DeFi Man

Posted on May 19, 2023Read on

Crypto fundamentals 101 Chapter 3: Tokenomics

“Tokenomics” is one of the most used words in crypto, and yet still probably the most overlooked factor by newcomers at the time of investing.

It makes reference to all the important information in relation with the token and it has a big impact on the token price action.

I like to think about tokenomics like a complex equation with multiple variables, almost infinite combinations, being some of them way more bullish than others, as we will see in this article.

Main objective is to identify how good tokenomics look like, and separe good traits from predatory ones, so you have all the tools you need to do a proper due diligence from now on when you are researching a new project.

Let’s dive in!

1. Equation variables

Supply and demand rule our world, and are the main reason behind crypto price action. So we will structure our analysis around that 2 main blocks.

Following framework aims to provide a quick glance into the most important variables in current crypto projects and the relationship between them.

Always keep in mind, low supply and big demand usually leads to good price action.

Tokenomics framework

2. Supply

The lower the supply the better

As simple as that. No need to overcomplicate things.

There are two important metrics regarding supply. Circulating supply and total supply

Total supply = Circulating supply + Locked tokens

Usually the easiest way to think about it is “the less supply that is expected to hit the market the better”

That usually translates into high ratios [circulating supply/total supply] are good, being the opposite also true. We can consider a high ratio everything bigger than 0.5, specially if it is a recently launched project.

2.1 Circulating supply expansion

Liquidity mining emissions

DeFi projects usually implement liquidity mining programs to bootstrap liquidity, attract users, incentivize token holders etc. I believe this is an ok strategy in the first stages of the project, but don’t let anyone gaslight you, this introduces a constant selling pressure, that while it might not have that much effect in the short term it will be noted in the long term.

Long term projects should strive for profitability, like any other business out there, so ideally revenues - emissions > 0 in the medium term and emissions should stop eventually. Below you can see some examples of what could be considered high inflation for a token (also unlocks are included in these numbers)

If the protocol emits more than 5% of the circ supply monthly that should be considered too high (with the exception of the first months)

Token unlocks

Projects almost always sell tokens at launch to fund project development and push the project forward, those tokens are usually vested and will unlock along the way, those unlock dates tend to be big selling events as “everyone wants to sell first”

And bullish unlocks? Yeah, they exist, Solana and MAGIC were good examples, but they are the exception to the rule, not the opposite. The bigger amount of tokens that gets unlocked the higher the chances of a flight to goblin town.

This is a necessary evil, projects need to have strong treasuries to fulfill the long term vision, so instead of avoiding every coin with unlocks, try to find out those with a long term calendar and light unlocks.

Best to avoid also projects with too predatory tokenomics (lots of tokens in the hands of team, insiders, private investors etc) as gravity for those is usually higher. Solana projects are a good example of this.

If more than 50% of tokens are in the hands of insiders, best to stay away.


2.2 Circulating supply reduction

Locking tokens mechanisms

Well designed tokenomics will incentivize holders to keep holding the token, so numba goes up. One of the ways to do this is introducing lock ups on a certain portion of the tokens in exchange for sweet deals. Curve was the first mover in this field with their ve-tokens giving bigger benefits to the people locking up their tokens for the most time. The other main model is the GMX one, introducing multiplier points and esTokens (tokens subjected to vesting)

Main takeaway is the more tokens are locked, the lower the circulating supply and thus less sell pressure. A sustainable locking mechanism needs the incentive program to be more than inflationary emissions of the project token, otherwise it is not more than a circular reference, and sell pressure will offset the gains achieved by the locking. Tokenomics are a necessary condition, but not a sufficient one. Revenue generation is the other part of the equation.

Usually when a protocol has more than 50% of the circulating supply staked, tends to perform better on medium-long timeframes.

Buy back programs

Some protocols use part of the profits to buy back tokens in the open market. Later they add them to the treasury, distribute to holders or burn them. This is a controversial measure, some say it is a good way to add buy pressure and thus help the token price action while others argue there could be better uses for that funds.

I personally think that while not being the best use of protocol profits, if you are not going to redistribute #realyield, this is probably the second best thing you could do for the price health of the token. Good option for projects concerned about regulatory issues related to distribution of #realyield but want to ensure some buying pressure. This action effectively increases the ownership % of each staker.

If your protocol is profitable enough to buy back 10% of the total cap, you are probably in front of a top performer in this metric.

3. Demand

3.1 Direct financial incentive

Cashflow tokens

The outperformance of this asset class during the last 12 months is the best proof this is the main demand driver, specially within bear periods, when these tokens have a clear ceiling while the rest does not.

