Crypto Tokenomics: What Drives Cryptocurrency Value?

Crypto tokenomics is a somewhat complex topic, but don't worry, this blog will break down the basics that everyone should understand before diving into the crypto space.

What is a Token?

A token is a digital asset that’s issued and managed on a blockchain. While people often use “token” and “cryptocurrency” interchangeably, there's a difference. 

Cryptocurrencies (like Bitcoin and Ethereum) are actually "coins" with their own blockchains, generally used like fiat currency to buy, sell, or store value. 

Tokens, on the other hand, are built on existing blockchains (like Ethereum) to improve the functionalities of the blockchain. Check my blog “What are Cryptocurrencies” for further understanding.

Tokenomics encompasses the economic model of both coins and tokens, analyzing factors like supply, demand, and utility to understand their long-term value and market potential.

Understanding Cryptocurrency Tokenomics

Tokenomics is a portmanteau of 'token' and 'economics.' It refers to the economic model of a cryptocurrency, focusing on how its supply, demand, utility and distribution impact its price and long-term value. To put it simply, Tokonemics is all about the factors that are involved in determining the price of a cryptocurrency and its long-term value. 

Simple Analogy to Understand Crypto Tokenomics

Let’s take a Sneaker company that produces sneakers. Now, let’s explore three different scenarios:

The company produces only 1000 pairs of sneakers for the public with special features (like access to exclusive events and discounts). The scarcity and high utility of these sneakers will create high demand, driving up their price in the market.

The company produces many pairs of sneakers, but they have no real utility or special value. With low demand, the price falls, and the company may struggle to maintain interest in the product.

The company produces many pairs of sneakers with high utility and expands its distribution internationally. Even with a larger supply, strong demand keeps the price stable or even increases the prices over time.

Likewise, Tokenomics in Cryptocurrency is the management of supply, demand, distribution and utility, so that specific cryptocurrency can sustain and gain value over time and compete with other cryptocurrency projects. 

Nice! Now let's understand how supply is categorized in any cryptocurrency to get a better idea about the supply side of a crypto.

Components of Tokenomics

Supply of the Token

Max Supply:

• Max Supply is the total number of tokens that will ever exist.
• Once set, it typically cannot easily be changed (e.g., Bitcoin's max supply is 21 million coins).

Total Supply:

• This includes all the tokens that have been created so far
• Includes tokens that are locked or not yet circulating.
• Example: A project with a total supply of 10 million tokens means 
• 10 million tokens exist, but some may be locked, to be released in the future.

Circulating Supply:

• The number of tokens currently available for trading in the market.
• Excludes locked or restricted tokens.
• Example: If a project has 5 million tokens in circulating supply, those are the tokens actively available for buying and selling.

For example, if we take a crypto project with:

• Max Supply: 10 million tokens (the total number that will ever exist).
• Total Supply: 7 million tokens (created so far).
• Circulating Supply: 5 million tokens (actively available for trading).

This breakdown means:

• 2 million tokens are currently locked and not yet available in the market.
• 3 million tokens (10 million - 7 million) are not yet created.

Let's look at a very simple analogy to understand this one as well. 

Imagine a toy company is releasing a limited edition of 10,000 toys.

• Max Supply: 10,000 toys, the most they’ll ever produce.
• Total Supply: So far, 7,000 toys have been made. This includes toys on shelves and those still in storage.
• Circulating Supply: Out of those, 5,000 toys are on store shelves and ready to buy.

In this setup, 2,000 toys are still in storage (like locked tokens), and 3,000 toys haven’t been made yet - similar to uncreated tokens in a crypto project.

Perfecto!! Now that you have got a solid foundation about Max supply, Total Supply and Circulating supply, let's talk about how these things relate to a key concept called Market Capitalization.

Understanding Market Capitalization

• Market Capitalization (Market Cap): Measures the total value of a cryptocurrency.
• Formula: Market Cap = Price of One Token × Circulating Supply
• For example, if a cryptocurrency has 5 million tokens in circulation, and each is worth $2, then:
• Market Cap = 5,000,000 × $2 = $10,000,000 ($10 million) What does this mean? This means that one 10 million is in circulation among buyers and sellers for that Crypto. It's that simple!

Where to Find Tokenomics Information?

