What is Tokenomics? A face-up game of cards with Market Makers

What is Tokenomics?

The term Tokenomics consists of two words: Token and Economics. Therefore, the word Tokenomics can be defined as the tokenized version of economics, or how crypto tokens can be developed and applied to the economy of a project.

Why does Tokenomics matter?

Before answering this question, let’s go through a small quiz together.

Take a look at the picture below and imagine the crypto market as a game of cards. There are many players in that game, such as:

• Developer: Andre Cronje, Vitalik Buterin...?
• Market Maker: CZ Binance, Sam FTX...?
• Major Venture Capitals: a16z, Multicoin, ParaFi...?
• Retail Investors: Most of us (including me).

So, who is the closest to the table? Who controls the game? In the picture, if even Justin Sun cannot approach the game, then retail investors like us are just spectators who are waiting for the result.

In fact, that turns out to be the truth: We are playing the game created by Market Makers, Builders/Developers and top Venture Capitals. From the ICO/IEO/IDO trend to the NFT, GameFi trend across multiple blockchains and ecosystems.

The next question is, how can they control the game? The answer is token. Token is the product that investors can use to trade and put faith in. However, tokens are also made by reputable Developers, Builders, and Market Makers. As we all know, the crypto market is a Zero-sum game, and surely everyone wants to gain profit.

Then who will lose money?

In order to make money and understand what Market Makers are doing, you have to understand how a token operates, or in other words, you have to understand the Tokenomics.

Let’s continue to find out the way big names operate the Tokenomics.

The components of a Tokenomics

Coin/Token Supply

Before, Total Supply and Circulating Supply are the two frequently used definitions. Nevertheless, both Coingecko and CoinMarketCap have recently complemented a new term: Max Supply, which is rather confusing.

I will explain further with visual illustrations so that you comprehend these phrases more easily.

1. Total Supply is defined as the total number of the circulating tokens plus the locked tokens, minus the burned tokens. The Total Supply is initially determined by the developer team so that it can suit the project perfectly.

To be more specific, there are 2 types of Total Supply:

Fixed Total Supply: The Total Supply is predetermined and cannot be changed. For example: The Total Supply of Bitcoin is 21 million BTC, the Total Supply of Uniswap is 1 Billion UNI...

Unfixed Total Supply: The Total Supply can be changed depending on the project features, which can be further divided into:

• The Total Supply increases due to mining. For example: ETH tokens are mined corresponding to the Ethereum Network’s performance, or CAKE tokens are minted when users participate in Farming activities on Pancakeswap...
• The Total Supply decreases due to burning. For example: The initial Total Supply of Binance Coin was 200 million BNB, which has been burned to 100 million BNB over time...
• The Total Supply constantly changes due to the Mint and Burn model. For example: The Total Supply of stablecoins, such as Algorithmic Stablecoin (FEI, AMPL...), Crypto-backed Stablecoin (DAI,VAI...), Centralized Stablecoin (USDT, USDC...).

2. Circulating Supply is defined as the total number of tradable tokens circulating in the market.

3. Max Supply is defined as the total number of tokens that can possibly be reached in the future.

4. Analyze Token Supply

Here are the Token Supply metrics of 3 different coins/tokens:

• ETH: The Ethereum token has no Max Supply and will only be minted when there exists the demand of using the Ethereum Network. After being minted, ETH will circulate without being locked by any parties (Circulating Supply = Total Supply).
• SRM: Serum was designed with the Max Supply of 10 Billion SRM. At the moment, the number of SRM can only reach 161 million SRM (Total Supply), however, only 50 million SRM are currently circulating in the market (Circulating Supply).
• NEAR: The Token Supply of Near Protocol is the most basic and most frequently seen. Initially, the Max Supply = the Total Supply and NEAR tokens will be unlocked until the 1 Billion NEAR is reached (Circulating Supply).

Market Cap & Fully Diluted Valuation

Market Cap is the total market value of a project relative to its token’s Circulating Supply. We can calculate the Market Cap with the Circulating Supply by applying the formula:

Market Cap = Circulating Supply * Token Price

Fully Diluted Valuation (FDV) is the total market value of a project relative to its token’s Total Supply. We can calculate the FDV with the Total Supply by applying the formula:

FDV = Total Supply * Token Price

Why is Market Cap more important than Price?

