The Only Tokenomics Video1 - Hard

Key Concepts: Token Sinks and Faucets

• Token sinks and faucets describe the flow of tokens in and out of circulation within a cryptocurrency project.
• Understanding these concepts is crucial for assessing a project's long-term sustainability and success.

Faucets: Introducing Tokens into Circulation

• Faucets release tokens into the market, increasing the circulating supply.
• Examples include: -Initial token distribution during the project's launch. -Airdrops, which distribute tokens to a wide audience, often for free. -Rewards earned by users for participating in the project.
• The main goal of faucets is to increase user participation and adoption of the project.
• Uncontrolled token distribution through faucets can lead to hyperinflation and devaluation of the token.

Sinks: Removing Tokens from Circulation

• Sinks reduce the overall token supply, applying deflationary pressure.
• Examples include: -Buyback and burn programs, where the project buys back tokens from the market and permanently removes them from circulation by "burning" them. -Transaction fees that consume tokens as users interact with the platform. -Locking tokens for voting or governance purposes.
• Some sinks are temporary, such as staking, where tokens are locked up but can eventually be released back into circulation.
• Burning mechanisms are permanent sinks.
• Sinks help stabilize or increase the token value by counteracting the inflationary effects of faucets.

Importance of Sinks and Faucets: Supply and Demand

• Sinks and faucets relate to the fundamental economic principles of supply and demand.
• Utility is important to drive demand, sinks are equally important to manage supply.
• Excessive inflation, caused by too many faucets and not enough sinks, can devalue the token, regardless of the project's utility.
• Both use cases and sinks are needed to sustain a token's price.

Designing Effective Sinks and Faucets

• The grand token equation determines token value: Token Value = Value of Use Cases / Supply of Token
• To increase token value (price), increase the value of the use cases or decrease the token supply.
• The best projects have highly desirable use cases, require their own token for access, and remove tokens from circulation when used.
• DeFi apps on layer 1 blockchains are good sinks as they use L1 tokens for gas fees, yield generation, and liquid staking.
• Vaults in DeFi apps are also effective sinks, reducing the L1 token supply (temporarily).
• Tying the token to real-world revenue is effective, requiring it to purchase products or services.
• Buyback and burn programs permanently reduce supply.
• Integrating tokens into other projects increases utility and demand, creating more sinks.
• Faucets should contribute to the overall growth of the project, for example, by increasing adoption and partnerships.

Sinks and Faucets in GameFi Projects

• GameFi projects must balance fun and game economy
• Sinks and faucets are especially important in GameFi to balance issuance and consumption.
• A harmonious balance between sinks and faucets is crucial for a sustainable game economy.
• Equation for GameFi projects: Fun + Utility of the Sink > Cost of the Sink
• If players find using a sink fun and useful, they will reinvest back into the game.
• If not, they will sell their reward tokens, increasing supply and decreasing token value.
• Examples of sinks in GameFi projects: -Unlocking new content with tokens. -Upgrading characters or resetting stats. -Auctions for rare items. -Taxes on marketplace transactions using the game's token.
• Sinks only work if people want to use them.

Case Studies

• Axie Infinity: -Relied heavily on faucets, with players earning SLP tokens. -Insufficient sinks to counterbalance incoming supply. -SLP tokens were often dumped on exchanges. -The price of their tokens crashed. -Reduction and sink additions were too late. -Balancing sinks and faucets early on is super important.
• STEPN: -Sufferred from runaway inflation. -Tokens earned from faucets exceeded tokens burnt. -Big drop in the value of their tokens. -Late sink additions couldn't reverse the downturn.
• Binance (BNB): -Extensive burn mechanisms. -Goal to burn half of total supply. -Burns transparent and automatic, based on BNB's price and activity. -Gas fees on the BNB chain burned. -Limited faucets and significant sinks. -Consistently maintained a price and reached new all-time highs. -Has strong use cases and proper sinks that reduce the supply.

Key Takeaways

• Balance sinks and faucets for sustainable growth.
• Need real-world demand for tokens and utility.