weeks), in Ethereum – every 1000 blocks.
Reduced mining rewards . In the BTC network, the payment for finding new blocks is halved every 4 years. At the same time, the release of new coins slows down and creates a moderate shortage of the asset in the market. The same processes occur in other projects.
Combustion mechanism . To combat inflation and increase the value of the token, some projects practice burning. This method is used, for example, by the Binance exchange. The exchange uses part of the net profit to purchase BNB tokens from the market, which inevitably increases the price. The act of burning occurs when currency is sent to a wallet whose address no one knows. All token burning operations are recorded in the blockchain as a transaction. Therefore, anyone can verify that the coins were destroyed.
Burning can also have disadvantages over time. When scaling the project, adding new services, increasing users, the same tokens will no longer be enough to cover all services. On the contrary, it is necessary to produce them additionally, and not buy them back from the market and burn them. Simply put, if the current level of tokens can serve 10,000 clients, then when there are 100,000 clients, the number of tokens will have to be increased 10 times. Or reduce the price 10 times. Few people think about this, since the main goal of an ICO is to raise money. The success of Bitcoin has clearly shown that projects with non-scalable internal currencies are often not used as a means of payment, but are accumulated in wallets as their value increases over time.
TOKEN DISTRIBUTION ANALYSIS
For further analysis, you need to understand several definitions:
Vesting is the process of blocking and distributing purchased tokens within a given time frame.
Cliff – long-term blocking of tokens until the vesting deadline. More often used for seed and private sale investors.
TGE (Token Generating Event) is generally a synonym for ICO. More precisely, it is one of the stages of ICO, namely the release and distribution of tokens (Token sale).
An example of the use of vesting: for the team and advisors (advisers of the project), thereby stimulating the creation of a competitive product and at the same time showing the community that there is no reason to get rid of tokens, because even those who created the project hold them. In token vesting, it is important to obtain an even distribution of tokens. Vesting, including a cliff of 1 year, can soften the split in the early rounds.
It is clearly noticeable that a quarter of the volume appears on the market at once, the remaining tokens are unlocked within three and a half years, they are physically impossible to sell, since they are frozen on a smart contract.
Typically, the developer of the tokenomics of the project determines in advance in what shares the tokens will be distributed when their owners will be able to use them. Main distribution categories:
1.SEED/STRATEGIC SALE
2.PRIVATE SALE
3. PUBLIC SALE
4.TEAM & ADVISORS
5.LIQUIDITY
6. MARKETING & TREASURY
Project owners can allocate different shares to each category. Let’s try to figure out how this can affect the project and what you need to pay attention to when studying the tokenomics of the project.
SEED/STRATEGIC SALE
This is the very first round of investment in the project. Most often, major venture funds take part in it, those that can provide the project with the bulk of the investments. You need to pay attention that for the tokens of this round there is a large vesting (from 1.5 years) and the price of the token in this round is not very much underestimated in relation to other rounds. The value x2 in relation to Public sale will be an acceptable value. If this value is higher, then this may indicate the possibility of unloading tokens of this round to those who will buy them on the listing. The unlock of this round should not exceed 10% on TGE. Cliff is possible, but not required.
PRIVATE SALE
This round is intended for large investors and influencers who can help develop the project. Development can mean marketing or community building. Vesting for this round averages 12 months. The price in this round should not be much higher than Seed/Strategic sale. This round must be clearly balanced. If too many tokens with a small vesting are allocated to it, then liquidity may not be able to cope with the redemption. If the disconnect is very small, then the project may not have a sufficient number of the same influencers, which implies a lack of media support and coverage. Reach, in turn, is the size of the community, and the community is the purchase of tokens at the Public sale.
PUBLIC SALE
This round generally does not exceed 10-15% of the total supply. The reason is that the main participants in Public sale are retail buyers. They are the ones who most often sell their allocations when listing a token on an exchange, which can bring down the price of the token in a matter of hours, sometimes even minutes. If at this stage the share of tokens allocated is significantly greater than 10-15%, then this may indicate either the faith of the project team in its community, or the incompetence of the person who developed the tokenomics of the project.
The price in this round is the highest, but there is no token blocking, and the allocations are the smallest. If the price at this stage is more than 2-2.5 times the Seed/Strategic sale, this is also not a good sign. The reason is the same; early investors (if they have a low rating) may want to take profits, which will also increase pressure on the price of the token.
TEAM & ADVISORS
Advisers do not pay for their tokens, they receive them for helping the project. Therefore, if this part of the tokens has a very fast unlocking, this may indicate the dishonesty of the advisor, who is pursuing his own personal interests.
An acceptable cliff for advisors is considered to be from 4-5 months, for a team – from 1 year, with mandatory vesting. The percentage of the total offer for the team and advisors should be no more than 25%. Otherwise, after the unlocking, the price may receive strong pressure from the released tokens.
LIQUIDITY
Liquidity – these are completely free tokens for the project. And the team can do whatever they want with them. Therefore, if the tokenomics of the project does not indicate the timing of the unlocking, this does not necessarily indicate a scam, but should be an object of increased attention for the investor.
MARKETING & TREASURY
These tokens are also free for the project. They must have a fairly long vesting. Tokens from this fund can be used to pay influencers, use them as an additional fund to reward the community, distribute airdrops, in general, any marketing activities. Often, these tokens are never released into the market, only as a last resort, or initially if the project was intended as a scam. The percentage of such tokens from the total supply should not exceed 10%.
It is difficult to describe all possible situations; each project has its own characteristics in distribution. To understand how individual everything can be, it will be interesting to consider the tokenomics of the famous Internet Computer project (ICP token), No. 37 in the Coinmarketcap ranking . The project is very respected, but tokenomics is quite controversial:
• the share of seed investors in the project was initially 25% with an entry price of $0.03. Vesting is unknown, if it existed at all;
• share of strategic investors – 7% with an entry price of $0.63 and vesting for three years, starting in May 2021. Investors: Polychain Capital, Andreessen Horowitz, CoinFund, Multicoin Capital and Greycroft Partners;
• private-sale round share of 4.96% with an entry price of $4 and vesting for one year starting in May 2021. Investors Andreessen Horowitz, Polychain Capital, SV Angel, Aspect Ventures, Electric Capital, ZeroEx, Scalar Capital and Multicoin Capital.
• share of strategic investors – 7% with an entry price of $0.63 and vesting for three years, starting in May 2021. Investors: Polychain Capital, Andreessen Horowitz, CoinFund, Multicoin Capital and Greycroft Partners;
• private-sale round share of 4.96% with an entry price of $4 and vesting for one year starting in May 2021. Investors Andreessen Horowitz, Polychain Capital, SV Angel, Aspect Ventures, Electric Capital, ZeroEx, Scalar Capital and Multicoin Capital.
The listing price of the ICP token in May 2021 was $450 (15,000x for the seed round, 714x for the strategic round and 112x for the private-sale). Within a few months the price dropped by 95%. ICP is currently trading at $18 per token. Accordingly, in the first months until the early investors partially came out, it was under no circumstances worth entering into such a project with a long-term horizon, despite the fact that ICP’s investors are top-notch and the project itself is unique.
To qualitatively assess the investment attractiveness of a project, it is necessary to conduct a comprehensive analysis. What problem does the project solve, what are the team members like, the experience of the team members, who are the competitors? An investor must find answers to these and many other questions.
And, of course, studying tokenomics as an important component of the new project.
Studying the quality of holders, distribution of shares, and vestings will help you make an informed investment decision.