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Best Tokenomics in DeFi Simply Explained

The Best Tokenomics of a crypto project is the best possible mix of all available tokenomics tools. Tokenomics are crucial for driving value for a specific token.

What are the best tokenomics?

The best tokenmics strongly depend on the individual DeFi protocol. There is no perfect formula to create the best tokenomics model. In fact, every protocol issuing a token can choose between a variety of tokenomics tools to create a token.

Choosing between those tools often comes with trade-offs that will be crucial for the success of the protocol. Deciding in favor of one specific tool often comes with the loss of a different feature.

In general, communities launching a token should ask themselves the following questions:

  • Is the token a capital asset?
  • Can I use the token for governance purposes?
  • Does the token have utility inside the protocol?

The best tokenomics are ultimately determined by the optimal mix of all available options. The mix of tools ultimately drives value creation for the token. That’s why the best tokenomics highly depend on each individual protocol.

Let’s take a look at the different tokenomics tools each protocol can choose from!

Tools to form the best tokenomics

Capital Asset

The most common use case of a DeFi token is to give it monetary value. By turning the token into a capital asset, holders directly profit from the protocol’s growth. The concept is very similar to the way stocks work.

In plain words, DeFi protocols generate revenue, which has to be allocated somewhere. There are two main ways for DeFi protocols to use their cash flow:

  • Token Burn: The protocol can use the cash flow to buy back and burn existing tokens. The concept is very similar to a share repurchase in the stock market. By buying back tokens, the supply is reduced and the remaining tokens ultimately become more valuable.
  • Fee Issuance: Another way to turn the token into a capital asset is to issue cash flow to token holders. In general, this concept works like a dividend. Token holders are eligible to claim a share of the protocol’s revenue. However, the protocol doesn’t have to emit all earnings to token holders. In addition, we can issue it to liquidity providers or other ecosystem participants.

The protocol has do define how much of the cash flow it issues to:

  • Token holders
  • Liquidity providers

In addition, it has to decide how much of the revenue should burn the token. Cash flow is limited and money allocated to token holders cannot be used somewhere else.

In order to create the best tokenomics, protocol participants need to make trade-offs. For examply, when deciding where to optimally allocate the revenue.

Governance Token

Another tool to create the best tokenomics is governance. Governance tokens allow users to vote on key decisions of the protocol. They represent voting power inside a project. That means they are a crucial part for a project to remain decentralized.

In general, token holders influence crucial decisions regarding the project. That involves proposing or deciding on new feature proposals on the governance platform. In fact, they can even change the governance system itself.

Governance token holders are incentivized to make honest decisions; they own a “stake in the protocol.” Therefore, they will vote on governance proposals rationally and try to bring the most value to the protocol. That’s because the value of governance token will rise if the quality of their decision is high.

We call protocols with a governance token “Decentralized Autonomous Organizations.” One well-known example of a governance token is Maker (MKR). MKR holders can vote on key protocol parameters involving the native stablecoin DAI.

Utility token

The third way to form the best tokenomics structure is to include utility for the token.. In plain words, a utility token is a token that people buy with the intention to use inside a platform/protocol in the future. Owning a utility token gives the holder a special status on the platform.

For example, an online game company could issue a utility token to its users. The token holders could then use the tokens for purchases inside the game. The token would have a special status because it would be the only way to purchase a specific item. That’s how the company ensures demand for the token.

Additionally, another example would be BNB. BNB is a utility token on Binance. Binance is one of the largest cryptocurrency exchanges. Inside the exchange, BNB holders have a special status because they can use BNB to trade and pay fees on the Binance. In addition, BNB holders receive a discount in transaction fees on the Binance Exchange.

Besides, there are several other ways to give your token utility inside an ecosystem. Token designers can definitely get very creative here.

Conclusion

All in all, to create the best possible tokenomics structure for a token, protocols have to choose between different utility tools. Often, it comes with certain trade-offs: For example,when deciding where to optimally allocate the revenue. The cash flow allocated to token holders cannot be allocated elsewhere.

That’s why it’s important to carefully consider all available options when forming the best tokenomics structure.

After the protocol has decided where to allocate the revenue, it’s important to make the token useful in other ways. The most popular way is to give it a governance function or to give it utility in the protocol’s ecosystem.

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