Tokenomics is a cutting-edge field at the intersection of economics, crypto, and technology. It involves creating systems that align the interests of digital token holders. It drive the growth of token value, usage, and adoption over time. For those navigating the crypto space or managing a blockchain project, understanding the basics and definition of tokenomics is crucial. Indeed, it helps in establishing, sustaining, and protecting a token’s value and effectiveness. This comprehensive glossary will provide the key terms and concepts needed to explore the world of tokenomics.

Main tokenomics definition

Tokenomics

The term “Tokenomics” combines ‘token’ and ‘economics’ to describe the principles that govern the functioning of a cryptocurrency token. It entails designing a specific economy for each crypto project, focusing on how tokens are distributed, owned, and grow in value. Key aspects include the initial token allocation, defining the token’s purpose and utility, identifying demand drivers, establishing an inflation model, managing supply, setting liquidity and reward models when necessary, and ensuring stability through various mechanisms.

Token

A token is a digital asset that is created, issued, and managed on a blockchain. A unit of value is represented by a token, and various roles within its ecosystem can be fulfilled by it. These roles include acting as a share in a project (security token), serving as a prepaid voucher for services (utility token), or providing voting rights in the governance of a blockchain project (governance token).

Utility tokens

Utility tokens grant holders access to specific products, services, or discounts within a blockchain project’s ecosystem. For example, in the Galileo Protocol project, their token LEOX serves as a utility token within the Galileo Protocol and serves multiple purposes, such as a means of payment, reward, and governance.

Governance tokens

Governance tokens give holders the right to participate in decision-making processes affecting the project’s direction and policy. An example is the BLOKC token of BLOK Capital, which allows holders to vote on decisions of the Blok Capital platform.

Security tokens

Security tokens represent a fraction of ownership in the asset they represent, entitling holders to a portion of the profits, similar to receiving dividends from stock ownership. 

Application of tokens across the different value propositions

In the dynamic landscape of blockchain and crypto, the success of a token is closely linked to the effectiveness of its value proposition. Similar to traditional business models, where a company’s value proposition outlines how it delivers value to its customers, in tokenomics, the value proposition defines how a protocol generates value for its ecosystem and how the token captures and accrues this value.

A well-structured value proposition is crucial because it directly impacts the demand and utility of the token, influencing its overall market value and sustainability. The growth potential of a token is often driven by how well its value proposition aligns with the needs and incentives of its users and stakeholders. Here is a breakdown of where and how tokens can be applied across different value propositions:

Volume-related value propositions

These models link token value to the volume of activity or transactions within the protocol. Tokens can gain value through fees or a percentage cut of the traded or transacted volume. This approach is effective in decentralized exchanges (DEXs) and other trading platforms, where higher volumes can enhance token value.

• Decentralized Exchanges (DEXs) / Trading Platforms: Tokens are used to pay trading fees or gain discounts on fees. They may also be staked for rewards, governance, or liquidity provision.
• Lending Platforms: Tokens might be used to offer better lending rates, reduce borrowing costs, or participate in governance decisions.
• Launchpads: Tokens can be used to access new project launches, where holding a certain number of tokens provides entry to token sales or discounted prices.
• Marketplaces: Tokens are used for listing fees, trading fees, or access to premium features.
• Lotteries and Prize Pools: Tokens could be used to participate in lotteries, with fees collected contributing to prize pools or future development.

User-related value propositions

These models generate value by creating engaging and user-centric ecosystems. Value is accrued by tokens when the platform is engaged with by users on a subscription basis, through in-app purchases, or in environments where services are offered in exchange for tokens.

• dApps with Subscription Models: Tokens can be used to pay for monthly subscriptions to decentralized applications (dApps), accessing premium services, content, or features.
• Games and Metaverse Platforms: In-game tokens can be used to purchase virtual assets, skins, or other enhancements. They can also serve as governance tokens to vote on game development or updates.

Transaction-related value propositions

These models are based on the number of transactions, regardless of their volume. They are especially relevant for Layer 1 (L1) and Layer 2 (L2) blockchains, infrastructure projects, and on-chain DeFi protocols.

• Layer 1 and Layer 2 Networks: Native tokens are used to pay for gas fees (transaction costs), secure the network through staking, or participate in governance.
• Infrastructure Protocols: Tokens can be used to pay for API calls, access data feeds, or secure the network.
• On-Chain Protocols (DeFi): Tokens can be utilized in yield farming, staking, and liquidity mining to reward users for participation, increasing both engagement and the token’s utility.

