In this series of articles, we want to talk about one of the most important and confusing aspects of web3 projects: TOKENOMICS!

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What are tokenomics? Why are they important? How can you assess a project's tokenomics and decide if it is good or not? These are some of the questions that we will try to answer in this particular post.

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But before we dive into the details, let us give you a quick overview of what tokenomics are and why they matter.

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What are tokenomics?

Tokenomics is a term that combines two words: token and economics. It refers to the design and function of a project's token, which is a digital asset that represents value, ownership, or utility within a crypto ecosystem.

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A project's tokenomics defines how the token is created, distributed, used, and governed within the project's platform or network. It answers questions like:

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- How is the token supply determined and controlled?

- How is the token distributed among the project's stakeholders and participants?

- How is the token used within the project's platform or network?

- How does the token influence the behavior and decisions of the project's stakeholders and participants?

- How is the token value determined and influenced by market forces and network effects?

- How is the token governance structured and executed?

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Why are tokenomics important?

Tokenomics are important because they determine the value and sustainability of a project and its token. A well-designed tokenomics can:

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- Align the incentives of the project's stakeholders, such as developers, users, investors, and validators. This means that everyone involved in the project has a reason to contribute to its success and growth, and to avoid actions that would harm it or its token.

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- Create a positive feedback loop that increases the demand and utility of the token. This means that as more people use the token for various purposes within the project's ecosystem, such as paying fees, accessing services, voting, staking, etc., the token becomes more valuable and useful, which attracts more users and increases the network effects.

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- Encourage innovation and participation in the project's ecosystem. This means that tokenomics can reward those who create value for the project and its community, such as developers who build new features or applications, users who provide feedback or referrals, validators who secure the network, etc.

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- Prevent inflation and dilution of the token value. This means that the tokenomics can control the supply and distribution of the token in a way that preserves its scarcity and avoids excessive inflation or dilution that would reduce its purchasing power or attractiveness to investors.

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These are some of the benefits of a good tokenomics design. However, not all projects have good tokenomics. Some projects may have poorly designed or executed tokenomics that can have negative consequences for the project and its token, such as:

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- Misaligned incentives of the project's stakeholders, such as developers who abandon the project, users who exploit loopholes or cheat the system, investors who dump the token, validators who collude or censor transactions, etc.

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- Negative feedback loop that decreases the demand and utility of the token. This means that as fewer people use the token for various purposes within the project's ecosystem, such as paying fees, accessing services, voting, staking, etc. The token becomes less valuable and useful, which repels more users and reduces the network effects.

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- Discourage innovation and participation in the project's ecosystem. This means that the tokenomics can penalize those who create value for the project and its community, such as developers who build new features or applications, users who provide feedback or referrals, validators who secure the network, etc.

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- Inflation and dilution of the token value. This means that the tokenomics can increase the supply and distribution of the token in a way that reduces its scarcity and increases excessive inflation or dilution that would reduce its purchasing power or attractiveness to investors. 

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How to evaluate a project's tokenomics?

Now that you have a basic understanding of what tokenomics are and why they matter, you may wonder how to evaluate a project's tokenomics and decide if it is good or not.

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There is no definitive answer or formula for this, as different projects may have different goals, strategies, and challenges. However, there are some general principles and criteria that you can use to guide your analysis and judgment. Here are some of them:

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1. Understand the project's vision and value proposition.

This means that you should first have a clear idea of what the project is trying to achieve, what problem it is solving, what value it is creating, and who are its target users and customers. This will help you assess if the project's tokenomics aligns with its vision and value proposition, and if it supports its long-term growth and sustainability.

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2. Analyze the token's role and function within the project's ecosystem. 

This means that you should examine how the token is used within the project's platform or network, and what benefits or rights it confers to its holders. You should also consider how the token influences the behavior and decisions of the project's stakeholders and participants, and if it creates positive or negative incentives for them. Some of the questions that you can ask are:

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- What are the main use cases of the token?

- How does the token facilitate transactions, interactions, or collaborations within the project's ecosystem?

- How does the token generate value for its holders, such as income, rewards, discounts, access, governance, etc.?

- How does the token affect the security, scalability, or performance of the project's network or platform?

- How does the token align or misalign the interests of the project's stakeholders, such as developers, users, investors, validators, etc.?

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3. Evaluate the token's supply and distribution model. 

This means that you should look into how the token is created, issued, allocated, and circulated within the project's ecosystem. You should also consider how the token's supply and distribution affect its value and scarcity over time. Some of the questions that you can ask are:

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- What is the total supply of the token? Is it fixed or variable? If variable, what factors determine its change?

- How is the initial supply of the token distributed among the project's stakeholders and participants? Is it fair and transparent? Does it reflect their contribution or involvement in the project?