• Cryptocurrency Project’s White Paper

• Cryptocurrency tracking sites - CoinMarketCap and CoinGecko show the max, total, circulating supply and market cap of most cryptocurrencies

Having a good understanding of these concepts is really important in this space because it helps you avoid falling for the lies or hype spread by others who might try to lure you in for their own advantage.

For example, if a YouTube influencer claims that a particular cryptocurrency is likely to increase in price from $5 to $100 within the next three months, you can analyze how realistic this target is by looking at the circulating supply and market cap.

Let’s say we have a cryptocurrency called Troy. The circulating supply of Troy tokens is 10 million, and the price of one Troy is $5, giving it a current market cap of $5 x 10 million = $50 million.

According to the YouTuber, the price is expected to rise to $100 within three months. For this to happen, we would need an additional $950 million flowing into Troy within this timeframe.

How did I get that number? First, calculate the market cap needed for a $100 price by multiplying it by the 10 million tokens in circulation. 

Then, subtract the difference between the old market cap and the new one, or just get the price difference and multiply it by the 10 million circulating supply.

So now, you can ask yourself, considering other factors too, whether an additional $950 million within 3 months is realistic. At first, a price jump from $5 to $100 might seem possible, but when we dig a little deeper, tokenomics helps us avoid blindly trusting anyone’s opinions.

Distribution

Distribution in cryptocurrency is all about how tokens (cryptocurrencies) are released, spread out or shared in the market. 

Developers of the Cryptocurrency use something called Vesting schedules, these schedules release the tokens into the market in a controlled way to achieve price stability and avoid any sell offs or sudden price dumps.

Websites like DropsTab and cryptorank provide information about tokens locked, token release timelines etc., so that anyone can know any major token release in advance. 

Utility of the Token

Utility refers to the purpose that a cryptocurrency serves within its ecosystem. A cryptocurrency that does not have a clear utility or a purpose can be considered as a bad utility while a crypto that adds genuine value and function can be considered as a good utility. 

Ethereum has a clear utility - Provides a platform for building and running smart contracts and decentralized applications (dApps).

LINK has a clear utility - Provides real world data to smart contracts, making smart contracts very valuable in DeFi platforms and various other applications. 

XRP has clear utility - Facilitate international cross border payments within a matter of seconds by collaborating with major banks. 

There are many Cryptocurrency projects who provide real value in this space. It is up to you to DYOR (Do Your Own Research) and find good utility Cryptocurrencies.

Demand for the Token

Demand for a Cryptocurrency can be determined by strategic, technical and marketing factors. 

Strategic - If a Crypto project has a clear utility and strong partnerships, these factors can enhance, trust, demand and attractiveness of that particular Cryptocurrency ultimately improving the liquidity of the cryptocurrency.

For example, LINK has partnerships with several DeFi platforms, Google Cloud, Amazon Web Services (AWS), ANZ banking group, etc. Not to mention XRP, which has partnerships with over 1000 banks and financial institutions.  

Technical - Security, scalability, interoperability, transaction speed and cost, decentralization, all play a vital role in creating demand for a particular Crypto.

For example, Solana (SOL) holds the title as the fastest large scale blockchain with a theoretical speed of processing 65,000 TPS (Transactions Per Second). 

Marketing - Influence endorsements and media coverage, direct community engagement through platforms X, Reddit and Discord, Innovative campaigns and Airdrops, marketing huge partnerships, all these activities help to attract early adopters to a crypto project and sustain its interest overtime. 

Final Thoughts

Cryptocurrency Tokenomics is a wide topic, and while there are concepts not covered in this blog, when you boil it down, tokenomics involves all the activities that impact the supply and demand for a specific cryptocurrency in the market, which ultimately determine its price, both in the short term and long term.

Tokenomics doesn’t guarantee success, but it gives a clearer picture of what might drive a token’s price. And with crypto, making informed decisions is always your best tool. So, always do your own research when you invest.

"If you’ve been reading this whole blog to this very final line, I wish you nothing but the very best. May you prosper financially and be a blessing to everyone around you." 

Disclaimer: The contents of this article are for informational purposes only and are not financial advice. The views here are just the author’s opinions. The crypto market is volatile, so be sure to do your own research before investing.