Combining multiple value propositions

Some protocols may combine multiple value propositions, leveraging diverse revenue models to maximize token utility and value accumulation:

• GameFi: A GameFi platform might combine elements like a marketplace (for buying/selling virtual assets), a game (where tokens are earned or spent), and loot boxes (chance-based in-game items purchased with tokens). Each of these components offers unique value and drives different economic activities that enhance the token’s demand and utility.
• Exchanges: Cryptocurrency exchanges might offer multiple services like trading (volume-related), a lottery system (volume and user engagement-related), and profile creation or premium memberships (user-related).
• Launchpads: Platforms that help new projects launch and raise funds may also offer DEX services. Here, the value proposition comes from both launching new projects (user and transaction-related) and enabling token trading (volume-related).

Key elements in designing tokenomics

Ecosystem design

Creating a visual representation of the ecosystem, including all key stakeholders, their interconnections, and actions, is highly beneficial. This mapping exercise offers invaluable insights into the ecosystem’s operations, aiding in the development of efficient strategies to achieve objectives. By thoroughly analyzing the interactions, incentives, and value flows, we can ensure the ecosystem is designed to promote long-term viability and growth.

Token utility

Refers to the practical use and functions of a token within its ecosystem, which creates demand for it. Utility can include means of payment, rewarding, staking, governance, discounts, and more. Defining clear and compelling use cases for the token is essential to ensure its adoption and ongoing demand.

Max supply or infinite one  

One of important decision when designing a tokenomics is whether to implement a max supply or allow for an infinite supply of tokens. A max supply sets a fixed limit on the total number of tokens that will ever be created. This scarcity can create a sense of value and urgency among investors, similar to precious metals like gold, which have a limited quantity. It can also help control inflation and ensure long-term value retention. On the other hand, an infinite supply allows for continuous token generation, which can be beneficial for incentivizing ongoing network participation and rewarding contributors over time. However, without careful management, it risks leading to inflation, where the token’s value may diminish as more tokens enter circulation. Therefore, the choice between max supply and infinite supply depends on the specific goals and economic model of the cryptocurrency project.

Token allocation

Token allocation is a metric that involves determining the proportion of tokens allocated to various stakeholders such as the core team, investors, community incentives, or reserve funds. Proper allocation ensures a balanced distribution of tokens, promoting fairness and encouraging active participation.

Token distribution

Token distribution refers to the process by which tokens are released over time. Cliff and vesting mechanisms are commonly used to manage this distribution, ensuring a gradual release of tokens to stakeholders. This approach prevents market selling pressure and encourages long-term commitment. A cliff period delays the initial release of tokens, providing a lock-up period before any tokens are distributed. After the cliff period, vesting schedules come into play, distributing tokens in regular intervals, which helps maintain a stable market and aligns the interests of stakeholders with the long-term success of the project.

Token incentives

Incentives are mechanisms through which a token economy motivates participants to contribute positively to the network. Examples include liquidity incentives, staking rewards, and emissions of new tokens. Well-designed incentives align the interests of all participants and promote the health and growth of the ecosystem.

Value capture and value retention

Value capture ensures that the token accrues value as the ecosystem grows and prospers. This involves designing mechanisms that capture value through token usage, fees, and other economic activities within the ecosystem. Also, value retention implements strategies to maintain the token’s value over time, such as incentives, deflationary mechanisms, token buy-backs, and providing continuous utility to encourage holding.

Token mechanics

Token mechanics refers to the rules and functionalities embedded in the token’s design. This includes mechanisms like token burning (destroying tokens to reduce supply), buy-backs (repurchasing tokens from the market to increase demand), and staking rewards (incentivizing users to lock their tokens). These mechanics are used to manage the token’s circulation and value, ensuring stability and attractiveness to holders.

 

Learn more about our methodology at Chainforce: Chainforce’s methodology

 

Key elements in simulating tokenomics

Tokenomics simulations are essential tools for understanding and optimizing the economic models of cryptocurrency projects. They allow project teams to forecast outcomes, identify potential issues, and refine their tokenomics to ensure long-term sustainability and growth. 

Supply and demand simulation

This simulation models the effects of various supply and demand scenarios on the token’s price and market behavior. It helps in understanding how changes in token supply (e.g., token burns or emissions) or changes in demand (e.g., increased usage or adoption) impact the token’s value over time.

