FOMO season is here. At least that's how it feels.
Crypto has been up for 3 months, and altcoins are shilled to the right and left on Twitter daily.
Everyone wants to make it.
As a consequence memes and Ponzi projects makes a comeback.
Tokenomics, Token Design & FOMO Season
Some of the meme projects are up several thousand % in the last few days. So in today’s post, I wanted to look closer at token design, how “easy” it is to create your own token, why some projects boom, and why some projects fade.
Let’s just start with an example right away:
Let’s call the project WAGMI and ticker $WAGMI (this ticker exists already, but let’s just pretend it’s a new one). Also, it’s an easy name to remember because of the meme vibe.
Next, we need to decide on the supply of the token.
Let’s say it’s 1,000,000.
You pair 1 mill $WAGMI with 1 million equivalent of Ethereum, for simplicity, let’s say that’s 500 ETH tokens. You pool it in the exchange contract, and this can then be used as liquidity. Users then trade against this liquidity pool.
Okay, to understand this, let’s look at the Uniswap model.
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The Uniswap model
Instead of relying on an order book and a constant supply of buyers and sellers to determine price, Uniswap simply uses a constant equation: x * y = k.
“X” and “Y” in the equation, show the quantity of the native token ($WAGMI) and ETH tokens currently available in the liquidity pool as variables, while “k” is a constant value.
So going by this equation, Uniswap essentially uses a model of balance between both sets of tokens along with the supply and demand required to reach a price.
Anyway, the price should now be $1, because there’s an equal amount of $WAGMI tokens and ETH in the pool.
How do we know that?
The balance equation is as follows:
500 ETH * ETH Price = 1m WAGMI * Token Price
500 ETH at $2,000 is 1,000,000 USD, meaning the value of the tokens on the other side is also 1,000,000 USD. Since there are 1m tokens, the price will equal 1,000,000/1,000,000 = $1
Since the only unknow is the token price, next we get this:
TokenPrice = (500 ETH * ETH Price) / 1m WAGMI
If someone buys $WAGMI with ETH, then the supply of $WAGMI decreases as the supply of ETH increases causing the price of $WAGMI to increase.
Then someone comes along and sells $WAGMI and receives ETH in exchange which causes the supply of ETH to decrease and the supply of $WAGMI to increase. This results in the price of $WAGMI decreasing.
So far, so good.
But what happens to the price when a trade is made?
From the example above we have $1m on both sides of the equation. A total of $2m liquidity. 500 ETH and 1m of $WAGMI
Okay, but let’s say someone want to buy the WAGMI token. Let’s say they want to ape in $20k worth of $ETH (10 ETH tokens).
Well, this leads to a rebalance from:
500 ETH * ETH Price = 1m WAGMI * Token Price
to
510 ETH * ETH Price = 980,000 WAGMI * Token Price
TokenPrice = (510 ETH * ETH Price) / 980k WAGMI = $1.0481
A 10 ETH buy of WAGMI tokens will lead to a price of 1,0408 = a 4% price increase
But all right. Now we have created liquidity.
So anyone can buy and sell $WAGMI.
And you’ve also learned how you can calculate the price of the $WAGMI token.
On paper, you’re now a millionaire, but as long as no one buys your token, you’re still at status quo. But why would anyone buy your token?
Creating incentives to buy your token
To create trading volume you need marketing, I won’t go into detail on this in this newsletter issue, but a common tactic is to recruit influencers on Youtube and Twitter to share about the project for a token allocation.
But okay, you can buy and sell the token. But in today’s crypto world that’s not enough. So let’s create some incentives to buy the token. Let’s make it cool to own $WAGMI.
But how?
Let’s make a liquidity provider (LP) campaign.
Pair your $WAGMI tokens with $USDT and get rewards in more $WAGMI tokens.
This leads to increased demand in $WAGMI —> which leads to increased $WAGMI price.
