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The term tokenomics is made up of the two words “token” and “economics”. In essence, it describes all the factors that can make a given token a worthwhile investment. The factors are many, ranging from the total amount of tokens to their respective properties and utility for its holders.
Why tokenomics are so important
Just like the currencies of different economies, tokens from crypto protocols also have their own characteristics such as voting rights, token count, cash flow characteristics and usage options. These properties, the tokenomics of a particular cryptocurrency, can affect the value of that token and thus its attractiveness to investors.
It is therefore essential for any cryptocurrency investor to understand how the tokenomics of a given token work, as these can be crucial for long-term appreciation. Below we take a look at some of the most popular tokenomics designs in the crypto market.
1. Governance Tokens (COMP, ENS, UNI)
Popularized by Compound and Uniswap in 2020, governance tokens offer exactly what the name suggests: governance rights over an underlying decentralized protocol. For a long time, governance tokens were the standard, especially in the DeFi sector.
In general, governance tokens have a bad reputation in the community, being labeled as worthless and having no economically measurable value. Each token corresponds to one vote – that’s all. This is a valid criticism. Prominent governance tokens like UNI and COMP do not offer investors participation in the Compound and Uniswap protocol revenues. But they obviously have some value as they can affect their underlying protocols.
In addition, governance tokens authorize their holders to change certain parameters of the protocol. In theory, this allows users to receive a portion of the log income in the future.
With Uniswap, for example, UNI holders recently voted to change the protocol’s fee structure so that UNI holders participate directly in the protocol’s revenue.
2. Cash Flow Tokens (GMX, SNX, MKR)
Such tokenomics are already a reality with other protocols. In addition to the governance function, GMX (GMX), Maker (MKR) and Synthetix Network (SNX), for example, grant their investors a direct participation in the earnings of their protocols via staking.
Maker was one of the first protocols to use such a token design. The Protocol’s revenue from the loans taken through the Protocol will be used to buy back and burn MKR. Holding MKR gives investors cash flow rights due to the ever-decreasing supply of MKR tokens.
While with MKR passive holding of tokens is sufficient to receive a share of the protocol’s revenue, with other protocols tokens must first be staked. For example, at GMX, those staking GMX tokens receive 30 percent of the revenue the protocol receives from users conducting trades on the DeFi exchange.
3. veToken (CRV, YFI, BAL)
Another design are so-called veTokens. Popularized by the decentralized exchange Curve Finance (CRV), tokenomics allows token holders to stake their tokens for a predefined period of time (typically from one week to four years).
By staking their tokens, users receive a veToken (veCRV for CRV) based on the length of the blocking period chosen. For example, a user who stacks 1,000 CRV for a year will receive 250 veCRV. This compares to 1,000 (250 x 4) veCRV for staking the same amount for four years.
The special thing about this is that veTokens usually have special rights in the protocol. At Curve, veCRV holders have the right to decide which of Curve’s liquidity pools receive so-called CRV liquidity mining rewards. Also, veCRV holders receive dividends generated by traders on Curve Finance. Overall, the veToken model thus combines the two tokenomics designs mentioned above and adds a few more properties.
Value-added token models are not the end of the story. Each protocol can decide for itself how to design its tokenomics. Theoretically there are no limits to the possibilities. There is no doubt that cash flow rights have positive potential for token holders and increase the attractiveness of the asset, especially if the protocol generates significant fees. But ultimately it is far from clear which tokenomics are optimal. One can assume that there will be a large number of new designs in the next few years, which will be combined in different ways.