Currently, the price of a token depends on various factors. Besides Fundamental Analysis, it also depends on the Circulating Supply of that token. For instance, considering a token A with a $10,000,000 Market Cap:

• If the Circulating Supply is 10,000,000 A token => 1 A token = $1.
• If the Circulating Supply is 10,000,000,000 A token => 1 A token = $0.001.

The number of circulating tokens can range from thousands to billions, but the Market Cap is arguably the key factor to have a direct effect on the growth of a token or project.

For example: In the case of Aave and Compound, by using Fundamental Analysis, we can assume that both projects have equal potential in the Lending sector. As a result, the Market Cap of Compound can possibly reach that of Aave.

In terms of their price, one COMP token is worth more than one AAVE token. However, COMP has a higher growth potential as the Market Cap of Compound is lower than Aave. If the Market Cap of the two becomes equal, the price of a COMP token will reach $735.

Token Governance

At the moment, there are more than 10,000 coins and tokens. Nonetheless, not every token follows the Decentralized model as Bitcoin, and there will be a number of tokens/coins that are governed by the Centralized model. I will filter the tokens into 3 basic types:

Decentralized: Decentralized tokens are completely governed by the community and do not attach to any organizations. For example: Bitcoin, Ethereum...

Centralized: Centralized tokens are governed by a leading organization who have full control over the token metrics and its underlying project. Usually, this is the case of Full-backed stablecoin projects such as Tether, TrueUSDm... or Centralized Exchanges such as Huobi, Binance...

From Centralized to Decentralized: There are still some coins/tokens that were originally centralized, but their governance power was later delegated to the community.

For example: At first, Binance Coin was totally governed by Binance. However, a while after the launch of Binance Smart Chain and the “Validator Spotlight” program, Binance gradually decentralized the BSC network and the BNB token, which gave users the governance rights.

Token Allocation

Before investing in any token, it is imperative that you look over its Token Allocation - an important metric that shows you how the tokens are distributed among Stakeholders, whether that distribution is reasonable, and how it can influence the project.

1. Team

This is the allocation reserved for the project’s developer team, which includes constructive contributors like founders, developers, marketers, advisors... An ideal portion would be about 20% of the Total Supply.

• If the allocation is too small, the team will have no motivation to develop the project in the long run.
• If the allocation is too huge, the community will have no motivation to hold the tokens since they are overwhelmingly manipulated by one party. The team will have the full ability to govern the protocol in a centralized manner, or navigate the token’s price at their will.

2. Foundation Reserve

This reserve will be used to develop the project or its products in the future. There is no specific standard for this part, which normally accounts for 20-40% of the Total Supply.

3. Liquidity Mining

The allocation for Liquidity Mining has appeared a lot recently, especially since the tremendous DeFi trend from September 2020. The tokens allocated for this section are minted as incentives for Liquidity Providers across multiple DeFi protocols.

4. Seed Sale/Private Sale/Public Sale

The tokens saved for this portion are used in fundraising events, which commonly comprise the Seed sale, the Private Sale, and the Public Sale.

5. Airdrop/Retroactive

In order to attract early adopters, projects often airdrop a small number of tokens (usually 1-2% of the Total Supply) to users.

Before 2019, the requirements to participate in an Airdrop were just simple actions such as Like, Follow, Retweet the project’s posts on Twitter.

Nevertheless, since 2020, partaking in an Airdrop has required much harder objectives, forcing users to “skin in the game”, directly use and interact with the products to receive Airdrop or Retroactive rewards. Some well-known cases can be listed as Uniswap (UNI), 1inch Network (1INCH)...

6. Other Allocation

This allocation can be flexibly adjusted depending on each project, and whether it is used for Marketing, Strategic Partnership, or any other expenses. Naturally, this portion only accounts for a small percentage of the Total Supply.

We can notice the difference between 2 different periods:

• 2017 - 2018: Publics Sale accounts for more than 50%, Insiders accounts for less. For instance: ADA, ETH, XTZ, ATOM...
• From 2019: Public Sale accounts for 20-30%, Insiders accounts for the highest portion. For instance: NEAR, AVAX, SOL...

Whereas:

• The Public Sale allocation is exposed to the community.
• The Insiders allocation is exposed only to the team, backers...

The reason behind this is that the token of a project used to have less use cases and the developer team needed a fund to start with.