- How is the ongoing supply of the token distributed among the project's stakeholders and participants? Is it based on merit or participation? Does it reward value creation or value extraction?

- How is the token's circulation controlled or regulated? Are there any mechanisms to prevent inflation or dilution of the token value, such as burning, locking, vesting, etc.?

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4. Review the token's governance and economics model. 

This means that you should understand how the token holders can influence or participate in the decision-making process of the project's development and direction. You should also consider how the token's governance and economics affect its value and utility over time. Some of the questions that you can ask are:

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- What are the rights and responsibilities of the token holders in relation to the project's governance? Can they propose, vote, delegate, veto, etc.? 

- How is the token's governance structured and executed? Is it centralized or decentralized?

- How is the token's economics designed and implemented? Is it based on sound economic principles and models? Does it account for external factors and risks? 

- How does the token's governance and economics adapt to changing conditions and needs? Are there any mechanisms to update or upgrade them over time? 

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These are some of the main aspects that you can consider when evaluating a project's tokenomics. Of course, there may be other factors or nuances that are specific to each project or context. Therefore, you should always do your own research and due diligence before investing in any crypto project or token.

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To illustrate the principles and questions that we discussed in the previous section, let us look at some examples of projects that have good or bad tokenomics, and what we can learn from them.

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Good Tokenomics - Bitcoin (BTC)

Bitcoin is the first and most popular cryptocurrency that was created in 2009 by an anonymous person or group known as Satoshi Nakamoto. Bitcoin is a decentralized peer-to-peer network that allows anyone to send and receive value without intermediaries or censorship. Bitcoin is also a scarce digital asset that has a fixed supply of 21 million coins.

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Bitcoin has a simple but effective tokenomics design that aligns with its vision and value proposition of being a global, open, and sound money. Some of the features of Bitcoin’s tokenomics are:

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The token’s role and function is clear and consistent: 

Bitcoin is primarily used as a store of value, a medium of exchange, and a unit of account within its network and beyond. According to a survey by Statista, 11% of Americans own some form of cryptocurrency, and Bitcoin is the most popular one. According to BitInfoCharts, there are over 40 million Bitcoin addresses that have more than $1 worth of Bitcoin, and over 2 million addresses that have more than $10,000 worth of Bitcoin.

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The token’s supply and distribution is transparent and predictable: 

Bitcoin has a fixed supply of 21 million coins that are created through a process called mining, where validators compete to solve cryptographic puzzles and earn newly minted coins and transaction fees. The mining reward is halved every four years, creating a deflationary pressure that increases the scarcity and value of the coin over time. As of June 2023, there are about 19.4 million Bitcoins in circulation, which means that over 92% of the total supply has already been mined. The next halving event is expected to occur in April 2024, when the mining reward will drop from 6.25 to 3.125 Bitcoins per block.

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The token’s governance and economics is decentralized and resilient: 

Bitcoin does not have a central authority or entity that controls or influences its development or direction. Instead, it relies on a network of nodes, miners, developers, users, and investors who collectively maintain and improve its protocol and software through consensus and coordination. Bitcoin also has a robust economic model that balances the incentives and costs of its participants, such as the difficulty adjustment mechanism that regulates the mining difficulty according to the network’s hash rate. 

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The token’s value and scarcity is determined and influenced by market forces and network effects: 

Bitcoin’s price and market cap are driven by supply and demand, as well as by its adoption, innovation, competition, regulation, etc. As of June 2023, the price of one Bitcoin is about $30,000, and the market cap of Bitcoin is about $590 billion, making it the largest cryptocurrency in the world by far. Bitcoin also benefits from strong network effects, as more users, merchants, institutions, and countries adopt it as a form of money or an asset class, increasing its utility and value. According to BuyBitcoinWorldwide.com, there are over 22,000 Bitcoin ATMs in the world as of June 2023, and over 15,000 merchants that accept Bitcoin as a payment method.

Good Tokenomics - Ethereum (ETH)

Ethereum is a decentralized platform that enables anyone to create and run smart contracts and decentralized applications (DApps) without intermediaries or censorship. Ethereum was launched in 2015 by Vitalik Buterin and other co-founders. Ethereum also has a native digital asset that fuels its network and ecosystem.