But it also leads to high token inflation. Because as you probably understood, these tokens must come from somewhere.
And if everyone gets unlimited tokens the token must decrease in value? Right?
Messari explained this well in the figure above, let’s go through it with the $WAGMI token as an example.
The new LP pool with $WAGMI/$USDT is launched.
You decide to pair your $WAGMI with $USDT and you are now an LP. LP’s earn 0.3% of all the transactions. The fees are distributed in both of the tokens ($WAGMI and $ETH). This is a fee that Uniswap takes and gives to the LPs.
The $WAGMI price increases because of increased demand of users. Everyone wants to earn money on LP’s.
APR can be calculated by taking daily fees * 365, and then divide it by the total liquidity. This means = higher trading volume —> higher APR. And more people in the LP pool = more people to divide the fees on —> lower APR.
In general everything is good as long as people continue to buy the token, or as long as demand > supply. But if users stop buying the token —> token price down —> APR lower because of lower trading volume —> more people will sell —> reduced token price. As you can see on the figure we have an uptrending spiral effect as long as people buy the token, and vice verse a negative spirale when liquidity and confidence in the token goes down.
Eventually the project dies, unless new incentives ae created. You will see this as “an updated roadmap”.
So what can a project do to create new incentives and a “better roadmap”? Some examples:
Building a DEX —> community feeling (gives people a “home”) and you don’t have to buy the token on Uniswap. Will most likely increase fees —> increase APR —> more people buy the $WAGMI tokens
WAGMI was launched as an ERC-20 token on the Ethereum chain. But why not make an own chain? Or a layer-2? Will create hype, communityfeeling and increased interest and (hopefully) liquidity
Change tokenomics: For example burning of tokens for every swap in the hope of reduce the token inflation.
Create an algo stablecoin (already tried by several projects, and hasn’t worked too well)
Cross-chain launch (eg. launch on several EVM chains) —> increased liquidity
Why should anyone buy your $WAGMI token?
If you want to create a token that will be successful, you need to solve people some “real” problems. I’m using ““ here, because after all, most projects doesn’t solve anything. But the few who do drives the industry forward.
For example, look at all the meme coins. They’re created for the meme culture only, and is a purer PvP-concept. You’re buying in the hope of dumping the bags on another person at a higher price.
As a result, many projects like this fail after some weeks/months due to a lack of demand for their services or products.
Because of that, the first step to creating a crypto token is to decide which business problems your token will solve, why you need it, and whether you need it.
If you want to create an asset-backed token, then the value of this token must be tied to some asset – real estate, stocks, gold, or anything else with tangible value.
If you want to use your token for fundraising purposes, you need to give the holders some kind of return on their investment in your project.
If you think about it, most tokens don’t have any value at all. Most tokens are governance tokens, but is really governance in DeFi today decentralized? Other tokens has the use value of paying gas in transaction swaps.
If we take $BNB as an example you could use it for:
a) gas fees
b) get rebate on trading fees on Binance by holding a certain number of $BNB tokens
c) Visa card cashback if you hold $BNB tokens
d) to invest in Binance launchpad projects
e) as payment on several sites that Binance has an agreement with
f) staking/LP, lending/borrowing, etc.
But your $WAGMI token? What’s the use case? Well, that’s something you have to decide.
Also, you have to decide on the token distribution, and how many tokens should be allocated to the team, advisors, DAO, etc.
For tokenomics, I highly recommend you to check out these well-written articles by Nat Eliason:
Tokenomics 101
Tokenomics 102
Tokenomics 103
Tokenomics 104
For more inspiration also check out this creative thread by DeFi Ignas:
https://twitter.com/DefiIgnas/status/1574675448054751233?s=20
Tokenomics and token design are something I want to discuss more later on.
But for now, let’s finish it off.
Hope you enjoyed this write-up and have a great Thursday!
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Thank you. This is a wonderful and informative piece.
Thank you.