But now, the crypto market has witnessed the appearances of numerous venture capitals and the tokens have been available on different blockchain platforms, which explains why the Insiders and the Foundation now hold the majority of the tokens.

Token Release

Token Release is the plan to distribute the tokens into circulation. Similar to Token Allocation, Token Release has a huge impact on the token’s price as well as the community’s motivation to hold the tokens. There are 2 types of Token Release at the moment:

1. Release tokens on schedule

Although the Token Release schedule varies between different protocols, it can be split into 3 types:

Under 1 year: Projects releasing 100% tokens in 1 year or less show that their developers and team are not dedicated, and they are not willing to create any long-term value for the project.

From 3 - 5 years: This is an ideal timeframe to fully release the tokens, as the crypto market is changing at a rapid pace. Counted from 2017 - the time when it started to be “Mainstream”, the crypto market is now only 5 years old.

After each year, the market has eliminated a variety of inefficient projects, at the same time  maintaining the productive ones. That is why 3-5 years is such a perfect number, as it stimulates not only the team’s motivation to grow, but also the community’s motivation to continuingly support the project.

Over 10 years: Except Bitcoin, every project that produces a 10 year or more Token Release schedule will have difficulty in motivating either developers or holders, since they have to undergo the token’s inflation for over 10 years. It is uncertain that the team can productively grow the project for such a long time.

To conclude, the Token Release needs to be designed in a way that satisfies 2 core elements:

• The benefits of token holders.
• The tokens’ value when they are released (inflation).

If the tokens are released faster than the product’s work rate, their price will decline due to inflation and token holders will lose interest.

2. Release tokens on demand

To deal with the possible inflation, some projects decide to release tokens on a flexible standard instead of a specific timeframe. This will help the projects make necessary adjustments according to the situation.

For example: MakerDAO does not have a specific Token Release schedule. Depending on the practical demand on the platform, the number of MKR tokens will be modified reasonably such that MKR tokens are only released when there are Lending/Borrowing activities.

Token Sale

Token Sale can be considered similar to the fundraising events in traditional markets, whereas companies raise funds by selling their shares. In the crypto market, the shares will be replaced with tokens.

While traditional companies usually hold 5 fundraising rounds, crypto projects only have 3. The business valuation can vary between disparate sectors, areas and scales. However, it is a common belief that in the Series C, promising companies can be valued at more than $100 million.

• Traditional Companies: Pre-seed, Seed, Series A, Series B, Series C.
• Crypto Project: Seed, Private Sale, Public Sale.

The average business valuation in the crypto market is lower because this market is fairly new, and its Market Cap is still much smaller than that of the stock markets in developed countries.

1. Seed sale

Seed sale is the first Token Sale of a project. In this round, the product of most projects are still under development. The seed sale can be regarded as the initial fundraise for some projects to start.

Most venture capitals participating in seed sales accept a high risk investment. In return, they can potentially receive high rewards if the project succeeds.

2. Private sale

If the participants in the seed sale are mostly risk-taking capitals, the private sale witnesses the appearance of bigger and more famous ones. Most projects in this round have introduced their products and proved their potential after the seed sale.

3. Public sale

Public sale is the fundraising round for the community. The projects can launch tokens in the form of ICO as in 2017, or through a third-party in the form of IEO or IDO.

4. Fair token distribution

However, some projects do not organize any Token Sale rounds, but rather distribute their tokens through Testnet, Airdrop, Staking, Liquidity Providing... In this way, the project becomes more “fair” in the eyes of the community, therefore becomes more accessible by public users.

Some famous Fair-launch projects are Uniswap (UNI), Sushiswap (SUSHI), Yearn Finance (YFI),... They did not raise funds by any means; instead, they distributed their tokens to the actual users and supporters.

Some pros and cons of this model:

• Pros: Tokens are fairly distributed to the valuable contributors of the project, ameliorating the situation of seed sale & private sale investors “dumping” tokens.
• Cons: The project may perhaps “miss” a portion of the funds that can be used to develop the products.

5. The influence of Token Sale on Tokenomics

There are no common standards for the price difference between each Token Sale round. The token price in the public sale can be twice as high as that in the private sale, whilst the token price in the private sale can be twice as high as that in the seed sale. It completely depends on the project.

