Understanding Tokenomics — Why Token Design Matters

Photo by Markus Winkler on Unsplash

Understanding Tokenomics — Why Token Design Matters

Welcome back to the 60-Day Web3 Journey. Join here for discussions.

Over the last 11 days, you’ve learned what blockchain is, how Bitcoin and Ethereum work, what smart contracts can do, and how DeFi and NFTs use those contracts to create financial systems and digital ownership. You’ve deployed code. You’ve understood how protocols move billions of dollars.

But here’s the question nobody asks until it’s too late: Why does a token have the value it does?

You’ve seen tokens everywhere by now. Uniswap has UNI. Aave has AAVE. Bitcoin has BTC. Ethereum has ETH. DeFi protocols have their own tokens. But why do these tokens exist in the first place? Why are they designed the way they are? And why does some random token go to zero while another goes to $100,000?

The answer is tokenomics.

This is Day 12 of your 60-day Web3 journey. Today, you stop being confused about why tokens matter.

What Is Tokenomics?

Tokenomics is a blend of “token” + “economics.” It’s the study of how tokens are designed, distributed, and used within a blockchain ecosystem.

But here’s the key: A token’s value is determined by how it’s designed, not by hype or luck.

Let’s break down what makes a token valuable:

Element: Supply
What It Does: How many tokens exist (or will exist)
Example: Bitcoin: 21 million total

Element: Distribution
What It Does: Who gets the tokens and when
Example: Aave: 16% to founders, 50% to community

Element: Use Case
What It Does: What you do with the token
Example: UNI: vote on protocol changes

Element: Scarcity
What It Does: How rare it is
Example: Ethereum: no max supply, but issuance limited

Element: Demand
What It Does: How many people want it
Example: Uniswap UNI: traded on every DEX

A token is only valuable if people want it. And people only want it if it does something useful or becomes scarce (or ideally, both).

The Three Types of Tokens (By Function)

1. Governance Tokens — The Voting Chip

These tokens let you vote on how a protocol changes. You own a piece of the decision-making.

Examples:

• UNI (Uniswap): Vote on protocol upgrades, fee structures, treasury usage
• AAVE (Aave): Vote on which assets can be lent/borrowed, interest rates
• MKR (MakerDAO): Vote on stablecoin parameters, collateral types

How it works:

1. You own 1 UNI token
2. New proposal: “Should Uniswap charge 0.01% or 0.05% on swaps?”
3. You vote your 1 token
4. If you owned 1,000 UNI, your vote counts 1,000x more
5. Majority wins

The catch: The more tokens you own, the more power you have. Some people see this as fair (you invested more), others see it as undemocratic (rich get richer).

2. Utility Tokens — The Tool

These tokens unlock features or services within a protocol.

Examples:

• ETH (Ethereum): You need it to pay gas fees for any transaction
• LINK (Chainlink): Staking it to become an oracle node (data provider)
• SOL (Solana): Used to pay transaction fees

How it works:

1. You want to swap tokens on Uniswap
2. You need ETH to pay the gas fee (say, $5 in ETH)
3. You send $5 ETH + your swap instruction
4. Miners take the $5 ETH as a fee
5. Your swap happens

Why this matters: If a token is genuinely useful (you need it to use the protocol), it will always have baseline demand.

3. Reward/Incentive Tokens — The Bribe

These tokens are issued to incentivize specific behaviors the protocol wants.

Examples:

• UNI (Uniswap): Rewarded to liquidity providers (people who deposit capital)
• COMP (Compound): Rewarded to lenders and borrowers to bootstrap the platform
• GGP (Goggles): Rewarded to stakers who validate transactions

How it works:

1. Uniswap launches a new trading pair (token X ↔ token Y)
2. But nobody has deposited liquidity yet, so spreads are huge
3. Uniswap says: “Deposit tokens here, and we’ll reward you with UNI tokens”
4. Liquidity providers arrive for the UNI rewards
5. Suddenly the pool is deep, spreads are tight, everyone benefits

The insight: New protocols often need to “bribe” users to show up. Once traction builds, the incentives can decrease.

How Tokens Get Distributed (Tokenomics 101)

This is where tokenomics gets interesting — and controversial.

Bitcoin (The Original)

Total supply: 21 million BTC (fixed, will never change)

Distribution:

• 2009–2012: Miners get 50 BTC per block found
• 2012–2016: Miners get 25 BTC per block (halving)
• 2016–2020: Miners get 12.5 BTC per block (halving)
• 2020–2024: Miners get 6.25 BTC per block (halving)
• 2024–2028: Miners get 3.125 BTC per block (halving)

The design choice: Every 4 years, the reward cuts in half. This creates scarcity and incentivizes early mining. It also means most BTC has already been mined (about 21.5 million out of 21 million). By 2140, no new Bitcoin will be created.

Why this matters: Bitcoin’s fixed supply is its defining feature. There will never be more than 21 million Bitcoin. This scarcity is why Bitcoin holders believe it will stay valuable.

Ethereum (More Flexible)

Total supply: Unlimited (no cap)

Distribution:

• Pre-launch (2015): 72 million ETH created (initial supply)
• Today: ~120 million ETH in circulation
• Every 12 seconds: ~2 new ETH created as validator rewards
• BUT: Users pay transaction fees in ETH, which get burned (destroyed forever)

The design choice: Ethereum has no max supply, so theoretically infinite ETH can exist. BUT the fee-burning mechanism (introduced in 2021) destroys ETH daily. As of mid-2025, more ETH is burned than created most days, making ETH deflationary (total supply shrinking).

