What are tokenomics and how do they influence price?

Are you curious about different cryptocurrencies, tokens and stablecoins? Keen on learning why they’re key to the Ethereum ecosystem? Great! You’ve come to the right place. To learn blockchain development and be certified I recommend visiting Ivan on Tech Academy

Blockchain is currently #1 ranked skill by LinkedIn. Because of that, you should definitely learn more about Ethereum to get a full-time position in crypto during 2020.

In my first and second pieces, I’ve discussed Ethereum 2.0 and the best tools for developers. In my third and fourth articles, I’ve discussed quadratic voting and open governance models. Then, in my fifth piece, I’ve looked into Swarm’s infrastructure.

In my sixth, seventh and eight ones, I’ve dove-deep into consensus algorithms and the blockchain trilemma. Lastly, I’ve looked into blockchain sharding technology, which projects are making it thrive and I’ve done an intro to Plasma and Looms

To spice things up a bit this week, I’ve explained the importance of blockchain explorers, why tBTC matters for Ethereum developers and the difference between cryptocurrencies, crypto-tokens and stablecoins.

Today, to conclude the latest piece, I’ll dive deep into cryptocurrency tokenomics. How do tokenomics influence price? Why should Ethereum developers care about a project tokenomics?

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Tokenomics 101

When investing in cryptocurrencies and tokens, it is easy to fall into the trap of classifying them as “digital stock”. In reality, the mechanics are quite different. Understanding the role of each token, aka tokenomics,  and how it integrates into a business plan, is absolutely essential for crypto-enthusiasts.

Without the proper understanding, there’s an increased probability of misalocating risk when investing. 

Let’s get to the basics of tokenomics. What is the purpose of a token? Why are they needed? How can utility be created? 

Tokenomics basics

At its core, a token is just a programmable currency unit that is chained onto a specific blockchain protocol. Using a software application, smart contract logic is added to the token and enables it to function as part of a larger ecosystem.

Instead of revenue being the ultimate use case, other use cases emerge. 

All of this technical jargon is just a fancy way of saying that tokens aren’t claims on income of a company – they are pieces of the ecosystem. There was a worry about Bitcoin being classified as a security, which would have numerous tax implications. However, the SEC has ruled it a commodity due to it not representing a share of a company or claim on profits. Most tokens (with some exceptions) are viewed as a commodity.

As long as a token enables some functionality to happen when a transaction takes place, there’s a potential for additional economic value to be created.

Cryptoeconomics of a company

Just like it is essential to understand the economics behind a fiat currency (for example money supply, inflation, or what happens if the government spends into a fiscal deficit), you also need to build an understanding of the factors affecting each cryptocurrency you invest in.

Cryptoeconomics is the term generally used to describe the mechanics and specifics of token distribution. This covers everything from the sale to the ownership structure. It can be generalised as the “terms of governance” used on that specific token.

Strong cryptoeconomics are important, but even more important is the way a token interacts with the business model of its parent company. Essentially, there must be an underlying logic connecting the token and the business. Otherwise, the token won’t likely hold long-term value. 

Let’s dig deeper.

Explaining Tokenomics

Tokenomics is all about understanding the role of a token. Once you have a use case and purpose, users will start demanding that token. There are many use cases (and more creative twists pop up every day), but the most common ones I discuss here. A batch of examples are:

  • Value exchange,
  • Fees,
  • Ownership,
  • And currency.

Many coins have multiple use cases, which adds to their utility and the strength of their tokenomics. You will most quickly understand the currency use case, as this is where Bitcoin operates. Bitcoin is a payment unit in this platform, and users purchase it for this specific reason. 

In Ethereum you always need to spend ETH to run smart contracts and use the network. Value exchange tokens are used on marketplace-type platforms to buy and sell products or services.  Logic can also be added, with a mixture of quality game theory, which enables additional use cases. Such an example are the now famous NFTs or the evergrowing DeFi space. Finally, tokens with right ownership logic allow for voting and rights.

Any use case may endup gainig value. Cryptokitties showed us how NFTs may rule collectibles. Decentraland, how it’s possible to own a piece of digital land. Aragon or Tezos are how it’s possible to have on-chain governance with voting-rights.

As long as there are quality tokenomics in the background, value may emerge. In hindsight, would you purchase a token withou a single purpose? 

This is more of a fundamental article about how you should assess less well-known coins. No matter how greatly a cryptocurrency is engineered, companies still need to build viable business models that thrive over the long term. The utility role of a token is absolutely key for your success as an investor in the company, and by learning to break companies down to these fundamentals, your investing may end up being much more profitable.

Conclusion

Do your own diligence (always!) and don’t fall into the fallacy of thinking amazing teams, products, communities, or whatnot are enough to take a cryptocurrency to the moon.

From my personal experience, pure hype does it better. Of course, hype can be linked to a great number of things – from amazing marketing teams to solid VC backing. Sometimes, even due to pure greed.

The reason why fundamentals are important is that, usually, the strongest projects – with all checkboxes ticked – are the ones winning in the long run. 

Resources

This article is not financial advisement. 

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