Decoding Tokenomics Fundamentals

As cryptocurrencies continue to disrupt traditional financial systems, tokenomics plays a pivotal role in shaping the dynamics of token prices. One popular token model gaining traction is the "network medium of exchange token." In this model, developers build a sharing-economy-style network where sellers offer services and buyers purchase them using the token. However, this approach introduces complexities and uncertainties regarding the token's value and long-term sustainability.

To grasp the essence of this token model, let's explore a simple economic scenario. Suppose a product in a decentralized network is valued at X, and buyers purchase Y units of the token during the sale. The sellers offer the product within the network for Z tokens, creating a cycle of transactions. Buyers use their tokens to purchase the product, but the cycle remains incomplete unless there is an ongoing stream of buyers and sellers. This perpetual dependency raises concerns about the token's stability and long-term viability.

Traditional macroeconomics employs a simple equation to evaluate the value of a medium of exchange, represented as MV = PT.? Token Supply (M), Token Velocity (V), Token Price Level (P), and Token Transaction Volume (T).

Token Supply (M)

Token Supply represents the total number of tokens available in circulation. This factor plays a significant role in determining a token's scarcity and, consequently, its perceived value. Tokens are often generated through Initial Coin Offerings (ICOs) or Token Generation Events (TGEs) and then distributed among investors and participants.

Token Supply = Tokens Generated - Tokens Consumed

Tokens Generated: This refers to the number of tokens created during ICOs or TGEs. It is important to consider the structure of vesting and cliff periods, as increased sell pressure may be expected during unlocks when participants seek to realize profits.

Tokens Consumed: Evaluating the number of tokens consumed through transactions is crucial to understanding the token supply available in the market. If there are insufficient consumption transactions, it might hinder the circulation of tokens, affecting tokenomics.

Token Velocity (V)

Token Velocity measures how frequently a token changes hands within a given period. In simpler terms, it indicates how many times a token is transacted during a specific timeframe. A higher token velocity suggests that tokens are actively being used for various transactions, while lower velocity indicates limited demand or utility.

Token Price Level (P)

Token Price Level is the inverse of token price. It represents the value of goods and services denominated in the token. As the token price level increases, the purchasing power of the token decreases, and vice versa. Understanding the token price level is essential for assessing the real-world economic value and usability of the token.

Token Transaction Volume (T)

Token Transaction Volume represents the economic value of all transactions conducted using the token. It provides insights into the level of economic activity within the token ecosystem. Token transaction volume is usually considered from an annualized perspective to capture the overall economic activity involving the token.

Token Price Determination

The formula for determining the token price is:

Token Price = T / MV

Here, T represents the Token Transaction Volume, M represents the Token Supply, and V represents the Token Velocity. By using this formula, we can calculate the token price based on the economic value of transactions and the relationship between token supply and velocity.

Understanding Token Velocity

Token Velocity is the average number of times a token changes hands within the token economy. To better grasp this concept, let's consider an economy that transacts in $ABC tokens, where there are only 10 $ABC tokens available in circulation.

For example:

Today, 10 $ABC tokens are exchanged for US$10 worth of services.

Tomorrow, those same 10 $ABC tokens are used to purchase US$10 worth of food.

The day after, the food vendor uses the same 10 $ABC tokens to buy US$10 worth of ingredients.

In this scenario, the economic value of transactions facilitated by the same 10 $ABC tokens is US$30, and the token velocity is 3 ($ABC tokens changed hands 3 times).

Determining Token Velocity

Token Velocity is calculated using the formula:

Token Velocity = Trading Volume / Token Transaction Volume

To determine the trading volume, we need to consider two types of trades: foundational trades (trading tokens for goods and services) and speculative trades (trade with the next investor, aiming for profit). Foundational trades involve purchasing and spending tokens, both of which contribute to the trading volume.

Speculative trades depend on assumptions about the number of tokens traded for speculative purposes.

Token Transaction Volume is measured by considering different transaction types, also known as Token Sinks. A transaction is considered a Token Sink when tokens are consumed or staked. For each transaction, the dollar value gamers are willing to spend needs to be estimated.

For example:

Transaction Type 1: Forging of Weapons

Number of gamers who will forge weapons: 1,000,000

Willingness to spend to forge a weapon: $1

Transaction Volume = 1M x $1 = $1M

Token Velocity Impact

Token Velocity plays a critical role in tokenomic design and can significantly impact token prices. A high token velocity indicates frequent token turnover, which may lead to reduced token value due to lower holding demand.

Conversely, a low token velocity may indicate a lack of token utility, potentially resulting in illiquidity and reduced economic activity.

Stabilizing Token Velocity

To stabilize token velocity, several strategies can be employed:

1. Balance Token Generation and Consumption: Properly manage token issuance to balance supply and demand, avoiding excessive inflation and deflation.
2. Profit Sharing Mechanism: Implement a profit-sharing mechanism that rewards token holders, encouraging them to hold tokens for longer periods.
3. Staking with Progressive APY: Offer staking options with progressive Annual Percentage Yield (APY) to incentivize longer lock-up periods and promote token holding.

Tokenomics is a crucial aspect of the cryptocurrency and blockchain space, influencing the behavior and value of tokens in the market. By understanding the four key ingredients for price discovery and considering the available token supply through Tokens Generated and Tokens Consumed, we can gain valuable insights into how token prices may fluctuate over time.

Founders and participants in token economies should carefully analyze tokenomics to forecast potential scenarios and make informed decisions. A well-designed tokenomics framework, combined with experimentation and adaptation, can contribute to a robust and sustainable token economy with a thriving ecosystem. Striking a balance between welcoming new entrants and preserving the value of existing tokens is essential for a healthy and successful token economy.

As the blockchain space evolves, striking a balance between innovation and stability remains the key to success.

Here are some useful links to dive deeper:

1. On Medium-of-Exchange Token Valuations
2. The velocity of TokensVelocity of Tokens
3. Token Design for Serious People