Tokenomics — All You need to Know
Dec 7, 2022
One of the key components of launching a web3 project is the token. Tokens operate as the core foundation behind our decentralized ecosystems.
As a result, designing a rigid economy for cryptocurrency tokens (tokenomics) is crucial to the long-term success of the project. Allocations, supply demands, and benefits of owning the token such as governance rights all need to be carefully considered during this process.
Tokenomics are one of the key elements that private investors consider when determining whether to invest in a web3 project or not. This is because well-designed tokenomics are much more likely to succeed in the longer term.
Here are some of the basic elements investors look into when evaluating the tokenomics of a web3 project.
Supply and Demand
From the fundamentals of basic economics, we know that the larger the supply of an asset becomes, the lesser the demand for that asset. And in Web3, rarity makes people want more.
The circulating supply and demand of the tokens (total supply of tokens available for trade in the market) need to be defined when designing the tokenomics to prevent sudden inflation of the asset. Increases in the supply of the circulating tokens can often indicate a potential downtrend in the token price.
Here are some questions you need to answer when designing the supply of your token:
- Is there a hard maximum supply?
- How and when are the tokens being released?
- Is there any deflationary mechanism?
Bitcoin, with 90% of the tokens already in circulation, has a maximum cap of 21,000,000 with the release rate being reduced in half (called the “halving”) every 4 years.
In contrast, Ethereum does not have a hard maximum supply; but it is widely used in transactions such as decentralized finance (defi), gaming, metaverse, NFT minting, decentralized identity, etc. Ethereum which is used to pay for gas when creating transactions ends up being burnt. As a result, the more activity that happens on-chain, the more deflationary Ethereum becomes over time.
Value Accrual Mechanism
Having a good accrual mechanism incentivizes a community to stay loyal to a project, with the exception of influencer-driven projects such as Dogecoin which skyrocketed due to hype and temporary demand created by Elon Musk and social media.
Projects typically introduce ways to attract loyal users to hold the tokens such as forms of yield generation through the “staking” of native tokens. Users may also be required to lock their staked tokens for a fixed period of time (1 month to 4 years) in order to receive the benefits of the yield.
These yields can be in the form of a native token or new assets within an ecosystem. For example, holders of the popular DEFI project Curve received new project tokens such as Frozen Yogurt, a Curve Finance fork.
A well-designed mechanism incentivizes holding through access to products and rewards.
For example, socialFi’s move-to-earn project stepN has an interesting incentive mechanism to ensure that participants engage with the project in the long term instead of liquidating it right away. In StepN, Green Satoshi Token (GST) can be earned when users walk/run.
However, if a token is minted regularly with no barrier of entry, it would quickly devalue the asset.
To prevent selling pressure, the StepN team increased the friction to earn GST.
Here are some of the strategies Stepn implemented:
- Users need to buy at least one sneaker (in the form of an NFT) in order to be eligible to earn GST tokens.
- A token-burning mechanism is introduced to reduce the circulation of GST in the market. Users must spend/burn GST tokens when upgrading sneakers, unlocking gem slots, or repairing sneakers.
Allocation of the Token
Allocation of the token also has to be designed with care to avoid steep liquidation or slippage after the token is listed on a decentralized or centralized exchange.
Tranches of the tokens can be split into:
- Private Investor
- Core Team
- Community & Partnership (ecosystem incentives)
- Public Sale
It is important to identify the tokenomics mechanism across all actors in the ecosystem to prevent the economic model from acting like a pyramid scheme, causing the token price to collapse.
Investors also want to know how you legally structure the distribution of the project which will be reflected in a simple agreement for future tokens (SAFT) as part of the due diligence process.
The allocation of the tokens largely depends on the project itself. If you are designing a decentralized autonomy organization (DAO) token or decentralized exchange, there has to be a large number of tokens allocated in the treasury.
In general, vesting is the process of gaining full legal rights to something. In the context of the traditional finance world, it refers to the right to receive equity or stock options incrementally over time.
In the blockchain world, project founders usually sell the tokens to private investors before the token generation event (TGE) at a discounted price. Once the token is purchased by the investors, they will need to wait for a certain period before receiving the token to avoid selling pressure during the public sale.
This period of waiting for the token to be distributed is called the vesting period. Vesting is also not just applicable to private investors, it also applies to founders, the founding team, advisors, and future employees.
In most cases, the start of a vesting process can often have a “cliff” period. A cliff typically means a period of time that must be passed before the vesting process begins. Tokens are designed to lock up to prevent early liquidation and promote long-term support of the project.
For example, if your company has a 1-year cliff, you would need to stay with the project for a year before receiving the first batch of equity. If this condition is not met, your tokens will be forfeited and reallocated.
What are the Common Types of Vesting?
Linear vesting is the simplest form of vesting schedule invented by the traditional financial world. It defines when the tokens are fully distributed to you after the cliff. In linear vesting, the same amount of tokens will be equally distributed to you periodically either by days, months, or years until they are fully released to the recipient.
Twisted vesting is the random distribution of tokens over intervals of time. The length of time can be measured in days, weeks, months, or even years. For example, the first 3 months unlock 45%, the next 1 month 10%, the next 3 days 10%, etc.)
What is smart contract based Vesting? Why is it better?
In the past, web3 companies distributed tokens either manually or by building in-house solutions.
The manual method of distributing tokens required going through a list in Excel to make sure investors, employees, and other stakeholders receive their tokens on time. Manual sending required a lot of tedious work as it is prone to errors and back-and-forth communication between the token recipients and the project.
At the same time, building in-house solutions required many engineering hours and expensive external smart contract auditing each time the smart contract changes. Additionally, building an intuitive and secured token-claiming portal takes a lot of time and effort as well.
Backed by prominent investors from Eniac Ventures, Biconomy, Spice Capital, Chainalysis, Baboon VC, AAVE, and more, VTVL is reshaping how projects, investors and employees distribute and claim tokens across blockchain systems such as Ethereum, Klatyn, Fantom, Avalanche, BSC, Polygon, Cronos, Aurora etc. As ex-Venture Capitalists, we started VTVL as we saw firsthand the relationships between projects and investors break down due to inconsistency between the token distribution/claiming and also overall transparency.
The process of creating vesting schedules via VTVL does not require coding as VTVL took care of the automation with audited smart contracts It is created to target the needs for web3 projects, venture capitals, private investors, and also employees to streamline the process of token claiming in a secured, convenient, easy and user-friendly way.
In terms of cyber-security, how secure is VTVL?
Under the leadership of VTVL’s CTO, Lawrence Hui, VTVL’s no code vesting smart contract went through a series of reviews, testing, and external audits as well as a bounty program to detect if there are any vulnerabilities.
To Conclude, self-sustaining and high-performance tokenomics requires a well-designed tokenomics model, scalable distribution tools, and also an ecosystem that adopts the tokens. A strong tokenomic model with real business use cases can ensure the ecosystem continues to grow.
More to Come…
We will be sharing more about our products, tokenomics/fundraising best practices, and upcoming web3 projects. Stay in the loop by following us.
Interested in seeing the VTVL demo and how we can help with your vesting schedules?
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This content should not be relied upon as legal, business, or investment advice. Please consult your advisors regarding these matters. References to digital assets or cryptocurrency do not constitute investment recommendations. Some information in this blog has been obtained from third-party sources and might contain third-party advertisements which had not been verified by VTVL. Any information in this blog is subject to change without further notice.