Understanding Tokenomics: The Single Most Important Factor for Crypto Investors.
Some of my worst investments were because I didn’t understand the basics of tokenomics. As an investor, it was ignorant of me not to know something as basic as;
- The total supply of the crypto project I was investing in.
- How many tokens will it be in circulation?
- What are the token use cases?
Two Topics to Equip Yourself With.
Going through the school of hard knocks, I didn’t need someone to tell me to re-examine my investment strategy.
Then I started seeing sentences like “you will get wrecked in crypto if you don’t understand tokenomics” flying around.
I’ve spent 50+ hours studying tokenomics, and this is what I have gathered, so you don’t make the avoidable mistakes I’ve made.
You need to equip yourself with two topics in the crypto industry to make generational wealth.
- Study tokenomics models: you will learn everything about tokenomics in this post.
- Study narratives: I discussed in detail how narratives influence the crypto market.
What Does Tokenomics Mean?
Tokens are cryptocurrencies created and represent an asset, a usage right, or a unit of value issued by a protocol and are typically distributed to the public through an ICO(Initial Coin Offering), airdrop, or private sale.
Economics is the study of scarcity and its implications for the production of goods and services.
Tokenomics refers to the study of the economics of cryptocurrencies and tokens. This enables investors to determine the quality and value of potential investments.
A token will be successful and appreciated only if it has good tokenomics. Developing proper tokenomics is crucial to creating a token that reflects the value growth.
What Is The Difference Between A Token And A Coin?
I have seen several people who have made the mistake of calling all cryptocurrencies a token or coin.
At some point, I made a similar mistake.
Knowing the difference may not be so significant that you could lose a job interview.
But, when you write or speak among enlightened crypto enthusiasts or crypto experts, how you use both can easily identify whether you’ve done your homework. No one enjoys listening to someone that hasn’t done his homework.
Token: is a cryptocurrency that requires a platform to operate or exist on.
For instance, Uniswap, DYDX, AAVE, Compound, etc., are running on the Ethereum platform. If the Ethereum blockchain ceases today, these protocols must be deployed on another blockchain to function. If not, they are dead.
Coins: is a cryptocurrency that operates on its platform independently.
For instance, Ethereum, Atom, Solana, Avalanche, etc., are running on their platform. They don’t need to rely on any blockchain to run their projects. Instead, protocols build on them.
Types of Token
- Utility token
- Security token
- Fungible token
- Non-fungible token
- Soulbound NFT
Utility tokens are digital assets that provide users with specific rights or access to certain features within a protocol. They are not typically mined but are pre-mined and distributed by the team behind the project.
Utility tokens are often used to fund the development of a cryptocurrency project. It may be used to purchase goods or services offered by the crypto project. It can be used to grant access to users in a game. For instance, players need AXS to gain access to play the Axie Infinity game.
Security tokens represent tradable financial assets(like shares, bonds, and stocks) from startups, public companies, real estate, intellectual property, art investments, or professional sports teams. These financial assets pay dividends, share profits or pay interest in a way that promises future profit. Investors who own a security token could own the complete company or a fraction.
Fungible tokens are digital assets that are divisible and non-unique. If I give you 1 Ethereum and you sell it, you can buy another 1 Ethereum from any exchange of your choice, and they will remain the same.
Popularly known as NFT. NFT is indivisible and one of a kind. Imagine I gave you one “Glass NFT,” and you sold it. Tomorrow, if you want to buy it from the NFT marketplaces, you won’t get the exact Glass NFT, or else the person you sold it to wants to sell them back to you.
Imagine I wanted to join a premium crypto discord group. One of the requirements was that every new member had to do KYC before joining. Instead of filling in my name and capturing my face, I connected my wallet to their server and was immediately verified.
This wallet contains an NFT that allowed me to join the server. This NFT is called a soulbound NFT. Soulbound NFT represents the identity and reputation of an individual. The identity includes my credentials, affiliations, and commitment. Soulbound NFT is not transferable. You cannot move it from one wallet to another.
Maybe you don’t have money to invest in crypto or join premium groups for concentrated information; you should read how to make money in crypto without money.
What Investors Should be Looking out for Before Buying a Token.
Since 2017, many businesses and startups have explored the value proposition of blockchain technology. They started building projects featuring smart contracts, payment channels, decentralized applications, decentralized finance, decentralized exchanges, NFT Marketplace, etc., to utilize and improve blockchain technology and drive it mainstream.
The team behind these startups usually designs a token to complement it, then releases it to the public through an ICO or airdrop.
Ideally, the token’s properties are determined to align with the team’s vision for the project and its goals. Listed below are some of the factors that investors need to take into consideration before investing in any token:
What is the initial and total supply of the token?
What are the token issuance and burning mechanism?
Will it follow an inflationary or deflationary model?
