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Intro to Tokenomics

Nov 08, 2022
byNDAX Labs

Valuing Currency Projects

1/5: The Why and What of Tokenomics

Until the invention of bitcoin, fewer investors asked questions about how many units of a certain currency were in circulation, how many more could be issued in a given calendar year, or even, for example, how geopolitical risk could affect these factors. In equity investing, of course, this is much more common: Investors look at a company’s market cap, debt, shares outstanding, floats, moats, product demand, etc…

With the arrival of Bitcoin, investors have been invited to examine many of these questions more closely–but as pertain to Money, Currencies, and Digital Assets (be they commodities or securities–as never before. This study is called Tokenomics.

So… What does it mean?

Tokenomics is a portmanteau of “token” and “economics.” It describes all of the factors that determine how a token functions and how it may be valued. It can also be viewed as the study of any particular currency’s monetary policy. When Ethereum implemented EIP-1559 for example, it changed its monetary policy to become deflationary by implementing a token/gas-burn policy.

It follows that tokenomics uses many of the same terms as mainstream economic analysis, such as supply and demand, market cap, and volume. For anyone who has taken Economics 101, many of these concepts may be familiar. But tokenomics also includes terms more specific to cryptocurrency, such as “burn schedule,” “mining,” or “staking.”

Why tokenomics?

Suppose you want to determine the value of a currency unit–whether crypto or FIAT–to determine whether it might work well for you as a store of value over the next 5, 10 or 25 years. You wouldn't simply go on instinct, or look at how many hashtags a project has on social media… You’d also want to examine the project’s core metrics such as issuance, exchange volume, holder distribution, liquid supply, demand, utility, adoption, and further; core characteristics, such as its on-chain analytics (which is a new area of study born of bitcoin).

For example, it used to be simple to tell the amount of US Dollars in circulation: It was published regularly by the Fed as the M2 Supply at https://fred.stlouisfed.org/series/M2. As the world reserve currency, and given that most commodities (like oil) are priced in dollars; demand for the USD was relatively stable and made its demand relatively easy to quantify and predict… But then came the global pandemic. And as countries began shuttering their economies to halt the spread of Covid 19, demand for oil (priced in dollars) plummeted, and the Federal Reserve injected trillions of dollars into the economy by purchasing treasuries and mortgage-backed securities to keep our societal wheels turning–and, well greased at that!

And then there is the issue of Euro-Dollars. Fractional reserve means that European banks have also been creating dollars on European ledgers–separate of the federal reserve!–since the 1960s. There is quite simply no longer a single source for how many dollars there are in circulation throughout the world… So that the St. Louis Fed famously stopped publishing US Dollar M2 money supply data (shortly after it began to hockey-stick up following the pandemic lockdowns) is no surprise. Tokenomics apply to FIAT, too.

To value any project–whether Amazon, US Treasuries, bitcoin or ether–we need to understand how they work. When it comes to crypto or FIAT; tokenomics is that study.

While some are forked or copy-pasted, most cryptocurrency projects are quite unique. For instance, how is its blockchain secured? Does it use Proof of Work, Proof of Stake, or another consensus mechanism? And what's its utility? Does it function as a store of value, or does it have a practical purpose like privacy, speed, paying for file storage or wifi or buying goods in a particular metaverse? As most cryptocurrencies and their tokenomics are unique, so are the characteristics which affect the way a particular cryptocurrency behaves in the market. Getting a firm grasp of a project’s tokenomics is essential to evaluate its potential as an investment: Tokenomics studies the factors behind a token’s supply and demand with the ultimate goal of determining its value today and over time. So, before aping-in to the shiny new project, here are some resources to help you learn to DYOR (do your own research).

Disclaimer: This article is not intended to provide investment, legal, accounting, tax or any other advice and should not be relied on in that or any other regard. The information contained herein is for information purposes only and is not to be construed as an offer or solicitation for the sale or purchase of cryptocurrencies or otherwise.