How to value cryptocurrencies the right way.
- What is a cryptographic token?
- What is Tokenomics?
- How to verify the Tokenomics of a Crypto project?
- #1. Study the white paper
- #2. Visit price tracking websites
- Key components of Tokenomics
- #1. token supply
- #2. Consensus Mechanism
- #3. token utility
- #4. token distribution
- #5. token burns
- Importance of Tokenomics in Crypto Investment
- #1. understand the risk
- #2. Find red flags
- #3. Evaluate token value
- #4. Determine future potential
- Last words
Tokenomics consists of important factors that allow you to determine the value of a cryptographic token.
The demand for cryptocurrencies has been increasing since the beginning of 2023. Eventually, most cryptocurrencies started to recover after negative market sentiments in 2022. Furthermore, the global cryptocurrency market is valued at over $1 trillion.
Bitcoin, the largest cryptocurrency, gained more than 40% in January 2023. Do you know how cryptocurrencies are valued? If the answer is no, don’t worry, we will discuss it in this article.
For crypto, Tokenomics adds value based on various parameters. But before we get into Tokenomics, we need to understand cryptographic tokens.
What is a cryptographic token?
A crypto token is a digital token that represents various assets, such as real estate, securities, or even digital art. Additionally, a token can also represent a specific use on a particular blockchain.
The value of a token is determined by the value of the underlying asset or its use case. Similarly, increased market demand for a token can also increase its price.
Now that you know about a token, let’s dive into Tokenomics.
What is Tokenomics?
Tokenomics is a combination of “token” and “economics”. Simply put, Tokenomics is the economics of a crypto token.
The initial idea for Tokenomics was proposed by BF Skinner, a Harvard psychologist. In 1972, Skinner proposed exchanging tokens between participants for coffee or sweets.
Tokenomics is based on the incentive mechanism that rewards people who use blockchain networks. This system motivates people to participate in crypto projects that have higher reward potential.
In the case of crypto projects, investors buy and hold tokens that they believe will be rewarded in the future. The higher the demand for tokens, the more value it adds to the project and the invested fund.
You might have an interesting question: “How can I check tokenomics?” Let’s get into that right away!
How to verify the Tokenomics of a Crypto project?
Tokenomics helps you a lot to understand the structure and design of a cryptographic token. This is how you can understand the tokenomics of crypto projects:
#1. Study the white paper
Most crypto projects publish a whitepaper that contains technical specifications and main goals. Here you can read and have a basic understanding of the entire project.
Additionally, some projects publish a litepaper, a simplified version of the whitepaper. So you can read a light paper to understand without jargon.
Tokenomics consists of an essential part of a technical document. You can read all the details related to the token and its functionalities.
#2. Visit price tracking websites
Diving into a white paper and finding the important tokenomics can be hectic and time consuming. If you find yourself in a similar situation, visit genuine price tracking websites.
You can visit simple platforms like CoinMarketCap or CoinGecko for a quick analysis of the tokenomics of a project. These platforms provide all the relevant details in one go.
Here, the most significant advantage is setting up your preferred fiat currency to assess the economics of a token. Also, you don’t even need to log in to find the token details. Impressive right?
Suppose you are looking for the tokenomics of the MATIC token of the Polygon project. You will find real-time market capitalization values and circulating supply.
In addition, you can also find the historical data of the token since its inception. Also, the details of the initial coin offering (ICO) are available with a single click.
In summary, it is important to verify the main components of tokenomics to have greater clarity about a project.
Let’s dive right into it!
Key components of Tokenomics
#1. token supply
The main factors that affect the price of a token are its demand and supply. You can find three types of supply for a token; circulating supply, total supply and maximum supply.
- Circulating Supply – This number includes the total number of tokens currently circulating on the crypto market.
- Total Supply: The total supply of a token includes the supply in circulation and the number of tokens that are mined but not available on the market. Furthermore, the total supply also does not include burned tokens.
- Maximum supply: This supply consists of the maximum token that the project has coded to extract or issue.
Also, token supply helps to find the crypto market capitalization or the market capitalization of a token. The market capitalization is calculated by multiplying the current price of the token by its circulating supply.
Suppose a token is trading at $20 and its circulating supply is 10 million. The token has a market capitalization of $200 million in this case.
