Almost everyday a new digital currency is introduced to the market, however, as a matter of fact, not all digital currencies not hold the same value, nor do they have the same level of sustainability. There is an underlying factor behind every digital currency on which the success of that digital currency depends on. The factor - it’s called “Tokenomics”. Their underlying Tokemics is the reason why digital currencies like Bitcoin, Ethereum have been able to secure their values and position in the market for a very long time. In the following lines, let’s learn about tokenomics and understand the importance of tokenomics for digital currencies.
What is Tokenomics?
Tokemics is the underlying DNA of any digital currency determining the financial or economical structure of that currency. Two different words “Token” and “economic” together form the work Tokenomics.
When digital currencies are designed the entire economic system of the currency is implemented in its tokenomics.
Tokenomics Explained
Traditional economic system involves different monetary policy, banks, and our familiar currencies; similarly as Tokenomics refers to the economic model and system of digital currencies, it too has different mechanisms that build itself up. Token supply mechanism, token distribution mechanism, token utility mechanism - everything are the elements that make up the tokenomic model of a digital currency.
Supply of tokens:
Token refers to the ownership of a digital asset such as digital currencies. Token supply mechanism refers to the process of creation of these tokens as well as the distribution of them.
To understand the token supply mechanism, we’ll have to understand two terms related to it: 1. Maximum supply, 2. Circulating supply.
Maximum supply of tokens
Maximum supply is the maximum number of tokens that a digital asset has. This concept is related to the stock market where a company has a fixed number of shares.
And, whenever there is the concept of maxim supply involved, “demand and supply” plays a vital role there to determine the value of the asset.
If there are enough tokens of the asset available in the market, the value of each token is usually lower.
As the supply is capped at a definite number, at a point of time, when the number of tokens being traded in the market comes down, the value of the tokens are likely to increase.
Bitcoin, the most popular digital currency, runs on the fixed token supply mechanism, that is to say, the number of Bitcon in the universe is capped at 21 million.
Another popular digital currency named Ethererum doesn’t involve a definite number of tokens, rather its supply is infinite; but to stop oversupply there are control mechanisms involved.
Circulating supply of tokens:
In simple words, circulating supply of tokens refers to the number of tokens that are available in the market at any point of time. As of now, this number for Bitcoin is heading towards 20 million.
Distribution of tokens
When a new digital currency is introduced to the market, its distribution plays a major role in its success. That’s why digital currency developers create a sophisticated distribution system which is designed in such a way that no single entity gets access to a majority stake in the digital currency.
Some of the entities among which a digital currency is initially distributed are - promoters, early investors, developers and common people.
Token utility
Utility tokens grant specific services to the current owner of a digital currency. The most popular utility token is a security token that is used to represent the ownership through a token; often the underlying item is a real-world asset.
Sustainability of a digital asset:
A sustainable tokenomics implies that the value of the digital currency will not go down in the near future and the curr
ency will stick there for long. When tokenomics are framed for a digital currency, developers of the currency have to keep the sustainability of the currency in mind.
It is a common practice to add a reward system in the tokenomics which helps to promote the user interactions, thus helping the sustainability.
Importance of Tokenomics
The importance of tokenomics, as previously mentioned, is nothing less than what DNA is for a living organism. It determines the sustainability of a digital currency and the complete economics of it. Below, we’ve explained the importance of tokenomics for a digital asset.
Investment assessment
Unlike stocks, where investors make decisions for investment based on the fundamental or financial performance of the company, there’s no such things involved in digital currencies. A promising framework an investor can look into before investing in a digital asset is tokenomics.
By carefully going through the documentation, investors get aware of the potential risks involved for investing in the digital currencies such as the impact of release of additional tokens in the future.
Investors can also understand how tokens of the digital currency are distributed. It also documents the associated reward programs of the digital currency, if any.
Stability of price:
Tokenomics involves supply control which involves how tokens are supplied and how tokens are destroyed to create scarcity of the currency in the market. A perfect combination of it helps the digital currency to thrive.
Sustainability:
Due to well-designed tokenomics, digital currencies like Bitoin, Ethereum, USDT have managed to sustain in the market despite all the odds. A perfectly designed tokenomics helps to minimise the impact of market volatility on the currency.
Incentive:
Incentives in the tokenomics helps to maintain a stable value of the currency as it encourages the holders to stake and hold the currencies decreasing the liquidity of the currency,
How Tokenomics works
The underlying principle behind tokenomics is quite complex. But, we have tried to explain the complex thing as easily as possible in the following lines.
- For any digital currency, first the tokens (representing the ownership of the currency), are generated and distributed. This mainly happens through programs like Initial Coin Offering or Initial Token Offering.
Early investors rounds also take place where promoters claim stake in the digital currency.
Distributions need to be fair to maintain the decentralisation of the digital currency. That’s why events like Airdrops take place with a goal of distributing the newly created digital currency among a large community.
- After the tokens are offered initially, various mechanisms are implemented to manage the demand and supply of the tokens.
The demand and supply mechanism includes new token release, burning of tokens, staking, etc.
- An important aspect for any digital currency to sustain is to maintain its value over time. That’s why various value creating mechanisms work together to maintain and boost the value of the digital currencies.
Key Elements of Tokenomics
If everything occurs to be too complex for you to understand, here we have listed out the absolute core concepts involved in tokenomics that make up the fundamentals of it.
Supply: Supply is a number suggesting how many tokens of a digital currency that exists for any particular digital currency.
Utility: Tokens can be used to gain access to services, access voting rights; utility refers to these use cases of token.
Incentives: Incentive refers to the rewards that one can get either by holding a digital currency for a fixed time or by stacking them, etc.
Tokenomics and digital currency value
The value of a digital currency has a direct connection with its underlying tokenomics, especially because it affects the demand and supply of a digital currency
Through supply control, tokenomics can create demand as well as control the supply of a digital currency in the market.
It is the fundamental concept behind any asset which is true for digital currency too, that is, if there is more demand for the digital currency than what is currently being supplied, the price of the digital currency will go up. In contrast, if the supply of the digital currency exceeds its demand, the price for the digital currency will go down.
Conclusion:
To sum up everything in a single sentence, tokenomics acts as the backbone on which the future of a digital currency depends. We hope that from this article on “Tokenomics for beginners”, you have got to know what tokenomics are in the context of digital currency As well as have understood the importance of tokenomics. Do you know you can buy or sell 50+ assets across the world using our digital payment gateway “Ramp”? Want to collect payments across the world? Introducing “Collections” - an affordable payment collection solution. If you want to pay your employees, vendors or freelancers, use our global payment solution “Payouts”.
Frequently asked questions
- Why is tokenomics important for Digital Currencies?
Tokenomincs in a way determines the sustainability, stability and also has a direct effect on the value of digital currencies, which makes it so important for digital currencies.
- What is vesting in tokenomics?
Vesting is a process that happens before the tokens are allocated to the public. It is the process which determines how the tokens are allocated to entities before they can sell or have them in their ownership.
- What is a governance token?
Governance token is a token which allows the token owner to participate in the voting process.
- What are security tokens in tokenomics?
In tokenomics, security tokens are a special type of token that are used to represent the ownership of a particular asset.
- What is the token burning in tokenomics?
Token burning is the act of eliminating tokens from all the tokens circulating hence reducing circulating supply.It can lead to scarcity that in turn may contribute to making reminders of the tokens more valuable since the general availability reduces making demands go up.
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