You may have heard the word “tokenomics” before in the world of digital assets and cryptocurrency, but what does it mean? More than just the combination of the words “token” and “economics,” tokenomics is an analysis of a digital asset’s fundamental characteristics.

First, we must remember that a token is a digital unit of a digital asset, used either as a specific asset or to represent a specific use on the blockchain. Tokens have multiple use cases, but the three most common are as a security, utility, or governance token.

Just as fiat currencies (government-issued currencies not backed by a commodity like gold) are all different, each digital asset token has its own monetary policy. Now let’s explore the core features of tokenomics.

Maximum Supply

Maximum supply is simply the total number of a specific token that can ever exist. There are both inflationary and deflationary tokens. An inflationary token’s supply increases over time, while a deflationary token’s supply decreases over time.

You might know that Bitcoin’s maximum supply is capped at 21,000,000. But you may not know that there is no limit to the maximum supply of Ethereum. Both Bitcoin and Ethereum are inflationary tokens, although one has a capped maximum supply, and the other’s maximum supply is infinite.

Mining

Mining is the main incentive for a decentralized network of computers to validate transactions. New tokens are given to those who devote their computing power to discovering new blocks, filling them with data, and adding them to the blockchain.

Minting

Minting is a digital asset’s schedule for adding tokens into circulation. Inflationary tokens typically add blocks of transactions on a set schedule, and mint a specific number of tokens per block.

Burning

Burning a token – or permanently removing it from circulation – reduces the supply of coins in circulation. Deflationary tokens may have a set burn schedule, or they may burn a percentage of every transaction. In theory based on the laws of supply and demand, reducing a token’s supply should support its price, as the remaining tokens in circulation would become more scarce.

Utility

Utility is a token’s use case, or more simply the problem(s) it’s trying to solve. For some digital asset investors, utility is the most important part of any token.

Transaction Fees

Every digital asset has transaction fees built into their basic operating structure. These fees are charged at different levels in order to keep the blockchain networks running, as well as incentivize the people providing transaction validation services.

Staking

Decentralized finance platforms offer high yields to incentivize people to buy and stake their tokens in a smart contract. These tokens are staked in liquidity pools, or huge pools of tokens that power certain exchanges and platforms. The yields can be as high as 10-20% in some cases, and are paid out in the form of new tokens.

As Coinbase details, there are risks associated with staking. Unstaking takes time, and because crypto can be highly volatile, there’s a risk that the market price could be significantly higher or lower by the time the unstaking process is complete. Staking rewards come from the underlying network – not the platform – and staking rewards are not guaranteed. It is possible that the rewards you earn will be higher or lower than initial estimates based on past network behavior, including the possibility that you will not earn any reward at all.

Token Allocation & Vesting Periods

Some digital asset projects have a detailed distribution of tokens. Oftentimes a certain number of tokens are reserved for developers or VCs. However, these tokens can only be sold after a defined period of time, in essence a vesting period. This simple fact impacts the circulating supply of the token over time. In some cases a token will set up a system to reduce the potential impacts that the scheduled token distribution will have on the token’s price.

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Investment advisory services offered through Crossover Capital Brands, LLC (dba Crossover Capital), a Registered Investment Advisor with the U.S. Securities and Exchange Commission.

This material is intended for informational purposes only. It should not be construed as legal or tax advice, and is not intended to replace the advice of a qualified attorney or tax advisor. This information is not an offer or a solicitation to buy or sell securities. The information contained may have been compiled from third party sources, and is believed to be reliable.

Alternative investments – such as hedge funds and private equity/venture capital funds – are speculative and involve a high degree of risk. Likewise, the emergence of digital assets comes with its own speculative characteristics and involves a high degree of risk. Various digital assets have unique features, and the regulatory risk environment continues to change as governance requirements, rules, and lawsuits emerge. There may be material differences in the type of marketplaces available for digital assets, and there could be significant restrictions or limitations on withdrawing from or transferring these types of investments. Digital assets may incur higher fees when compared to traditional assets, and these expenses may offset returns.

Crossover Capital may not be able to independently verify digital asset valuations provided by institutions that hold or offer digital asset services. As a result, Crossover Capital will generally rely on information reported to it by third parties. As such, the information contained herein is for informational purposes. Clients should recognize that they may bear digital asset-based fees and expenses at the manager-level, as well as indirect fees, expenses, and performance-based compensation for digital assets. Spot bitcoin exchange-traded products were recently approved for listing and trading by the SEC. However, such approvals do not indicate SEC approval to use or invest in bitcoin. Clients should remain cautious and aware of the various risks associated with digital assets that have a value tied to bitcoin or other crypto related products.