Some tokens have a maximum supply, such as the ADA token from the Cardano project. ADA has a maximum supply of 45 billion tokens. However, project tokens like Shiba Inu, Polkadot, and Tether do not have a maximum supply.
#2. Consensus Mechanism
The consensus mechanism of a cryptographic project allows the blockchain network to validate and secure each transaction. Most projects use proof-of-work (PoW) or proof-of-stake (PoS) mechanisms.
The PoW mechanism rewards its miners after they complete the validation of the transactions. However, miners require high-end computing devices to run the validation process.
Unlike PoW, proof-of-stake mechanisms allow you to verify the network transaction by involving cryptographic tokens. So you have to stake tokens for a limited period to get rewards.
Most of the new blockchain projects prefer a green mechanism, which is why PoW has gained great popularity recently. Ethereum’s shift to a staking mechanism is one of the important milestones in the crypto industry.
#3. token utility
The token utility is the actual use case for a cryptographic token. The developers of the crypto project choose the utility of their token based on the mission of the project.
Some tokens allow users to pay transaction fees, while others can be used to buy or sell NFTs. Also, if you have governance tokens, you can vote for the main decision-making process of a project.
Play-to-win game projects reward their players with tokens. Players can use these tokens to purchase in-game items.
For fitness enthusiasts, there are movement projects to win that encourage users to exercise. Here you will receive utility tokens as a reward based on your physical activities.
Some projects focus on stablecoins. In this case, the token will be tied to a fiat currency such as the US dollar. Furthermore, the value of the token is kept close to the value of the associated coin.
#4. token distribution
A large part of the token supply is usually allocated between the founders and investors of a crypto project. Therefore, it is crucial to know the behavior of the big holders.
Suppose an individual or an organization with large holdings sells all of their tokens. The token price can fall or even crash badly in that case.
You can also check if investors or founders have a minimum lock-up period to sell their tokens. The longer this period is, the lower the risk of a huge sale.
Additionally, the token distribution includes the percentage of the total token allocated for marketing. Additionally, projects allocate a small percentage to team members. For example, Chiliz crypto projects allocate 5% of their total token supply to the team.
An initial coin offering (ICO) is one of the preferred ways for crypto projects to distribute their tokens to interested buyers. If you are interested in the vision of a project, you can participate in its ICO.
#5. token burns
Burning a token means removing a large number of tokens from your circulation supply. In this case, the tokens are transferred to an inaccessible wallet.
Token burning permanently removes the token from its existence. In most cases, project developers burn tokens to decrease the supply of that particular crypto token.
Binance Coin (BNB) is famous for its token burning process. At the time of writing, the Binance project has burned over 150,000 BNB tokens.
Importance of Tokenomics in Crypto Investment
Tokenomics is one of the important factors that investors consider before buying crypto tokens. Tokenomics allows investors to:
#1. understand the risk
Tokenomics plays a crucial role by providing enough fundamental details related to a token. An investor can have an approximate assessment of risk based on this data.
If you find the token of a crypto project to be very risky, you can make an investment decision accordingly. Here you can avoid a risky project or allocate a minimum amount to balance your overall risk exposure.
#2. Find red flags
Crypto tokens are listed on a daily basis and it is hard to spot bad projects. Here, tokenomics can help you find tokens with bad fundamentals.
For example, suppose you find a token with most of its distribution with only one founder or investor. In this case, it is better to avoid investing in that token. Here, a single token holder can drive the token price down.
#3. Evaluate token value
As we discussed above, tokenomics allows us to estimate the market capitalization of a crypto token. This value helps compare the token against other tokens with similar market capitalizations.
In most cases, the market capitalization of the most in-demand tokens continues to increase over time. For example, Bitcoin tops the list with a market capitalization of over $442 billion.
#4. Determine future potential
A well-structured tokenomic model allows investors to determine the ability of a crypto project to achieve its goal. You can also refer to the roadmap in the whitepaper to predict the growth of a project.
Assessing the potential value of a token allows you to consider your investment decision. Simply put, you can stay away from unworthy crypto projects.
The tokenomics of a cryptographic project comes with different valuable data. This data helps determine the value of a cryptographic token.
It is not easy to determine the potential of a token considering a single parameter. For this reason, combining all the parameters mentioned in this article is better for a better token valuation.
Ultimately, do your own research (DYOR) before buying crypto tokens.
You may also be interested in crypto index funds and ETFs.