Some Parameters of Tokenomics to Be Aware of
Analysis of price movements of a cryptocurrency and its growth potential is not comprehensive without considering its tokenomics. In this regard, there are many factors that may be examined, such as coin supply (circulating supply, total supply, maximum supply), a type of supply (unlimited and limited supply), emission schedules (and relative inflation rates), vesting periods.
Perhaps, there is no clear good or bad model of tokenomics, in each case, it should suit a particular purpose a cryptocurrency is designed for (and often crypto projects update tokenomics when their cryptocurrencies mature either in a centralized or decentralized way through DAOs). Nevertheless, we can try to figure out some features which could affect supply and demand, and potentially indicate a possible price decline at some stages of the cryptocurrency’s lifecycle.
Firstly, many coins with unlimited supply are believed to be struggling to hold value in the long run as a growing massive of coins depreciates due to inflation pressure. They may be less advantageous than deflationary coins promising to be scarce and therefore more valuable once they reach their supply limit. For example, with an annual inflation rate of 66.73% , CAKE does not incentivise stakers to hold their CAKE rewards but to sell them for a market price. Even regular massive burnings hardly overcome the problem. So, with respect to such coins, it is important to consider their emission schedules and use cases. ETH can be an example of well-designed tokenomics implying a non-fixed supply: its current inflation rate is 0.54%  and it is expected to have negative inflation in the future. An unlimited supply of ATOM (an inflation rate of 5.97%) has not prevented the cryptocurrency’s value to grow over the past years due to new significant use cases (a coin used in bridges, for fee payment or as airdrop to stakers of new projects like OSMOSIS and JUNO). It should be noted that for CAKE’s utility, a solution could be the creation of its own network with validators using CAKE as a native cryptocurrency.
Secondly, many coins with a fixed supply have not reached their maximum yet, so it is not known with certainty how efficiently their tokenomics will eventually work. Besides, the coins, having reached their limits in supply, may lose in value due to lack of utility.
Moreover, some cryptocurrencies with a fixed max supply in fact experience inflationary pressure. Sometimes one can meet warnings regarding ‘low float’ cryptocurrencies with a high max supply (usually can be easily tracked by FDV). For example, now there are relatively few DYDX, ILV, and OXY coins in circulation (7%, 6%, <1% of the max supply, correspondently). If their current prices hold when these coins reach their max supply, based on their market cap (over $7–8b as of 11/02/21), they will be placed in the range of the top 25 cryptocurrencies under the current economic conditions. By itself, it does not mean much, but compared with fully diluted market caps of other cryptocurrencies, we may see how a particular project is evaluated at present by the market participants. At the same time, high inflation pressure on these cryptocurrencies (204.35%, 458.33%, 362.21%, correspondently ) at some stages potentially may negatively affect their price valuation.
N. Patel gives an example that the investors who bought DOGE during the first several months after launch in 2014 had been underwater for a quite long time (some of them more than 3 years). One of the main reasons for it was a rapidly increasing circulating supply (approx. 60% in 5 months) that made it impossible to sustain the initial price level. In this respect, a circulating supply/max supply ratio combined with a block structure (or emission rate) can give a clue about possible price movements. Nevertheless, as it is widely known, the investment in DOGE of that time fully justified itself for those who hold it until 2021. DOGE did not have any official pre-mine and its emission rate has been clear and anticipatable. However, if token’s high inflation is coupled with a massive allocation to the team, marketing, development and so on, meaning that actually only a small proportion of the supply is left to the public, it can be a warning sign. In this case, one may perform more due diligence on such a project and find out where the rest of the total supply is, to avoid unexpected dump when a lock-in period expires. Other issues which could be checked are vesting periods, unlocking time, a price of the initial offering. At the same time, we cannot say that such projects will not be highly valued, just like any other company’s shares in the traditional market if it is managed properly, they may succeed, but it may be not about decentralization anymore.
Many protocols focus on the increasing value of their cryptocurrencies and resort to some mechanisms to limit supply or in another way to make the price less volatile. Apart from burning, there are also different kinds of locking mechanisms that lock up tokens for a predetermined duration of time (locking in staking, crowdloans, unbounding). Locking can also be used in the interest of the people behind the project, i.e., they can motivate investors to lock the liquidity and by this drive up the price, and then when the price is high (relative to the initial offer), to dump their holdings while the investors cannot move their locked funds. Another interesting feature is a high transaction fee for the selling of a token. Under this scheme, it is very unfavorable for investors to exit the project in a short term after entering it. However, as the practice has shown, it did not prevent Safemoon (with a 10% transaction fee) from dropping dramatically.
The creativity of crypto projects in terms of tokenomics does not seem to run short and we can meet interesting new solutions. For example, MMO incorporates an algorithm minting less MMO coins if the price goes higher. Whether such an approach is sustainable, the practice will show.
We can conclude that sometimes at the launch of a cryptocurrency, it is necessary to create high inflation in order to saturate the market with coins and make the project work; in the latter stages, it is preferable for the cryptocurrency to get negative inflation (in case there is no fixed supply). And, certainly, despite any type of tokenomics, what makes the cryptocurrency interesting and ambitious is its real-life use case, unordinary utility (not one more a ‘Bitcoin/Ethereum-killer’) and being valuable to many people.
1, 2, 3. According to the analytical platform Messari. URL: https://messari.io/screener/BDBCED13
4. Patel, Nik. An Altcoin Trader’s Handbook. Kindle Edition. P. 100–101.
Disclaimer: The information contained in this article is for informational purposes only, and is not intended as, and shall not be understood or construed as, financial or legal advice. It is very important to do your own analysis or to consult a qualified financial advisor before making any investment.