Incentive mechanism simulation

Incentive mechanism simulations evaluate the effectiveness of various incentive structures, such as staking rewards, liquidity mining, or governance participation rewards. These simulations help to ensure that the designed incentives align with the project’s goals and drive the desired behaviors among participants.

Market impact simulation

Market impact simulations analyze how large transactions, such as whale movements or significant token releases (e.g., from vesting schedules), affect the market price and liquidity. This type of simulation is crucial for planning token distribution and mitigating potential negative impacts on the market.

Governance simulation

Governance simulations explore how different governance models and voting mechanisms influence decision-making processes within a blockchain project. They can help in designing fair and efficient governance systems that encourage active participation and equitable decision-making.

Adoption and growth simulation

This simulation focuses on projecting the growth of the token ecosystem, including user adoption rates, transaction volumes, and network effects. It helps in identifying the key drivers of growth and the potential challenges in scaling the project.

Economic stability simulation

Economic stability simulations assess the resilience of the token economy to various shocks, such as sudden drops in token value or changes in regulatory environments. These simulations are essential for ensuring that the tokenomics design can withstand external pressures and maintain stability.

Token distribution and vesting simulation

This type of simulation models different token distribution and vesting schedules to optimize the release of tokens to stakeholders. It helps in preventing market flooding and aligning the interests of all parties involved with the long-term success of the project.

Stress testing

Stress testing involves simulating extreme or unexpected market conditions to evaluate the robustness of the tokenomics model. This includes scenarios such as rapid price declines, sudden surges in transaction volume, or large-scale sell-offs by key stakeholders (“whales”). Stress testing helps identify potential points of failure within the token economy and prepares the system to handle adverse situations without collapsing. It also aids in determining the effectiveness of mechanisms like buy-backs, burns, or emergency governance measures to stabilize the ecosystem during crises.

Types of tokenomics simulations

Monte carlo simulation

Monte Carlo simulations use random sampling and statistical modeling to estimate the probable outcomes of various scenarios. In tokenomics, these simulations can predict token price fluctuations, user adoption rates, and other dynamic factors. This helps in understanding potential risks and rewards under different conditions and making data-driven decisions.

Terms you should know in tokenomics

Airdrop

An airdrop is a marketing strategy where free tokens are distributed to a community to encourage adoption. This generates buzz and rewards participants for supporting the platform.

Automated Market Maker (AMM)

AMMs are decentralized platforms that facilitate the trading of digital assets through algorithm-driven liquidity pools, often mentioned 1:1 with Liquidity Pools. Unlike traditional order book-based systems, AMMs use mathematical formulas to price assets, allowing users to trade directly with the liquidity pool. There are different types of AMMs, such as Uniswap v2 and Uniswap v3, each with its unique mechanisms and improvements to optimize trading efficiency and capital utilization.

Burning

Burning refers to permanently removing tokens from circulation, often to reduce supply and potentially increase value.

Buy Back

Buy back refers to the process where a project repurchases its own tokens from the market, often to reduce the circulating supply. This mechanism can potentially increase the token’s value and can also be used to stabilize the market or provide liquidity.

Circulating Supply

Circulating Supply is the total number of tokens currently available for trading on a platform.

Consensus Algorithm

A consensus algorithm is a set of rules used to achieve agreement among network participants on the current state of the blockchain.

Deflationary Economy

A deflationary economy involves reducing the total supply of tokens over time, which increases scarcity and can potentially maintain or increase the token’s value.

ERC-20 / BRC-20

ERC-20 is a technical standard for fungible tokens on the Ethereum blockchain, representing digital assets that are identical and interchangeable with each other. BRC-20 is a similar standard for fungible tokens, but it is built on the Bitcoin blockchain. While both ERC-20 and BRC-20 serve the same purpose of creating fungible tokens that are interchangeable and easily transferable, they operate on different blockchains with distinct protocols and underlying technologies.

ERC-721

ERC-721 is a technical standard for non-fungible tokens (NFTs) on the Ethereum blockchain, representing unique digital assets.

Yield Farming

Yield Farming involves lending and staking crypto assets to earn returns (yield), primarily on decentralized finance (DeFi) platforms. While similar to staking, Yield Farming typically requires participants to provide both the native project tokens and other more liquid tokens (like ETH or stablecoins) to liquidity pools.

