In recent years, cryptocurrencies have become a new Eldorado for investors. Cryptocurrencies and blockchain technology were on everyone's minds last year thanks to Non-Fungible Tokens (NFTs). That momentum continues today with more people interested in DeFi products than ever before - especially as we see an increase of adoption across various industries such as Finance or Tech.
For token holders, there is a perceived link between a successful project and an eventual increase in the associated token price. However, this is frequently confronted with the harsh fact that such connections are not as straightforward as they appear.
Years after the ICO rush of 2017, many crypto projects have been successful in raising capital and building their own token. But it seems like there are some clear examples today of big projects intensively funded which were unable to transfer this same level of success into the price of their token. How could this happen, you might ask - and I would say with good reason because there are many different factors at play here.
But before we dive any deeper, let's get to the basics.
What is Tokenomics?
Tokenomics is a term that has been around since 2017 and is becoming more and more popular as the cryptocurrencies Market gains in notoriety. Tokenomics is a term formed by pairing up the two words "token" and "economics". Tokenomics is simply put, how token value is determined and what affects its value. This means that tokenomics covers much of the same ground as traditional economics.
Tokenomics isn't just about finance; there are other forces at play such as politics, social dynamics, use cases, as well as unique characteristics that appeal investors. All determine the price (and value) of a token. For example, we can look at the price of a token and imagine that it's determined by the criteria laid out in traditional economic models, such as supply and demand. This is certainly true to an extent, but we can't forget that there are factors that go beyond just having enough tokens and people who need them.
The unrelated relationship between Project success and Token success
Any token has two forms of value: its inherent value and its speculative value. The percentage of a cryptocurrency's value that originates from the underlying asset's demand is known as its intrinsic value. The speculative value is the portion of a token's worth that derives from people's expectations for future price appreciation.
While Speculation is appealing, it's difficult to manage or predict and leaves promising projects at the mercy of short-term investors.
We can see that the relationship between token value and project success is not linear. For example, in many cases tokens have done poorly compared to the company stocks value despite having sometimes much more exposure in the press or being user-friendly for traditional finance investors.
A viable token should foremost serve a purpose or a function. Simply stated, a project's token economy must be well designed. This implies creating a token ecosystem in which token holders are incentivised to keep the project's token for reasons other than its price speculation.
A token that is designed such that token holders can use them to purchase and sell goods and services, or generate residual income (such as interests), will ultimately have a higher probability of success for adoption as well as price appreciation.
Token economic models and viability
Some projects require consumers to purchase a certain amount of their tokens before enabling them to use their goods and services. The issue of such model is that they are not providing incentives to the user to hold their token as it has no definable value. It only creates an additional step which impoverish the user experience while generating irritation for the users who wish to consume the solution or product in question.
A subscription model is one interesting approach to increase token usefulness and encourage token stashing or holding. A structure like this would need projects to explain the utility of their tokens. They would subsequently establish an economy in which consumers of those tokens would be able to consume the good or service defined against that token over its lifespan.
The token's tokenomics will usually be thoroughly discussed in the project whitepaper, and it should enable you to understand the functionality, goal, distribution, objectives, and much more.
The concept of token economics is complex. There is a misperception by a lot of crypto enthusiasts between a project's success and the success of its Token in terms of value.
Even the most successful Projects must consider the quantity of tokens to issue, burn rate, and amounts to set aside for various groups and individuals working on the project. In addition, it is vital to come up with a viable goal and use case for the token. Finally, the greatest problem project teams must overcome is short-term investors who have no interest in the project but are solely focused on making a quick profit out of their Token value.
Just like with traditional economics, tokenomics isn't perfect. There are models that try to address some of the limitations of the current models but it's important to keep in mind that there are limits to our understanding of how market forces work. Understanding why they work is incredibly hard and requires actionable strategies to take advantage of them.