The main advantage that crypto projects have compare to traicional ones is the creation and integration of digital assets, the so-called tokens, which can radically change the way a business operates. This means that an unprofitable business can become profitable by introducing a token.
On the other hand, even a good business can become unsustainable if the token is poorly integrated into the project. In this first article, Crypthi will address the main elements of tokenomics, an emerging field that researches the integration of crypto tokens into different projects.
Token issuance: incentivizing users
The main component of a token is its inflation. Projects that launch a crypto asset can use its issuance for various purposes: funding investments, providing incentives for adoption, or rewarding and punishing a behavior.
Token issuance is a very powerful tool, but it also carries risks, so its volume needs to be managed: high inflation will allow for more incentives to be distributed, but will also dilute the asset, bringing greater selling pressure and, consequently, devaluation.
Low inflation brings the opposite scenario: it better preserves the value of that asset in the long term, which may encourage people to hold it. However, it leaves fewer resources available to distribute incentives.
This dilemma between the pros and cons of using this token issuance is similar to that faced by a government. Injecting money into the economy can boost a country's growth, but on the other hand, it tends to devalue the currency. Therefore, it must decide to what extent to use this trick, and it's easy to lose control.
There is also the risk of a competitor attracting a service's users simply by offering them larger incentives with its own token.
Burning: valuing an asset through deflation
But it's not just token inflation that can be used as a weapon to boost crypto projects: some opt for the opposite path. The project can rely on token "burning" mechanisms to reduce its supply instead of increasing it. Token burning involves sending the assets to an invalid address through the blockchain, effectively removing them permanently from circulation.
In this case, the focus of tokenomics is not on distributing rewards to incentivize product use. Instead, the goal is to generate a progressive scarcity of the asset to boost its value. This encourages people to buy the token as a store of value. Binance, for example, uses its profits to buy and burn BNB tokens.
However, it's important to remember that the token will only be effective as a store of value if there is a good product that provides clear functionality for it. After all, a useless token will not be more valuable just because it has become scarcer.
Distributing the token
Finally, the other key component behind a token's economy is its distribution. It's important to balance the token's distribution among different groups, especially between the team behind the project and its users.
It's desirable to reserve a good portion of the token for incentives to promote the adoption and the expansion of the project. It may also be helpful to keep a reserve of tokens in a treasury for a later spend, as the project may take unexpected turns.
Teams typically reserves portions of the token to themselves as compensation. However, holding too much can leave fewer resources for user incentives or project financing, and it's generally not well-regarded.
There are major crypto projects where the team reserved 50% or even more of the supply of tokens, but the public usually considers a fair distribution to be between 20 and 30%.
If the team's aim in launching the token is to finance the project, they can reserve part of the token supply for an initial sale. They can focus on both retail, with an IPO-like launch, or on the "smart money" from VCs, through private rounds.
Final thoughts
Tokenomics is an emerging area that offers new perspectives for a business. It's especially used in Web3 projects but can be applied to a wide range of business models depending on the project's goals and current conditions.
The big difference with these assets (tokens) compared to traditional ones is that their quantity can be diluted, contracted, or redistributed. But as this generates supply pressure, it's important that the asset has a corresponding factor for demand.
Remember that the proper use of tokens can bring significant advantages to your project, but it can also do the same for your competitors. Other projects can copy your business model and offer greater incentives to take your user base.