Why this matters: Ethereum chose flexibility over scarcity. It needed a way to pay validators indefinitely. The fee-burn keeps supply in check while incentivizing network security.

Uniswap (The Governance Token)

Total supply: 1 billion UNI (fixed)

Distribution:

• 600 million (60%): Distributed to community (airdrop + liquidity providers + developers)
• 150 million (15%): Uniswap Labs team
• 150 million (15%): Investors/founders
• 100 million (10%): Advisors

The design choice: Uniswap’s founders deliberately gave 60% to the community. This was a statement: “We’re decentralizing governance from day one.” They didn’t keep the majority for themselves.

Why this matters: Token distribution affects who controls the protocol. If you keep 90% for yourself, you control the vote. If you give away 60%, you’re genuinely decentralizing power (at least initially).

The Real Question: Why Does Token Price Change?

This is where tokenomics connects to economics.

A token’s price is determined by supply and demand:

Supply:

• How many tokens exist right now? (Circulating supply)
• How many will exist in the future? (Max supply)
• Are tokens being created? Burned?

Demand:

• How many people want to buy this token?
• Why do they want it? (utility, governance, speculation, HODLing)
• Is adoption increasing or decreasing?

The formula (oversimplified):

Token Price = Market Cap ÷ Circulating Supply

Example:

• Uniswap market cap: $10 billion
• UNI circulating supply: 600 million tokens
• UNI price = $10B ÷ 600M = ~$16.67 per UNI

If demand increases to $20 billion market cap, UNI price jumps to ~$33.

But here’s the catch: If supply increases (more tokens created), the price can drop even if market cap stays the same.

Real-world example: Bitcoin halving (2024)

• Before halving: 900 BTC created per day (miner rewards)
• After halving: 450 BTC created per day
• Supply dropped 50%
• Demand stayed the same
• Result: Bitcoin price increased significantly (less supply = higher scarcity)

This is why cryptocurrency projects watch their tokenomics closely. Too much new supply, and the token price tanks even if the protocol is doing great.

The Dark Side of Tokenomics: Pump & Dump

Not all tokens are created equal. Some are designed to extract value from users, not create it.

The classic scam:

1. Create: New token launched with huge promises (“Revolutionary AI + Blockchain!”)
2. Hype: Team markets aggressively, influencers promote, price goes up 100x
3. Distribute: Team and insiders sell their tokens (they got them for free at launch)
4. Crash: Token price drops 99%, retail holders left with worthless tokens
5. Disappear: Team goes quiet or moves to the next scam

Red flags:

• No real utility for the token (just speculation)
• Founders keep 50%+ of supply
• Promises of guaranteed returns
• No clear roadmap
• Team is anonymous

Good tokenomics:

• Clear utility (you need the token for something)
• Transparent distribution (you know who owns what)
• Founders have “skin in the game” (they’re locked in for years)
• Real adoption metrics (actual usage, not just price)
• Public roadmap and governance

Learn more about avoiding scams

Connecting Back to Your Journey

Remember Day 10 (DeFi)? I explained how Uniswap and Aave work as smart contracts.

Now you understand why those protocols created tokens in the first place:

• UNI: Uniswap needed a way to let users vote on protocol changes (governance)
• AAVE: Aave needed a way to distribute early adoption incentives (rewards)

And you understand why token prices change:

• Bitcoin’s price is partly because of the halving (supply decrease)
• Ethereum’s price is affected by burn rate (supply destruction)
• Smaller tokens crash because insiders sell all at once (supply shock)

This is why tokenomics matters. It’s not just abstract economics — it’s literally how the blockchain ecosystem is designed.

Key Takeaways

• Tokenomics = the design and economics of how tokens are created, distributed, and used.
• Three main types: Governance (voting), Utility (needed to use protocol), Reward (incentive to participate).
• Token value depends on supply + demand. More scarcity + more utility = higher price potential.
• Distribution matters. If founders keep most tokens, they control the protocol. If they distribute widely, it’s more decentralized.
• Bitcoin’s design: Fixed 21 million supply, halving every 4 years, creates artificial scarcity.
• Ethereum’s design: Unlimited supply, but burn mechanism keeps it in check, prioritizes flexibility.
• Red flags: No utility, founders keep everything, anonymous team, guaranteed returns promises.

What Happens Next?

By now, you’ve learned:

• Days 1–7: The fundamentals (blockchain, Bitcoin, Ethereum, wallets, gas, Layer 2s)
• Days 8–9: How code works (smart contracts, deployment)
• Day 10: How DeFi protocols move money (Uniswap, Aave)
• Day 11: How NFTs create ownership (smart contracts for digital assets)
• Day 12 (today): How tokens are designed and why they have value

Tomorrow (Day 13), we’ll explore consensus mechanisms — the actual technology that keeps blockchains secure. You’ll understand Proof of Work, Proof of Stake, and why Ethereum switched from one to the other.

But tonight, think about this: Every token you see — Bitcoin, Ethereum, any random coin — is designed by humans to solve a specific economic problem. Some solve it well. Some are designed to scam you. Learning tokenomics helps you tell the difference.

Understanding Tokenomics — Why Token Design Matters was originally published in Coinmonks on Medium, where people are continuing the conversation by highlighting and responding to this story.