Nevertheless, it is compulsory that they keep it at a rational ratio. If the price difference between each sale round is too massive, the early investors will have the tendency to sell their tokens early. On the contrary, later investors will lose interest in joining other Token Sale rounds.

In addition, projects will implement the “Token Release” feature to treat investors more equally: Tokens that are bought at a lower price will have to be locked for a longer period; in contrast,  tokens that are bought at a higher price will be unlocked earlier.

Token Use Case

The Token Use Case is the applications and purposes of that token. It is the most important factor of a Tokenomics, which indicates how a token can be used and how much its price should be based on the benefits it brings to token holders.

Tokens are commonly used for:

1. Staking

Most projects support Staking with their native token, which incentivizes more token holders as they can earn extra tokens with Staking.

Staking requires users to lock their tokens inside the protocol, reducing the number of circulating tokens on the market, therefore positively affecting the price of that token. With networks using the Proof-of-Stake mechanism, the network becomes safer and more decentralized as the number of staked tokens increases.

For example: Cardano (ADA) grew from $0.2 to $2 (+1,000%) in 2021. Theoretically, that means the money put into Cardano has to be 10 times larger.

However, this is not the case. The reason behind that growth is because 75% of the Circulating Supply have been staked, which reduces the circulating ADA and the sell pressure on the market, hence stimulating the growth of ADA.

2. Liquidity Mining (Farming)

Users can provide liquidity in DeFi protocols to receive the project’s native token as a reward.

For example: Provide liquidity for Uniswap to receive UNI...

3. Transaction fee

To perform a transaction, users have to pay a small amount of transaction fee to the Validators who are confirming your transaction. Each blockchain uses a separate native token as payment for the transaction fee (usually blockchain platform projects). For example:

• Ethereum uses ETH.
• Binance Smart Chain uses BNB.
• Solana uses SOL.
• Polygon uses MATIC.

4. Governance

As mentioned above, the platform can be either Centralized or Decentralized, depending on the project’s decision. That being said, most DeFi protocols now follow the Decentralized governance model.

As a result, token holders have the right to propose ideas and vote on the platform. The suggestions can be related to transaction fee, Token Release schedule, or more serious problems such as expanding the project to another blockchain.

Currently, prominent DeFi platforms like Uniswap, Sushiswap, Compound,... have applied the Decentralized Governance model. However, a major part of the community is only allowed to vote instead of proposing changes, as the number of tokens required for this permission is too high.

5. Other benefits (Launchpad...)

Some projects have recently complemented the Launchpad feature into their products, which requires users to stake their tokens to participate in Token Sale events on the platform, or in lottery events to receive NFT,...

For example: Polkastarter requires users to stake POLs, DAO Maker requires users to stake DAOs...

Tokenomic Case Studies

Disclaimer: These are only personal viewpoints, and should not be considered financial advice under any circumstances.

Note: Tokenomics is an imperative metric to evaluate a project, but it is only one among many other aspects. It is not the sole factor that has a direct impact on a token’s price.

I will mention some efficient as well as some inefficient Tokenomics case studies so that you can easily understand.

Efficient Tokenomics

1. Binance Coin (BNB)

Token Supply

• Initial Total Supply: 200,000,000 BNB.
• Token Release schedule: 5 years (now 100% unlocked).
• The token burning mechanism is applied until the Circulating Supply becomes 100,000,000 BNB.

⇒ Deflationary, create motivations for the token price to increase and for BNB holders to believe in the project.

Token Use Case

Nonetheless, Token Supply is not the main reason for BNB’s tremendous growth lately, but rather how BNB tokens were designed to be used on both Binance Exchange and the Binance Smart Chain network.

• Binance Exchange: Reduce transaction fee, participate in Launchpad, Staking, Lending & Borrowing, Derivatives,...
• Binance Smart Chain: Native token, pay network costs, stake and farm (using BNB as the indispensable token when creating a liquidity pair, a similar situation as ETH on Ethereum, which is the key leading to BNB’s growth).

Binance is also developing Binance Pay, which can lead to BNB becoming one of the most popular payment currencies if Binance Pay succeeds in the future.

The result: The BNB price went sideways at $20 until it dramatically increased to an ATH of $650 (+3,250%) and now remains at approximately $300 (+1,500%).

You can see more details about BNB's tokenomics right here.

2. Pancakeswap (CAKE)

CAKE is the native token of Pancakeswap - an AMM DEX on Binance Smart Chain.

