Cryptocurrencies are governed by a set of rules called “tokenomics.” The term, a portmanteau of token and economics, refers to the monetary policies baked into each token or coin.
A cryptocurrency’s tokenomics govern its supply, outlining how and when more tokens are added into circulation. It can also respond to demand, determining when tokens are removed from circulation (if ever) and how holders can earn the cryptocurrency.
For instance, Bitcoin’s tokenomics, outlined in 2008 by Satoshi Nakomoto, dictate that no more than 21 million coins could ever enter circulation and that each coin has to be earned by a network of computers called miners. Ethereum’s tokenomics place no cap on its supply but burns Ether, the blockchain’s native cryptocurrency, used to pay for transactions.
Tokenomics influence how people use and value a token. NFTs, one-of-a-kind tokens, incentivize holders to value them for their digital scarcity; that has made NFTs a medium prized for digital art.
Many decentralized finance projects also reserve tokens for early investors, advisers, or the founding team. These tokens are subject to vesting periods, and usually enter circulation after a year or two. Unlocks can crash a coin’s price if newly liberated holders suddenly dump their holdings all at once. This can lead critics to accuse certain projects of having unsound tokenomics that serve to enrich insiders rather than foster long-term viability.
Cryptocurrency developers usually outline these tokenomics in a white paper published before its release. Further details are normally covered in a project’s Gitbook documentation, or on its website. A project’s founders will then bake this monetary policy into the cryptocurrency’s code.
Although investors do not expect a project’s tokenomics to change, developers authorized to make changes to the contract can do so. For example, the designers of the Ethereum-scaling solution Optimism accidentally set the coin’s annual inflation to 20% instead of 2%—a mistake they rectified after releasing the token.
Go deeper:
Incentive structures—Cobie, a critical crypto influencer
Things to look out for when investing in cryptocurrencies—Nansen
See also:
Crypto investing 101
What is Ethereum?
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MarketCapOf—compare tokens and understand how circulating supplies matter