Tokenomics 101 📈

Hey y’all! Chad here - Kendall and I officially kicked off the academic year at The Wharton School (catch us sitting together in Accounting!). And after a week full of “networking”, “small group dinners”, and “business trips” our wallets said it was time to be responsible, starting with going to the grocery store to cook our own meals. But low and behold, it's hard to be responsible at the grocery store when prices jumped 12.2% over the past year (according to the June Consumer Price Index). Good ol’ inflation. 

Sadly, inflation also exists in cryptocurrency, best explained through a concept known as Tokenomics. Today we’re going to do a little education on this concept, why it matters, and what happens when tokenomics go wrong. 

So, what is Tokenomics?

At the most basic level, the word Tokenomics is a combination of “token” and “economics.” Let’s first start by aligning on what tokens are. Tokens are any digital records, such as NFTs, on the blockchain. They represent things, such as digital art, an article online, or even a portrait of yourself (although you have to be pretty vain to do that haha). The value of tokens comes when the thing is seen as attractive or valuable to a group of people. 

Although it’s sometimes easy to conflate tokens and coins, another key difference between them is that tokens aren’t money. Unlike coins, tokens don’t have their own blockchain. Instead, they operate on other crypto coins' blockchains. For example, Ethereum uses Ether as its native cryptocurrency, but tokens such as BAT (Basic Attention Token) and Loopring exist on Ethereum's blockchain.

What impacts the economics of a token?

When you think about economics, words such as “supply” and “demand” probably come to mind–and for good reason.

The value of the token depends on everything from the maximum supply of tokens, how new tokens are added or removed from circulation, incentives for token holders, and the project’s utility.

Projects that get this right surge in value, so developers focus on changing these key variables to impact the supply and demand of the token:

1. Mining – New tokens are given to those who devote their computing power to validating transitions on the blockchain.

2. Staking – People who lock away a number of coins in a smart contract are rewarded in return with tokens.

3. Yields – DeFi (decentralized finance) platforms offer high yields, paid out in the form of new tokens, to incentivize people to buy and stake tokens.

4. Token burns – Some blockchains or protocols will permanently remove tokens from circulation to reduce the supply and make the available tokens more scarce.

5. Limited vs. unlimited supply – This determines the maximum supply available. 

6. Token allocations and vesting periods – A lot of times, a small portion of tokens are reserved for VCs or developers who can sell those tokens only after a certain time period. 

Putting theory into practice - the case of Axie Infinity

Let us introduce you to Axie Infinity, an NFT-based online video game inspired byTamagotchis and Pokemon Go. Last summer, Axie Infinity was the pinnacle of success for Play to Earn Gaming (yup, just how it sounds - players earn money for playing the game). In this game, players breed and collect Axies, cute little NFT characters, that fight against other Axies. 

Unlike conventional in-game items (think mushrooms in Mario or even Pokemon), the Axies can be traded on the game’s marketplace for REAL money. The earnings were so lucrative that thousands of people in Southeast Asia quit their day jobs to play this game full-time, earning scholarships to cover upfront costs of playing (you have to buy a few starter Axies before you can play, costing a few hundred dollars). 

But the fun was short-lived.

The game of Axie Infinity runs on two tokens: 

• Smooth Love Potion (SLP): the game’s uncapped utility token that is earned from winning battles and achieving goals in game, primarily burned by breeding Axies

• AXS: the game’s governance token

Despite huge success,the growth could not be maintained. 

Less and less users played the game → less and less Axies were bread → the supply of SLP quickly outpaced the demand → value of the SLP token to crashed 

This was just one case study on how Tokenomics will play a huge role in the future success of all token projects. While many believe that the golden days of Axie Infinity are behind, the team at Sky Mavis is actively putting in new gaming economics to prevent another crash. If anything, Axie Infinity gave us a peak at the potential of gaming NFTs, and how Tokenomics could become a more robust, studied field–maybe even a college major! As the world goes more digital and adoption of blockchain technology becomes more mainstream, we’re bound to see creative new ways for developers to leverage standard economic principles to further their projects.

Thanks for reading! ✌🏽