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What Is Tokenomics? Supply & Demand of Crypto Explained
March 1, 2022
Tokenomics is the topic of understanding cryptocurrency's supply and demand characteristics. In a traditional economy, economists track the issuance of currency using official data. This data is found in reports called M1, M2, M3, or M4. While we won't go too deep into these categories, that's a whole other topic; keep in mind that M1 describes the most liquid currency, M2 is less, etc.
Tokenomics & M1-M4: The Importance of These Numbers
These numbers help keep transparency while monitoring different aspects of a currency's supply.
They are important because governments and other official bodies have a history of creating additional money in their countries. It's not always easy to balance a budget or raise revenue to run a country, so a common practice was to create more currency.
Things like pandemic responses and bank bailouts have required governments worldwide to create more currency very quickly in today's world. And while governments oversee this process, creating additional currency causes a reduction in the value of existing money. This reduction is called inflation, and it's most easily noticeable when the prices of everything we buy rise year after year.
What Are Tokens?
Before we get into the specifics of tokenomics, we need to understand tokens. Tokens are a unit of cryptocurrency that people use to represent a specific use on the blockchain or a particular asset. Tokens have many use cases, but utility, governance, and security are the most common ones.
Tokens and cryptocurrencies built on the blockchain have pre-set issuance schedules. So we can predict how many coins will get created in the future. Although these issues schedules may get altered, it requires the agreement of many people and is difficult to implement. However, due to that difficulty, it provides security and comfort for cryptocurrency owners because the tokenomics and how many tokens they can expect to be created in the future are much more predictable than when a government will make new money.
The Total Bitcoin Supply
We know the total amount of Bitcoin that will ever get created is 21 million. We will reach that total supply around 2140. After that, the number of coins created will decrease by half approximately every four years. This process is called Bitcoin halving, which was designed to create scarcity and provide upwards pressure on the cryptocurrency's prices.
Twenty-one million Bitcoins sounds like a lot, but it seems much smaller when you compare it to roughly 8 billion people on the planet. That imbalance is why many people compare Bitcoin to gold then call it hard money.
Since it was the first cryptocurrency created, its issuance process and schedule have led the way for other cryptocurrencies. Many others also have a hard cap of coins; however, some currencies, like Litecoin, have a larger overall number.
Some cryptocurrencies have a very different schedule, however. For example, Grin and Dogecoin have essentially unlimited issuance policies. Every time a new block is created, the token supply increases with no cap.
As of September 2021, there are over 131 billion Dogecoins in circulation. Unlike Bitcoin's deflationary supply, Dogecoin has an inflationary supply. Many proponents of cryptocurrency argue that those tokenomics are what makes it work as a usable currency.
Grin's founders also hope to make it easier for tokens to become a usable currency and maintain a stable price. However, it will be years before we know whether this is true.
There are plenty of coins and tokens with a maximum issuance between these two extreme positions, but that number is exceptionally high. For example, the cryptocurrency Tron has a supply cap of over 100 billion tokens.
And in some situations, the number of tokens are coins will reduce. For example, many cryptocurrency projects have rules where a certain number of coins will get burned at intervals. These burns typically relate to operating fees, meaning that the more it's used, the faster tokens get burned.
The Importance of Understanding Tokenomics
A famous rule of investing, stated by Seth Klarman, is that supply and demand are the only things that determine market prices in the short run. So if we take that to be true and apply it to cryptocurrencies using blockchain technology and the stock market, then understanding what impacts the supply and demand of tokens are crucial to speculators and investors.
So there are various factors to think about when looking into cryptocurrency tokenomics. One of the most important factors is understanding how people use digital currency. For example, is there a clear link between the platform's usage and the asset? If so, there's a chance that a growing platform will require the usage of certain tokens, ultimately increasing their price. If not, why would someone use the token?
Other important tokenomics questions to consider include:
How many tokens currently exist?
How many will be created in the future, and how quickly?
Who owns the coins, and are there any set aside for developers in the future?
How many tokens have or will be burned, lost, deleted, or unusable?
Tokenomics & the Value of Crypto
Tokenomics is useful to help understand how much a cryptocurrency asset might be worth in the coming years. For example, many people who are new to crypto might think about a token's value in comparison to the price of Bitcoin. In reality, other coins and tokens might not reach that high of a value. For example, Bitcoin Cash has the same hard cap as Bitcoin, so one day, it might be possible. On the other hand, Tron has over 100 billion tokens, meaning it is very unlikely for one of those coins to be valued at thousands of dollars or more. Tron would have to become the single most valuable business ever to exist for that to happen, and how likely is that?
While these questions can be challenging to answer, tokenomics can provide an additional way to view cryptocurrency assets and understand whether or not it's likely to perform well in the future.