Token Supply

• CAKE has no Total Supply (The number of CAKE is unlimited).
• 530,000 CAKE tokens are distributed on a daily basis through Syrup Pool, Farming Pool, and Lottery Pool.
• CAKE will be burned when ANY Pancakeswap product is used.

Token Use Case

CAKE was designed to be applied in every feature of Pancakeswap, including the Syrup Pool (Staking), IFO (Staking), Lottery and Prediction (Payment).

=> Although the Total Supply of CAKE is undefined, Pancakeswap does a great job in managing the Circulating Supply of CAKE, and maintaining a balance between the Token Release and the Token Burn.

Pancakeswap is not only clever at increasing the applications and Buy Demand for CAKE, but also proficient at successfully sustaining the incentives for CAKE holders.

The result: The price of CAKE rose from $0.4 to an ATH of $40 (+10,000%), and now remains at $14 (+3,500%).

You can see more details about BNB's tokenomics right here.

Inefficient Tokenomics

Pangolin (PNG)

PNG is the native token of Pangolin - an AMM DEX on Avalanche. Although PNG is, to some extent, similar to CAKE in its features, I personally believe that Pangolin had some serious problems in designing its tokens which are not working productively.

Unreasonable Token Supply 

Initially, the Total Supply of PNG was 538,000,000 PNG. After every 4 years, the number of PNG tokens being distributed into the market will be halved. This is an identical approach as Bitcoin, which will take Pangolin 36 years to fully unlock its tokens.

However, BTC has been acknowledged as a SOV (Store Of Value) asset and has been trusted by a massive crypto community, whereas PNG is a newly developed token. There is no guarantee that the Pangolin team can develop the protocol for the whole 36 years, let alone the crypto market has existed for only 10 years.

There is no balance between the Revenue and the Token Release Value

There are currently 175,000 PNG being unlocked every day, which is worth about $197,500. On the other hand, the revenue of Pangolin couldn’t even reach $30,000/day. This turns PNG into an inflationary token, which results in the token holders losing interest in the project and selling their tokens.

Therefore, before investing in any token, we have to look at the project from multiple aspects. The project can easily “create” an ideal scenario with its written documentation, but whether that scenario can be put into practice requires real-time data and proofs. Can the project receive as much revenue as expected?

⇒ The Token Release schedule is inappropriate, the PNG tokens cannot be applied efficiently on Pangolin. The “ideal scenario” of the Tokenomics does not match with the real-time data.

The result: After reaching a peak of $15, the price of PNG has declined considerably to $1.2 (divided 12 times). Even when the crypto market saw a strong upward trend in April to May 2021, the PNG price did not have any remarkable rise.

In September 2021, various Avalanche tokens such as AVAX, SNOB, XAVA... have significantly grown in their price, but PNG was still moving extremely slowly. Although Pangolin is backed by the Avax Labs, Pangolin has now been surpassed by Trader Joe.

Viewpoints on the Case Studies

As mentioned above, the Tokenomics design is not attached to anything. Depending on the product model and the sector that the project aims towards, the team can adjust the Tokenomics accordingly and appropriately.

Evaluating a token is not only about analyzing its applications, but also about investigating its target market.

How massive is that market segment? How many users are there? Is the Tokenomics design balanced between its applications to the project and its benefits for token holders?

For instance: From the beginning, Pancakeswap (CAKE) determined their target market to be Binance Smart Chain - the second largest DeFi ecosystem in terms of TVL (Total Value Locked) and has had a huge number of users.

Understanding the situation, the Pancakeswap team designed the Tokenomics so that a huge Token Allocation was reserved for Liquidity Mining Reward to attract users and investors. Afterwards, in order to raise the Buy Demand for CAKE, the Pancakeswap team applied CAKE in every possible feature that Pancakeswap provides.

Conclusion

We have gone through an article about Tokenomics. Here is the recap of some notable points:

• Tokenomics consists of many elements, such as Token Supply, Token Allocation, Token Sale, Token Release,...
• Tokenomics is a compulsory factor to evaluate a project, but there are still a variety of other elements to consider, such as the token’s applications or the target market.
• Tokenomics can be designed in numerous ways. However, how much revenue the platform earns and how the project captures the value for its tokens is of the foremost importance.

I hope it has helped you in gaining more valuable insights into this sector, including its components and meanings.