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Ethereum has a complex but innovative tokenomics design that aligns with its vision and value proposition of being a global, open, and programmable platform for web3. Some of the features of Ethereum’s tokenomics are:

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The token’s role and function is versatile and multifaceted: 

Ethereum’s native digital asset is called ether (ETH), which is used as a gas fee for executing transactions and smart contracts on its network, as well as for accessing services or features on its DApps. Gas fees are paid in ether (ETH). Gas prices are denoted in gwei, which itself is a denomination of ETH - each gwei is equal to 0.000000001 ETH (10−9 ETH). Ether (ETH) is also used as a governance token for influencing or participating in the decision-making process of its protocol or ecosystem. For example, ETH holders can vote on proposals for improving the network or allocating funds from the treasury. Ether (ETH) is also used as a store of value, a medium of exchange, and a unit of account within its network and beyond. According to Etherscan, there are over 200 million ETH transfers per day, with an average fee of $2.43 and an average value of $1,000. According to CoinGecko, there are over 4,000 DApps built on Ethereum, with over 100 million users and over $100 billion in total value locked.

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The token’s supply and distribution is dynamic and adaptive: 

Ethereum does not have a fixed supply limit like Bitcoin, but rather has a variable supply that changes according to its monetary policy and network activity. Ethereum’s supply is mainly determined by two factors: the issuance rate of new coins through staking, which rewards validators for securing the network; and the burn rate of existing coins through fees or upgrades, which reduces the inflation or dilution of the coin value. Ethereum’s supply also depends on other factors such as forks, hacks, lost coins, etc. As of June 2023, there are about 122 million ETH in circulation, which means that about 58% of the total supply has already been issued. 

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The issuance rate of ETH has decreased significantly since September 2022 after the Merge, which switched the consensus mechanism from proof-of-work to proof-of-stake. The burn rate of ETH has increased since August 2021 after the implementation of EIP-1559, which introduces a base fee that is burned for every transaction.

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The total supply of ETH can be calculated by adding the initial supply at genesis (72 million ETH), the staking rewards (variable depending on participation), and subtracting the burned fees (variable depending on network activity). The formula can be written as:

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Total Supply = Genesis Supply + (Block Rewards + Uncle Rewards) + Staking Rewards − Burned Fees

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The circulating supply of ETH can be calculated by subtracting the non-circulating supply from the total supply. The non-circulating supply includes the staked ETH on the Beacon Chain (about 8 million ETH), the lost or inaccessible ETH (estimated at about 3 million ETH), and any other locked or frozen ETH due to various reasons. The formula can be written as:

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Circulating Supply = Total Supply − Non-Circulating Supply

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The token’s governance and economics is decentralized and progressive: 

Ethereum does not have a central authority or entity that controls or influences its development or direction. Instead, it relies on a network of nodes, validators, developers, users, and investors who collectively maintain and improve its protocol and software through consensus and coordination. Ethereum also has a progressive economic model that adapts to changing conditions and needs, such as the switch from proof-of-work to proof-of-stake consensus mechanism, which aims to improve the security, scalability, and efficiency of the network. As of June 2023, there are over 8 million ETH staked on the Beacon Chain, which is the backbone of the proof-of-stake system. The stakers earn an annualized reward of about 6%, while securing the network from attacks.

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The token’s value and scarcity is determined and influenced by market forces and network effects: 

Ethereum’s price and market cap are driven by supply and demand, as well as by its adoption, innovation, competition, regulation, etc. As of June 2023, the price of one ETH is about $1,800, and the market cap of Ethereum is about $220 billion, making it the second largest cryptocurrency in the world by far. Ethereum also benefits from strong network effects, as more users, developers,DApps,and tokens use its platform and ecosystem, increasing its utility and value. According to CoinGecko, there are over 10,000 tokens built on Ethereum, with over $300 billion in total market cap.

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Bad tokenomics - SafeMoon (SAFEMOON) 

SafeMoon is a cryptocurrency that claims to be “a human-focused technology and innovation business expanding blockchain technologies for a brighter tomorrow.” SafeMoon has a staggering supply of 777 trillion tokens, which requires a careful and thoughtful tokenomics design. However, SafeMoon has poorly designed or executed tokenomics that can have negative consequences for the project and its token. Some of the features of SafeMoon’s tokenomics are:

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The token’s role and function is unclear and inconsistent: 

SafeMoon does not have a clear use case or function within its network or ecosystem. It is mainly used as a speculative asset that relies on hype and marketing to attract investors. SafeMoon does not provide any benefits or rights to its holders or users, except for the promise of passive income through its reflection mechanism. According to CoinGecko, SafeMoon has no active DApps, no partnerships, no roadmap, and no whitepaper.

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The token’s supply and distribution is opaque and unpredictable: 

SafeMoon has a variable supply that changes according to its monetary policy and network activity. SafeMoon’s supply is mainly determined by two factors: the burn rate of existing coins through fees or upgrades, which reduces the inflation or dilution of the coin value; and the reflection rate of new coins through fees or rewards, which increases the income or dividends of the coin holders. However, SafeMoon does not disclose or explain how these factors are calculated or adjusted over time, creating uncertainty and confusion for investors. According to Etherscan, SafeMoon has burned about 192 trillion tokens (25% of the total supply) since its launch in March 2021, but it is unclear how much more will be burned in the future.

