What are the best ways to design tokenomics? A quick primer

What are the best ways to design tokenomics? A quick primer

As more and more projects launch their own tokens and design their tokenomics it's essential to understand how to design a tokenomic model that works. Unfortunately, many projects simply ‘copy paste’ other projects tokenomic designs without thinking through whether their model is a right fit for them.

What do the best tokenomics models and designs look like? Let’s look at five principles to consider that best tokenomic models use.

Five principles the best designed tokenomics use

Tokenomics, one of the big innovations of web3, bring a lot to the table. Done right they can supercharge your product. Messed up, they can bring it crashing down.

Here are five principles to consider when designing the best tokenomics:

1. Understanding why you have a token in the first place. What is the purpose of the token? What goal is it serving? Without a clear understanding of the token's purpose, it's difficult to design a successful tokenomic model. There are seven reasons to launch a token. Best tokenomic designs know exactly why they’re launching a token and what purpose it serves.
2. Understanding when the right time to distribute your token is. Too many projects launch their tokens too early (or too late) and end up messing up their project. It's important to consider the timing of token distribution and how it will impact the project's growth. Tokens are not startup equity, although many projects treat them like that. This mismatch causes lots of tokens to fail. The best tokenomic designs match the ‘when’ of their token to the stage their product is at.
3. Understanding the supply and demand dynamics behind your token. Who wants your token? Why is someone using it? Who's selling your token? How are tokens entering the market? When and how many tokens? These are all important questions to consider when designing a tokenomic model. Best designed tokenomics match their forecasted supply and demand so the market can absorb demand without undue price spikes and shortages.
4. Token liquidity. How can people access your tokens? What is the expected volume? Ensuring that your tokens have liquidity is crucial for the success of the project and the growth of the network.
5. Security. The best tokenomics take all edge cases into account and preserve product, token and user security. This means thinking about long term viability and financial attack surfaces.

By considering these five principles, you can design a tokenomic model that serves your project's goals and incentivizes participation.

Who are the web3 projects with the best tokenomic designs

Looking at these four factors, let’s answer the question of which projects have the best tokenomics in web3?

These three projects are great examples of great tokenomic designs.

1. MakerDAO
2. Bitcoin
3. Thorchain

Others with good, but not great, tokenomic designs are:

1. Liquity
2. Curve

Note that this isn’t an exhaustive list, just examples, and there are some parts to a tokenomic design that I haven’t included.

An analysis of MakerDAO’s tokenomics

MakerDAO’s tokenomics is made up of three tokens: DAI, MKR and ETH. Simply, the system works as an on chain ‘central bank’ where users deposit ETH as collateral to withdraw DAI, a USD pegged stablecoin. MKR is the bridge token used to add collateral, incentivize participation & governance, and ensure the stability of the network. MKR is created and sold off to pay back DAI loans whenever the price of ETH falls, and is also used to pay loan fees and liquidation penalties.

Why Token

The why of MakerDAO’s token design is very clear: the system is designed to create a stable coin based on ETH as collateral. But ETH is a volatile asset, which doesn’t make it the best collateral. Hence a third asset is needed to backstop the protocol - MKR. MKR can only act as collateral if it has intrinsic value, which it accrues by protocol mechanisms such as burn and governance.

When Token

From the early days of the protocol MakerDAOs tokenomic structure has been complete and token supply has increased in accordance with actual demand. This meant there was never a supply overhand due to lack of product-token fit and the tokenomics had real utility at launch.

Token supply and demand

MakerDAO didn’t launch with a perfectly matched token supply & demand. For several years supply far outweighed the burn mechanism in the protocol, but during the 2021 bull market things started to even out.

When balancing the supply and burn from the demand during this period, approximately 4% of MKR got burned, which is equivalent to many public company’s stock buybacks. While this does decrease during bear markets, and it’s not the best to take the best bull market as a benchmark, the point remains the same. With good market dynamics, the supply and demand of MKR balance out nicely. This wouldn’t have worked out this way without MakerDAO launching with most of their tokens and the market reaching an equilibrium.

Token liquidity

MakerDAO launched with plenty of liquidity and since MKR is one of the original tokens in the space, they’ve been listed on exchanges since the early days and the team didn’t hoard tokens, meaning the token could be distributed to many different holders.

How do the best designed tokenomics look?

The best tokenomics projects are designed with purpose, timing, supply and demand dynamics, liquidity and security and long term viability in mind.

By understanding the purpose of the token and the right time to distribute it, as well as considering the supply and demand dynamics and ensuring liquidity, a successful tokenomic model can be created that serves the project's goals and incentivizes participation.