Fully Diluted Market Cap / Fully Diluted Valuation

The fully diluted market cap is the total value of a token if all tokens were in circulation, calculated by multiplying the max supply by the current price per token.

Gas

Gas is a unit of measurement on the Ethereum blockchain representing the amount of computational effort required to execute a transaction or smart contract.

Halving / Halvening

Halving is a process that reduces the rate at which new coins are created, often leading to an increase in value due to reduced supply.

Hard Cap

A hard cap is the maximum amount of funds a project seeks to raise during its fundraising event.

Layer 1

Layer 1 refers to the underlying infrastructure of a blockchain network, such as the protocols and consensus mechanisms governing its operation.

Layer 2

Layer 2 solutions are built on top of Layer 1 infrastructure to enhance the functionality and scalability of the network.

Launchpad

A Launchpad is a platform that helps new blockchain projects raise capital and launch their tokens. It provides a space for vetted projects to connect with potential investors and gain exposure.

Liquidity

Liquidity refers to the ease with which an asset can be bought or sold in the market without affecting its price. In the context of cryptocurrencies, liquidity is essential for efficient trading and price stability. High liquidity means there are ample buyers and sellers, which leads to tighter spreads and less volatility. Conversely, low liquidity can result in large price swings and higher transaction costs.

Liquidity Pool

A liquidity pool is a crowdsourced pool of cryptocurrencies locked in a smart contract used to facilitate trades on a decentralized exchange.

Liquidity Mining

Liquidity Mining is a DeFi strategy where users provide liquidity to a protocol’s pools and earn rewards, usually in the platform’s native tokens. By depositing token pairs into a liquidity pool, users facilitate trading on decentralized exchanges and are compensated with fees or additional tokens.

Market Capitalization

Market capitalization is the total value of a cryptocurrency, calculated by multiplying the total supply by the current price.

Max Supply

Maximum supply is the total number of tokens that will ever be created, set at the time of a cryptocurrency’s creation.

Mining

Mining is the process of validating blockchain transactions and receiving rewards in the form of new coins.

Minting

Minting is the process of generating new coins by authenticating data and recording it on the blockchain through a proof-of-stake protocol.

NFT (Non-Fungible Token)

NFTs are digital assets representing ownership of unique items or content, stored on a blockchain.

P2P (Peer-to-Peer)

P2P refers to a decentralized network where participants interact directly with each other without intermediaries.

Proof of Burn

Proof of Burn involves burning tokens to achieve distributed consensus, where miners show proof of burning tokens to mine new blocks and earn rewards.

Proof of Stake

Proof of Stake is a consensus algorithm where the creator of a new block is chosen based on their stake in the network.

Proof of Work

Proof of Work is a consensus algorithm where the creator of a new block is chosen based on their ability to solve a computational problem.

Security Token Offering (STO)

STO is a regulated fundraising event where digital tokens representing real-world assets are offered.

Staking

Staking involves holding crypto funds in a wallet to support the functionality of a blockchain system and receiving rewards in return.

Swap

A swap is a transaction where one cryptocurrency is exchanged for another, either through an exchange or directly between users.

Token Issuance

Token issuance is the process of creating and distributing tokens on a blockchain network.

Token Listing Price

Token Listing Price is the initial price at which a token is made available for purchase on a secondary market.

Token Velocity

Token velocity is the rate at which tokens are exchanged or used on a blockchain network.

Token Vesting

Token vesting is the release of tokens over time to align the interests of token holders and project creators.

Total Supply

Total Supply is the number of tokens created and issued within a blockchain network.

Unlock Schedule

An Unlock Schedule is a plan for releasing tokens over time as part of a token vesting arrangement.

Ve Tokens (Vote Escrowed Tokens)

Ve Tokens are tokens locked for a certain period, granting governance rights, higher staking rewards, or other privileges.

Wallet

A wallet is a digital storage platform that allows individuals to securely store and manage their digital assets.

Whale

A Whale is a large holder of a particular token or cryptocurrency, capable of significantly influencing the market.

On the road to expertise in tokenomics

Armed with these frequently searched terms, you’re well-prepared to delve into tokenomics and expand your knowledge. For additional resources, you can consult the research section on our website.

 

To gain deeper insights and personalized guidance, or if you need advice for your tokenomics, schedule a meeting with our founder and Head of Tokenomics, Vincent De Vos: schedule a meeting.