The Importance of Tokenomics to Investors

2022-07-18, 02:18

One key aspect of investment is to anticipate the future value of a digital asset and its potential for growth. In order for an individual to predict the future value of a token, he/she needs to understand the variables that affect its price. And of course, an essential determinant of the price of a cryptocurrency is its demand and supply. For example, investors hold a cryptocurrency only if they anticipate its price to increase in the future, whether in the short run or the long run. It is also vital for the users of a digital asset to understand its policy framework which is similar to a fiat currency’s monetary policy. These concepts are the fundamental components of the tokenomics of a cryptocurrency. In this article, we discuss the importance of tokenomics and the factors that influence the market behaviour of a token.

What is a token?

A token is a digital unit which performs a specific function and maintains a certain value within a period of time. Usually, tokens have many uses which include being units of payment within certain platforms or applications, investment assets or means of conferring some rights such as participating in the decision making process to community members. We can classify tokens in different ways, which we shall discuss briefly.

Source: Coindesk

Fungible and non-fungible tokens

Fungible tokens are digital cryptographic units which have the same value and can be replicated or interchanged. Cryptocurrencies are examples of fungible tokens. What this means is that we can exchange the tokens because they have the same value or price and we cannot differentiate one from another. As a specific example, two bitcoins are exactly the same and perform similar functions.

Non-fungible tokens, on the other hand, are unique digital assets which represent ownership of a store of value. In other words, a non-fungible is a proof of ownership of a specific asset. In light of this, you cannot interchange non-fungible tokens (NFTs).

Utility and security

We can also classify tokens as assets or security. Utility tokens are the tokens that give their holders special rights, privileges and preferential treatment. They can also function as means of payment for products and services within a crypto economy. For instance, BAT is a utility token used when advertising products and services.

Security tokens represent a stake in the project. In other words, they represent long term investment in a certain cryptocurrency. For example, they grant the holder the right to have a say in what happens in the project or organization.

Source: Investopedia

Tokenomics

Now that we understand the types of tokens let’s discuss what tokenomics entails. Tokenomics is the study of how tokens or cryptocurrencies work, their purposes and the factors that determine their values. Therefore, tokenomics involves the study of the determinants of market values of cryptocurrencies or other digital assets.

The other way to better understand tokenomics is to focus on the root of the word. It is a combination of two words, token and economics. In a more general sense, economics is the study of the demand and supply of an asset and the factors which influence its price.

Factors that determine the values of cryptocurrencies or tokens

The price or value of a token is at the centre of tokenomics. Mostly, investors study the behaviour of a token in order to predict its value both in the short-run and the long term. The reason is that investors are concerned about the return on their investment, something which depends on the price of the token or asset. The determinants of the value of a token include its demand and supply.

Supply of the token

Investors should understand circulating supply, total supply and maximum supply of a cryptocurrency. Circulating supply refers to the number of coins or tokens which are in the market and available for trade. Maximum supply means the total quantity of a specific token or cryptocurrency that will ever exist. Total supply refers to the quantity of a token that exists at the moment, whether in circulation or are locked in smart contracts. Most crypto projects gradually increase the quantity of tokens in circulation in order to maintain stable prices. This is because the supply of a digital asset is one key determinant of its value.

Demand of the token

The price of a cryptocurrency depends on its demand and supply. Demand relates to the level of interest the market has on a cryptocurrency. If the demand for a token is higher than its supply its price will rise. In contrast, if the supply of a token is greater than the demand its price will fall.

Market capitalization

A cryptocurrency’s market capitalization influences its level of investment. This is because the size of the market cap determines its popularity. Many investors like to invest in cryptocurrencies which have high market capitalization. Generally, the higher the market capitalization of a token the more stable its price and vice versa. However, a low market cap may indicate that the project has the potential to expand and improve.

The token’s model

Another vital component of tokenomics is its model. Some cryptocurrencies are inflationary while others are deflationary. A token is inflationary when it does not have a maximum supply. This is the case with ethereum; it has no known maximum supply. On the other hand, a deflationary cryptocurrency has a known maximum supply. For example, the maximum supply of bitcoin is 21 million. Some projects burn their tokens in order to increase their prices. Burning simply means taking a certain quantity of a token from circulation.

Token distribution

The distribution or allocation of a token can influence its value and the level of investment. Distribution or allocation refers to the proportions which the key stakeholders of a project are entitled to own. Some projects allocate tokens to developers, marketing departments, community rewards and investors, among others. The best distribution of a token awards a small proportion to internal investors and leaves a greater share to external investors.

Tokens and governance issues

Decentralized autonomous organizations give token holders the right to make decisions through voting and making development proposals. This ensures that the decisions made are in the best interest of the community and the investors.

Source: soccerspen

Staking and utility

Staking tokens reduces the circulating supply and most likely increases its value. Nevertheless, in most cases the tokens are staked for a period of time.

Conclusion

In simple terms, tokenomics is the economics of tokens. It covers factors that influence the supply and demand of the token such as burning, allocation, yield and model, among others. The levels of supply and demand determine the price of the token. The rise in demand while supply remains constant results in a price increase. On the other hand, if the supply of the token increases by a greater margin than the demand, the price will fall.

Author: Gate.io Observer: Mashell C.

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