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The token’s governance and economics is centralized and flawed: 

SafeMoon has a central authority or entity that controls or influences its development or direction. The project is led by a team of anonymous or inexperienced founders, who have been accused of fraud, scams, or mismanagement. SafeMoon also has a flawed economic model that creates negative incentives and costs for its participants,such as the 10% transaction fee that discourages trading or liquidity, or the reflection mechanism that encourages hoarding or dumping. According to BscScan, SafeMoon has about 2.8 million holders, but only about 100,000 transfers per day, indicating low activity and high friction.

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The token’s value and scarcity is determined and influenced by market forces and network effects: 

SafeMoon’s price and market cap are driven by supply and demand, as well as by its adoption, innovation, competition, regulation, etc. However, SafeMoon does not benefit from strong network effects, as it does not have a loyal or engaged community, a useful or innovative platform, or a competitive or sustainable edge. According to CoinMarketCap, SafeMoon’s price has dropped by over 90% since its all-time high in April 2021, and its market cap has fallen from over $6 billion to less than $1 billion.

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Bad tokenomics - Bitconnect (BCC) 

Bitconnect was a cryptocurrency and lending platform that promised to generate high returns for its investors through its trading bot and volatility software. Bitconnect was launched in 2016 by an anonymous person or group. Bitconnect was also a Ponzi scheme that collapsed in 2018 after being exposed by regulators and influencers.

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Bitconnect had a deceptive and fraudulent tokenomics design that did not align with its vision and value proposition of being a transparent, secure, and profitable platform for web3. Some of the features of Bitconnect’s tokenomics were:

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The token’s role and function was deceptive and fraudulent: 

Bitconnect was used as a tool to lure investors into its lending platform, where they had to exchange their Bitcoin for Bitconnect tokens, and then lock them up for a certain period of time to earn interest. Bitconnect did not provide any benefits or rights to its holders or users, except for the promise of high returns through its trading bot and volatility software, which were never proven or verified. According to CoinMarketCap, Bitconnect had no active DApps, no partnerships, no roadmap, and no whitepaper.

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The token’s supply and distribution was opaque and manipulative: 

Bitconnect had a variable supply that changed according to its monetary policy and network activity. Bitconnect’s supply was mainly determined by two factors: the issuance rate of new coins through mining or staking, which rewarded validators for securing the network; and the burn rate of existing coins through fees or upgrades, which reduced the inflation or dilution of the coin value. However, Bitconnect did not disclose or explain how these factors were calculated or adjusted over time, creating uncertainty and confusion for investors. Moreover, Bitconnect manipulated its supply and distribution to create artificial scarcity and demand for its token, such as by limiting the availability of its tokens on its own exchange, or by inflating its price through market making or wash trading. According to CoinMarketCap, Bitconnect had a total supply of 28 million tokens, but only 9.6 million tokens were in circulation.

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The token’s governance and economics was centralized and corrupt: 

Bitconnect had a central authority or entity that controlled or influenced its development or direction. The project was led by a team of anonymous or untrustworthy founders, who were later sued or arrested for fraud, scams, or money laundering. Bitconnect also had a corrupt economic model that created negative incentives and costs for its participants,such as the lending scheme that exploited investors’ greed or fear, or the referral system that incentivized promoters to recruit more victims. According to CoinMarketCap, Bitconnect had about 1.5 million holders, but most of them lost their money when the platform shut down.

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The token’s value and scarcity was determined and influenced by market forces and network effects: 

Bitconnect’s price and market cap were driven by supply and demand, as well as by its adoption, innovation, competition, regulation, etc. However, Bitconnect did not benefit from strong network effects, as it did not have a loyal or engaged community, a useful or innovative platform, or a competitive or sustainable edge. Instead, Bitconnect’s value and scarcity were based on hype and deception, which collapsed when the truth was revealed. According to CoinMarketCap, Bitconnect’s price peaked at over $500 in January 2018, but dropped to less than $1 in February 2018.

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Conclusion 

Tokenomics is a complex and fascinating topic that deserves more attention and exploration in crypto space. It can make or break a project and its token value and sustainability.

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In this article, we have tried to give you a brief introduction to what tokenomics are and why they matter. We have also discussed some of the principles and questions that you can use to evaluate a project’s tokenomics and decide if it is good or not. Finally, we have looked at some examples of projects that have good or bad tokenomics, and what we can learn from them.

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We hope that this article has helped you gain a better understanding and appreciation of tokenomics, and that it has inspired you to do more research and analysis on this topic. You should always do your own research and due diligence before investing in any crypto project or token.