What incentivizes users to hold, spend or use the token? This includes the potential for value appreciation, staking rewards, services that can be exchanged or accessed with the token, voting, contributing to the protocol, participation in governance, etc.
3. Use cases
What are the use cases of the token?
Will it be used as a gas fee within the protocol? Are there services within the protocol that users have to use the token to pay for?
4. Initial distribution
How are tokens allocated between the team, private and public investors?
Will there be a vesting schedule to ensure gradual token release promoting commitment to the project and discourage immediate selloff after ICO or airdrop?
Do private investors habitually dump their tokens when released, or do they buy more?
5. Technical considerations
Is it going to be released in one or more blockchains?
6. The value exchange
Are there services within the protocol that users can participate in to earn some tokens? Axie Infinity($AXS) allows users to earn while they play games within its ecosystem.
Listen to the opinion of experienced people talking about a token. Imagine you believe in Ethereum. Take your time to listen to
- the views of Ethereum maximalists.
- the views of bitcoin maximalists about Ethereum.
- the views of neutral people about Ethereum.
It will give you a different perspective.
Some Common Terms You Should Know The Meaning When Researching About Tokenomics.
Distribution and Allocation
Tokenomics distribution and allocation can be explained in two terms.
Pre-mining vs. Fair-launch:
In a pre-mined token launch (ICO), investors, developers, and team members are granted tokens before the public offering.
A fair launch is when a cryptocurrency is mined, earned, owned, and controlled by community members.
Investors see the price of a coin at $0.0000092 and think they will become rich when it hits $1. They didn’t check the circulating supply to see if it was possible. They are more interested in the price.
The circulating supply of a token is the number of tokens that have been published so far and are currently in circulation.
The maximum supply of a token is the maximum number of tokens that can ever be generated (mined or minted).
Market Capitalization (Market cap)
The Market cap is an essential factor to think about before you invest. It’s calculated by multiplying the number of tokens in circulation (supply) by the current market price of a single token.
A lower market cap has more potential to grow and make you wealthy. The higher the risk, the higher the reward. I wrote about risk management and time horizon — a 20+ years old person will approach investment differently from a 60+ years investor.
Large-cap tokens are usually for securer investment. At the same time, their growth possibility tends to be smaller.
Tokens below a 100 million market cap have more potential to do 100x than tokens with $1+ billion. Shiba Inu is a $5 billion token; the chances of doing 100x are tiny.
People who invested in LUNA, AXS, SOL, etc., when they were worth a penny made more money than people that bought bitcoin and Ethereum.
Some big words there.
But I got you.
Inflationary tokens are tokens whose circulating supply increases periodically. Bitcoin is an inflationary token. They keep adding more bitcoin into the circulating supply until the total supply has been exhausted. Pancakeswap is also an inflationary token. Where do the rewards they pay stakers to come from? Newly minted CAKE
Deflationary tokens are tokens that are there circulating supply that keeps reducing periodically. Binance coin is a deflationary token. They buy BNB back and burn it, increasing the scarcity of BNB, which would increase the price. Reducing tokens is also a marketing strategy for some protocols to encourage their community to hold their tokens.
Consensus is how different trustless entities agree to achieve a common result.
When researching a token, I first examine how they secure the network and achieve global consensus. There are different consensus mechanisms, but the most well-known ones are,
POW(proof of work)
To validate a transaction, you must prove to other network participants that you put in an effort by solving some mathematical puzzle. The network of Bitcoin, Dogecoin, Monero, etc., runs on a POW consensus. Ethereum was running on POW but has migrated to POS.
POS (proof of stake)
Blocks are verified by using the machines of coins. Investors offer their tokens as collateral for a chance to validate blocks and transactions on the network. This is a new technology, and most new crypto projects adopt this type of consensus. Binance, Avalanche, NEAR, and Cosmos are POS.
Rewards / Staking / Earnings
Another essential aspect of a project is sharing the benefits and helping the network.
Often, token projects reward users and investors for contributing to the network. Incentivizing the miners (proof-of-work model), securing the network (proof-of-stake), or confronting inflation are some reasons to do it.
How to earn rewards?
- Running Masternodes
The more utility a token has, the more value it has and the chances that the price will increase. You should be looking for tokens that have the following;
- high demand.
- scarce in circulating supply.
- More than one use case.
For instance. Binance coin($BNB), the coin of one of the largest crypto exchanges by volume, is used.
- For gas fees in Binance exchange
- For gas fees on BNB Chain
- For Launchpad on the exchange
- For Staking
- For sending and receiving payments.
Tokenomics is one of many yardsticks to have a successful investment. Narratives can outweigh tokenomics.
Understanding the fundamentals will help you identify coins that would easily give you 20x+ if you enter early.
Disclaimer: This is not financial advice. This is for educational purposes. Contact your financial advisor before taking any action.