Tokenomics: The Key Driver of Cryptocurrency Price Appreciation

Tokenomics is a word that gets thrown around a lot in the cryptocurrency world. But what exactly is it? It's one of the most powerful forces shaping the price appreciation of a cryptocurrency

Tokenomics is a term used to describe the economic aspects of a cryptocurrency, such as its total supply, issuance rate, and burn mechanism. It plays a crucial role in determining a coin's potential future value and is closely monitored by traders.

A coin's supply is a key factor in its tokenomics. Some cryptocurrencies, like Bitcoin, have a limited total issuance, while others, like Ethereum and Dogecoin, have a higher rate of issuance. The speed at which new coins enter circulation can impact their availability and value.

Another aspect of tokenomics is the ability to burn coins. When cryptocurrency owners use the currency for specific purposes, such as paying transaction fees, a portion of the coins may be "burned," effectively removing them from circulation. This can help support the coin price by reducing the total supply.

By managing supply through issuance and burning, a coin issuer can influence whether a cryptocurrency is inflationary or deflationary. In an inflationary system, more coins are issued each year than are taken out of circulation, leading to a positive net issuance. Over time, the purchasing power of the currency falls as more is issued. Conversely, in a deflationary system, more coins are taken out of circulation than are put into circulation, pushing net issuance into negative territory. This results in the purchasing power of the currency rising over time.

Many cryptocurrencies aim to showcase deflationary tokenomics to support the coin price. For example, Ethereum's Merge in 2022 saw the coin transition from a proof-of-work to a proof-of-stake system. As part of this change, Ethereum sharply reduced its net issuance to become deflationary. It introduced a mechanism to burn coins during transactions, leading to a net deflationary supply, according to many.

In effect, Ethereum's issuers "rigged" the coin's tokenomics to support its price, increasing the likelihood of price appreciation over time, although it's not guaranteed.

While everyone may talk about a coin's deflationary issuance driving up price, it's important to remember that supply is only half the equation. Demand is the critical factor in driving a coin's price higher. There are many things in short supply that are worthless — for instance, the number of glasses in your kitchen cabinet is limited, but nobody will pay anything for them. In the absence of demand for an object or a cryptocurrency, a limited supply is meaningless.

Without demand, any cryptocurrency is worthless, as it has no value apart from what people are willing to pay for it. This is why there are around 20,000 or more cryptocurrencies in existence, but only a small handful are actually worth anything at all, with nearly all of them being effectively worthless.

However, managing the supply of a popular cryptocurrency—one that already has demand for its coins—can move its price higher (or lower) because it encourages traders to buy. They can purchase with the knowledge that a cryptocurrency won't be overinflated by the coin's issuers. This attracts demand, which in turn attracts still more demand, resulting in a virtuous circle.

It's these psychological dynamics that are so important in manipulating crypto prices. By increasing enthusiasm around deflationary coins and setting them against a relatively fixed or even shrinking supply of coins, prices can rise indefinitely.

As the first cryptocurrency, Bitcoin's tokenomics have been extensively studied and are highly deflationary. Famously, there are only 21 million coins available for mining, and even this limited issuance slows over time, with the total supply expected to be issued around the year 2140. As issuance slows, Bitcoin mining requires increasing energy and expense.

However, there are other favorable tailwinds for Bitcoin's supply. While 21 million coins is the maximum number of outstanding coins, some estimates suggest that around 3.7 million coins have simply been lost, likely forever. These coins may have been purchased early in Bitcoin's lifetime, when coins were cheap and considered a curious novelty. But if Bitcoin owners threw away hard drives that held these coins, they're likely permanently unavailable and effectively dead. So the real maximum supply is even lower than the potential maximum.

Thus, Bitcoin benefits from ever slower issuance and a capped number of coins on the supply side. Additionally, it gains from a herding effect as the most popular cryptocurrency, as well as the perception that it's a scarce resource. On the demand side, Bitcoin analysts keep ratcheting up price targets, driving “Bitcoin fever” ever higher and stoking demand for the coins.

With supply fixed and demand potentially continuing to rise, we could see lollapalooza effects on the price, as has already happened for an asset that was created out of thin air. However, if demand dries up for any reason—say, if quantum computing can break the coin's cryptography and effectively counterfeit coins—Bitcoin's price could fall to nothing. Again, it