Conceptually, it makes sense that these kind of tokens generate good demand and little sell pressure, as holders receiving dividends is really attractive and they can sell that dividends to derisk their investment in the coin.

5% APRs on average are good returns, 10% are excellent.

It might seem low, but we have to consider APRs are updated with price, so the actual returns if the protocol usage and the token price surges are way higher. Just to give a quick example, GMX will distribute 10% APR to stakers this week, but if you bought GMX at launch (2$) you are actually receiving each year 3,5 times the amount you initially invested in the project.

Inflationary rewards

It is a decent way to bootstrap initial liquidity and incentivize holders to keep staking at the early stages of the project while the product has not achieved organic traction, it also can be attractive for holders to acquire cheap tokens that could be very valuable in the future.

Main drawback is that while increasing demand for the token, it also increases the sell pressure so the gains regarding improving price action are neglectable or even negative in the medium term. Not the best lever in this aspect.

3.2 Indirect financial incentive

Discount on fees

Depending on the use case of your project, this can be an interesting demand driver like Binance has shown over the years. It usually applies best in applications with high capital efficiency that can be quite hefty to use for power users like exchanges.

Other applications like lending, vaults etc with lower revenue generation per unit of TVL will not be able to extract as much value from this feature.

It is important to recognize it will not appealing for the average Joe, as it will only be an +EV move to buy and hold for those power users of the platform, but it can still provide a strong buy pressure if the application gains enough organic traction.

The protocol will earn less revenue if the feature is enabled, but it clearly provides additional utility for a token.

Voting power

There are big treasuries out there like UNI or AAVE, that could eventually redirect some funds in a way that could be +EV for certain parties (p.e. enabling the fee switch)

These kind of decisions are reportedly open to voting by the DAO in some projects, so the voting power could potentially be very powerful in those, but in general I do not believe this to be a strong lever for demand.

There are too many caveats, such as most projects not allowing the DAO on voting in some kind of decisions, insiders hoarding the majority of tokens, governance process being too slow etc

Take this variable into account and assess how powerful it can be in each case

UNI Fee switch proposal

3.3 Hype & Intangibles


While I do not consider hype to be a part of tokenomics in the usual way, it unequivocally drives a lot of the demand for a token, so I felt it was the right thing to include it in this section.

Everyone that has been in crypto long enough knows that pumpamentals are as important as fundamentals for a project to thrive. This is usually more effective short term, but there are projects that have managed to keep the excitement through incredible long times like Cardano, so just pay attention and understand that while tokenomics on paper may not look too good, some fundamentals can be compensated with enough narrative and good communication.


Almost everyone in crypto is a profit maxi, whether they say it or not. Having said that, some decisions are not taken entirely based on numbers, so if the potential outcome could be similar between two options, you could choose one over the other based on some intangibles that are difficult to measure. While it is not easy to evaluate in the due diligence process of a project, remind this can happen.

Pro-tip here is this section usually applies in projects with strong communities, where the sense of belonging to a certain group with common beliefs, interests etc may prove more important than a simple P&L. It is seen more commonly among NFT projects.

In some cases it can also provide an additional indirect financial return, rocking a certain pfp could get you buy in in certain groups, ecosystems etc

4. Summary

  1. Tokenomics are a necessary but not sufficient condition for a project to thrive. Adoption of the project use case is usually the other necessary condition.

  2. Good tokenomics aim to reduce the circulating supply and increase the demand for the token.

  3. The higher [circ supply/total supply] the better. Higher than 0.5 is usually good enough.

  4. Liquidity emissions are a good measure in the short term to gain traction but should be stopped in due time to avoid an excessive inflation.

  5. Token unlocks are a necessary evil, but more than 50% inflation/year is usually toxic for the PA of the token.

  6. Mechanisms to lock tokens are good for tokenomics, but to be sustainable they need to be based on more than distributing inflationary rewards.

  7. Buy back initiatives are usually net positive for a project, specially if that project refuses to distribute #realyield to holders.

  8. Cashflow tokens are the most powerful demand driver for a token.

  9. Inflationary rewards may be needed but are net negative for a project tokenomics, specially if they perpetuate too much in time.

  10. Discounts on fees can be a decent driver of demand, specially on applications that command high fees on power users.

  11. Voting power can potentially be a good driver of demand, but only in a handful of cases, so do not bet too much only based on this

  12. Hype & Intangibles play an important role in the overall demand for a token, don’t underestimate this lever.

5. Final remarks

Thanks for reading!

Hope it proves useful and serve as a quick quality check for future tokenomics designs

Crypto fundamentals 101 will always be free, but if you leverage trade and want to give GMX a try, feel free to use my ref code to obtain a 10% discount on fees and collaborate with content creation.