Tokenomics 101: Understanding What Makes Cryptocurrency A Good Investment
Updated: Sep 16, 2022
What is the secret behind the success of some cryptocurrency projects? Why are some tokens priced so low when others are so high? How do you decide if a token has value or not? These are the investors' most common questions before diving into crypto. This article will cover the basics of tokenomics and how it can help you make informed decisions when investing in new blockchain projects.
What is Tokenomics?
Tokenomics is a new concept that has emerged with the age of cryptocurrency. It refers to the study of economics and the game theory of cryptocurrencies. The token, also known as cryptocurrency, is the core value holder within a blockchain network to transact value between users. Transferring value can include paying for services or products or staking the token to run a node. These computer nodes secure and validate transactions for the blockchain network. Staking, similar certificates of deposit, returns the interest to a user for "staking" or removing that currency from circulation for a fixed period. The goal of tokenomics is to create a new type of economics that will be more inclusive, transparent, and decentralized.
The cryptocurrency market is highly speculative, so investors need to understand how tokens work before they invest in them. Some factors to consider when gauging the potential future value of a cryptocurrency are what the token does, who created it, the token use cases, and its value proposition. The quality and success of a new cryptocurrency depend on what its Tokenomics are.
How Does Tokenomics Work?
Tokenomics measures the relationship between the token and the project's success. It measures the demand for the token, the supply of the token, utility of the token, and other factors in determining the project's long-term viability. Typically with increased token demand, projects grow in value. Similarly, the price usually increases if the token supply is limited and the demand exceeds the supply.
Why is Tokenomics Important?
Tokenomics is vital because it can help you determine if a token has value or not. If the token has a high utility, and if the token is scarce, it has value. The amount of value depends on the relationship between the token's demand, supply, and adoption. Creators define tokenomics when constructing their blockchains. These rules govern how much is in the cryptocurrency supply, the mining reward, and what consensus mechanism the blockchain utilizes. There are many tokenomics factors to consider when evaluating a cryptocurrency's potential investment value. Now let's take a look at the basic tokenomics concepts.
The Basics of Understanding Tokenomics
Token Utility: The token utility is the reason for its existence. The best tokens have a clear and specific utility on the network; they are essential in the network's operation.
Network Utility: The network utility relates to the token's value within the network. With higher token usage within the network, the higher the network utility will be.
Network Adoption: Network adoption is the rate at which people use a token. The higher the token adoption by the public, the higher the token and network utility will be.
Retained Token Value: Token value is directly related to the token price, supply, and demand. The higher the token price, the greater the token value.
4 Types of Cryptocurrency Tokens
Tokens fall under various classifications, but this article will focus on four broad categories: Transactional & Payment Cryptocurrency, Platform & Infrastructure Cryptocurrency, Security Tokens, and Utility Tokens.
Transactional & Payment Cryptocurrencies
As the name suggests, these assets are mainly for payments. For example, you could use payment currencies to pay for goods or services or bills or trade digital currencies for local fiat currencies like the US dollar. Apart from payments, these cryptocurrencies are limited in functionality. The most famous example is Bitcoin (BTC), but others include Litecoin and USD Coin (USDC).
Platform & Infrastructure Cryptocurrencies
Specific blockchain infrastructure and platforms require payment for computing resources to run programs on a shared blockchain network. These computing resources require Platform & Infrastructure cryptocurrencies as payment. For example, the Ethereum blockchain runs using the cryptocurrency Ether (ETH). The Ethereum blockchain infrastructure allows users to create and use decentralized applications. Other examples include Binance Coin (BNB), Cardano (ADA), and Cronos (CRO).
These are backed by a physical asset and represent ownership in that asset. For example, shares in a company or gold bullion are considered examples of securities. Security tokens often intend to help their holders gain access to an investment opportunity (e.g., equity) or earn income related to the underlying asset. Security tokens are subject to federal securities regulations. Security tokens provide a secure and scalable method to hold an investment that may be difficult to keep in large quantities physically. One example is Pax Gold (PAXG), a digital token backed by one fine troy ounce (t oz) of physical gold stored in Brink's vaults.
These grant token holders access a company's product or service without intrinsic value outside that company's ecosystem. They can be used as a means of payment in that ecosystem or traded on secondary markets like exchanges if they are publicly tradable. Basic Attention Token (BAT) is an example of a utility token that rewards users and advertisers when utilizing the brave browser.
What Makes a Good Cryptocurrency Investment?
Good cryptocurrency investments depend on useful utility, functional network utility, mass network adoption, high retained token value, and limited token supply, causing scarcity.
One example of a good cryptocurrency investment is a utility token with multiple use cases. If a utility token has a wide array of use cases, the Metcalf Ratio will be higher. (The Metcalfe Ratio measures the relative value of a network based on the number of connections in a system.)The higher the ratio, the more valuable the network becomes.
Utility tokens can purchase goods and services and incentivize network participation and voting rights in specific applications. Utility tokens have the potential to become one of the most important financial instruments ever created. They have highly flexible and scalable use case applications, not just within the company issuing them but across the entire blockchain network and beyond.
Investing in the right crypto project can be difficult. Understanding the tokenomics of the coin is essential to know whether the project has potential future value or not. Typically, tokens are the gas used to power a blockchain network engine. Understanding the nature of tokenomics helps you to grasp how digital currency works and its underlying values. The next time you're looking to invest in a new crypto project, make sure to understand the tokenomics and rules that govern that blockchain network.
Do you think tokenomics will help you make an informed decision on your next crypto investment? Share your thoughts below in the comments.
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