Intro to Tokenomics

2/5: The How: Utility & Supply

How does it work?

We’re researching a complex web of interconnected processes that all contribute to a cryptocurrency’s value and future outlook. Just like life, it’s messy and chaotic. It won’t work the same way every time, and more often than not, people and markets are unpredictable.

However, there are general patterns that emerge based on macro and micro trends both within the crypto ecosystem and in the global political economy.

These are the most critical factors that are instrumental to most currency tokenomics.

Token Supply

There are two primary metrics to keep in mind when looking at token supply. The first is the maximum supply. This tells you the total amount of tokens that will exist in a cryptocurrency's lifetime. For example, Bitcoin has a maximum supply of 21,000,000 BTC. Once all 21 million BTC are mined, no new coins will ever enter circulation. The USD for example does not have a maximum supply, as we have seen: Had the dollar still been backed by gold, this might be a different story as gold is scarce and has an inflation rate of around 2%/year… But that ship sailed in 1971, so determining the total supply of dollars in the world is now almost impossible. (Stay tuned for our next series; The History of Money.)

The second metric is the total circulating supply. This tells you how many tokens currently exist in the market and can be bought, sold, or held. Circulating supply can be thought of as a company's available shares on the market.

Bitcoin has a current circulating supply of over 19.1 million BTC (at the time of writing), roughly 91% of its maximum supply. While this may sound like Bitcoin is running out quickly, it has other characteristics influencing its supply levels that will be discussed later.

Some cryptocurrencies don’t have a capped supply, like Ethereum. Instead, these cryptocurrencies rely on limited minting rates and burn mechanisms to keep the circulating supply in check.

In broad terms, if a currency’s supply remains the same or decreases while demand increases, its value will also increase. For example, gold’s yearly supply is well known and increases marginally each year, it may also theoretically retain strong purchasing power for its holder. This is known as scarcity. If on the other hand, however, demand decreases or its supply increases at a greater rate than demand, its value will likely decrease.

Utility

Utility tells us what a currency is used for. If it fulfills a highly sought-after purpose and proves beneficial for a wide variety of people or companies, its value is likely to increase. For example, since it is used to settle most international trade, one of the currencies with the greatest utility in the world today is the US Dollar. Utility for Gold is a store of value, electronics, or jewelry/art.

As another example, Chainlink (LINK) is a utility token that helps the Chainlink network incentivize data accuracy and secure transactions between information oracles. Since there is a growing use case for reliable data transfer between users, companies, and exchanges, Chainlink’s value has consistently remained among the top-ranking cryptocurrencies.

However, if a utility token becomes outdated or is only required by a small group of users for niche operations, it may be less likely to grow in value. And to make matters murkier, as Web3 continues to develop and the industry expands, new forms of crypto utility are emerging all the time. Here are some of the most common use cases on the market today:

  • Store of value (BTC, USDC, USD, Gold, Real-Estate, Art, Stock, etc)
  • Smart contracts (ETH, SOL, AVAX, ADA)
  • Payments (XRP, LTC, XLM, USD)
  • Governance (DAO, MKR)
  • Exchange tokens (BNB, UNI)
  • DeFi (COMP, AAVE)
  • NFTs and gaming (AXIE, CHZ, APE)
  • Utility tokens (LINK, GRT, FIL, VET, MANA)
  • And Memes (DOGE, SHIB)

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.