The relationship between monetary policy and tokenomics

Traditionally speaking, the concept of a monetary policy doesn’t come from crypto. Instead, it refers to a central bank’s macroeconomic measures to regulate a nation’s money supply and ensure sustainable economic growth.
But what does monetary policy have to do with tokenomics? As part of a project’s tokenomics, monetary policy deals with inflation and deflation of its token supply.
A healthy monetary policy implies that a project has a token issuance mechanism that incentivizes network participants to continue to behave in the best possible way. Additionally, it attracts new users to join the network and helps the token gain a higher valuation.
These are some of the questions you can ask about a project monetary policy to draw conclusions about its future inflation or deflation:
• How fast are the tokens released in circulation?
• Does the release rate change over time?
• Are there deflationary pressures, such as token-burning?
• Are there significant changes in technology that can affect the project’s token supply? For example, Ethereum plans to move from proof-of-work (PoW) to proof-of-stake (PoS).
In the same way that central banks strive to keep inflation at an optimal level, crypto projects focus on a token supply that best suits their strategy. There is no ‘one size fits all’ monetary policy, as the goals of crypto projects differ significantly.
For example, some projects may opt for a deflationary token model as it can help grow the value of each token (the less tokens there are, the more valuable each token becomes). In other cases, an inflationary model may be more suitable as it can incentivize holders to stake their tokens, which will also keep the network secure and decentralized.
Some projects offer incredibly high APYs of hundreds or even thousands of percent to incentivize people to remain within their ecosystems and bring forward unique use cases.
Contrary to a central bank’s monetary actions, many crypto projects do not actively manage their token supply. Instead, they have coded rules that automatically handle the underlying protocol’s token metrics. For example, blocks (tokens) are added to the blockchain with PoW and PoS consensus mechanisms, with pre-defined tokenomics metrics like circulating supply and maximum supply limiting the current and future token amounts.
At the same time, projects usually determine their token release schedules in their white papers, so the public has a good idea of how the tokenomics metrics will change over time.
However, it’s important to remember that monetary policy is ultimately decided by the communities through their governance process. This means that the protocols are not set in stone and can undergo significant changes based on how the majority votes on upgrades.
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