What Is Tokenomics in Crypto and How it Works

Written by

Tamara T.

Crypto Analyst

Published Mar 10, 2023 at 4:10 PM
Last updated Jan 18, 2024 at 12:54 PM

Stepping into the cryptocurrency world requires that you familiarize yourself with its most basic terms. One of these is tokenomics, which describes the factors that influence the value and use of a certain token. It deals with the basics of the token’s creation, supply, demand, distribution, and burning process. 

Tokenomics plays a particularly important role for investors who wish to buy some crypto. Evaluating the tokenomics of every project is, therefore, essential for the success of any crypto project. If you are new to the cryptocurrency world, you might find it useful to discover what is tokenomics. This is where our guide can help you! Keep reading and find out everything you need to know.
 

What Is Tokenomics: Basic Terms

Are you looking for the tokenomics meaning?

Tokenomics explains the incentives that motivate investors to purchase and hold certain cryptocurrencies. Additionally, the term is used to determine the utility of the coins that impact their demand. You should also know that supply and demand affect the price of the coin drastically, and projects with an incentive have blooming potential.

What Is Tokenomics: Understanding

Before making any investment decisions, you'll certainly want to familiarize yourself with some of the most frequent terms - market cap, supply and demand, mining, volume, and many more. 

Get ready to dig deeper into the topic!
 

Market Cap Explained

Market capitalization is one of the most frequently used terms in crypto. The term determines the current market value of the crypto network. We can get this variable by multiplying the circulating supply of certain assets by the price of a single unit.

Let's imagine we have two networks, A and B. The A network has a total supply of 2000 that are all in circulation. On the other hand, network B has 50,000 coins in circulation out of 80,000 of the total supply. The prices of the coins are $50 and $3 respectively.

The question is, which of the two coins has a higher market cap?

Market cap = circulating supply × price

A network = 2,000 × $50 = $100,000

B network = 50,000 × $3 = $150,000

What Is Tokenomics: Market Cap Explained

As you can see, the market cap of network B is higher despite the coin’s lower price. This means that the market cap is a better estimation of the network’s value than the crypto price.

In this place, we should also pay attention to the total market cap. This term indicates the total value of all altcoins, stablecoins, crypto assets, and tokens combined in the market. This variable matters, because it signifies the size of the entire industry. 

On the other hand, you might probably hear about diluted market cap. This term stems from the stock market and indicates the future supply of the specific crypto asset. You should be aware that not all cryptos and tokens have their total supply available at any time.

For instance, the total supply of Bitcoin will eventually be $21 million. At the moment, there's something over 19M in circulation. To calculate the diluted market cap, we should take the BTC’s maximum supply instead of the circulating volume. 

Total Market Cap vs Diluted Market Cap

So the formula is:

Diluted market cap = Current Price x Max Supply
 

Determining the Price of a Digital Currency 

Cryptocurrencies are known as tradable assets.  Their price depends on both demand and supply. The first indicates how many coins are available in the market, while supply refers to the level of the customers’ interest.  In contrast, the price is some sort of relationship between demand and supply. 

In case of a high demand for certain crypto, but a limited supply, the price will go up. Sometimes, you can also see that the demand for the coins increases regardless of their true value. We call it ‘overbought’. On the other hand, when a significant amount of coins is sold without a particular reason, we use the term ‘oversold’.
 

What Is the Available Supply?

When you think of the cryptocurrency supply, you probably assume its meaning. This is the total number of circulating coins. You should know the difference between the available supply and the total number of coins. The number of circulating coins (traded assets) is always smaller than the total number of coins in the market. The reason for the difference is that many people keep their tokens in private wallets outside of the market.
 

Fixed Supply

Cryptocurrencies with a fixed supply include coins that have a predetermined limit at the moment of their issue. Under this category, we also include cryptos with planned final supply, where coins are regularly released with different methods. For example, Bitcoin releases new coins with the mining process, while Ripple issues new coins from the cryptographic lock.
 

Crypto Mining

Some cryptocurrencies rely on the mining process to determine their total supply. The release of coins is possible in different ways - but everything happens through the mining process. You will see that some crypto increases the supply over time, yet their supply is limited. Bitcoin is a perfect example of this. Other cryptos stand out with an infinite supply, but the release of new coins is slowing down over time. The ideal example is Ethereum; however, this could change soon.
 

Unlimited Supply

There are also cryptocurrencies with an unlimited supply. These work like fiat currencies and cause inflation, and the perfect example is Dogecoin. However, you can also find many stablecoins such as Tether, USD Coin, and Binance USD with uncapped supply since their limit depends on the existing reserves. Such coins can grow infinitely, which makes them more intriguing. 
 

Crypto Yields

Yields are also important in tokenomics model. Yield farming allows users who possess crypto to get more tokens. This includes the possibility of lending your funds to anyone looking for a loan via smart contracts, and getting interest and principal tokens. You should also know that decentralized finance platforms provide huge yields to encourage people to purchase and stake tokens.
 

Token Burning 

Another important element of tokenomics design is token burning. The process refers to pulling the coins out of circulation. The perfect example is the Binance company, which burns its BNB tokens to decrease the total supply and then removes them permanently. The goal is to continue with the burning process until the company reduces the total supply by 50%.
 

Token Allocations and Vesting Periods

When talking about crypto projects, we cannot forget the token allocations. Typically, a certain percentage of tokens go to developers or venture capitalists. However, they can get rid of these coins only after a certain period. This affects the number of circulating coins after a certain time. The ideal solution would be to find a balance between the impact on the token’s price and the circulating supply.
 

Mining and Staking

Tokenomics also relies on the mining and staking process. Bitcoin and Ethereum, for example, issue tokens to encourage miners to authenticate transactions. This is part of the proof of work process. As part of the same, miners use computer power to mine new blocks and add them to the chain. As opposed to this, the proof of stake mechanism means that rewards go to participants who had locked some crypto in the smart contracts.
 

Other Standard Metrics in Crypto Tokenomics

If you want to delve deeper into the crypto tokenomics, you should also know the importance of other terms. 

Since tokenomics analyzes the key characteristics of crypto, this can help you to compare tokens and make well-thought decisions. 
 

Cryptocurrency Volume 

What is volume in cryptocurrency? 

Let's start from the beginning. 

The volume is the total amount of coins exchanged in the last 24 hours. Precisely, it includes a combined amount of purchases and sales over a certain period. The rule is that cryptos with a higher market share also stand out with higher market volume. This happens because of their higher liquidity.

According to the data on Coinmarketcap, the most traded cryptos on January 17, 2023, are Bitcoin and Tether, with $22,328,001,227 and $30,106,782,631 respectively.

Other Tokenomics Metrics
 

Change

Apart from crypto trading volume, you should also consider the change in prices before making any investment decision.

Understanding crypto trading requires that you know the basic principles of the market and familiarize yourself with the latest trends.

Cryptocurrency price is subject to regular changes. Such changes are shown in percentages. For instance, if a price falls 50%, the change will be shown as -50%.

Charts usually feature a change over the last day or hour, but you can also check other timeframes. It's up to you to choose a preferred time frame according to your interests. 

If you are an experienced trader, then you’ll want to focus on short-time intervals. Conversely, experienced investors should focus on long-term timeframes. 
 

Different Coin Prices on Different Platforms

If you have searched for the largest crypto exchange by volume, you may also notice another trend - crypto prices are different depending on the platform you choose.

The question is why this happens in practice.

Every trading platform works separately with its supply and demand. This determines the price of every crypto. The price is decided somewhere in the middle of buys and sells, meaning that some people set buy/sell orders at low prices while others prefer higher prices.

Another reason for the difference in prices is efficiency. Markets are not efficient enough and prices of specific cryptocurrencies vary. This is because of different fees charged to investors alongside different levels of liquidity and trade volume on exchanges. 
 

Tokenomics Shouldn't Be Hard

As you can see, understanding tokenomics allows investors to have a broader view of possible future events. An investor should also be able to predict supply inflation rates and their connection with existing market capitalization. If you know these elements, it is much easier to get a return on investment.

All in all, you should scrutinize all tokenomics elements to make better-informed decisions. Getting started from our comprehensive guide is the first logical step in that process.