Have you ever wondered why some of the coins that you hold do worse than others? One reason that is often overlooked is tokenomics and this honestly could make or break a project’s performance even if they have an amazing team, groundbreaking technology and everything else that you can ask for.
In this article, we are going to explain why tokenomics matters. We will give you specifics of what you should look for and at the end of the article you will be able to grasp what does it mean to have good tokenomics anyways.
What Is Tokenomics And Why It Matters?
Tokenomics is literally short for “token” + “economics”, so it is the economics of a token/coin. You can think of each crypto project as having its own economy surrounding its token.
But unlike our regular economy where the rules are set by the government and central banks, crypto economies are completely controlled by code; this means things like (1) what the token is used for, (2) what the inflation rate is, (3) who receives tokens as rewards and (4) are all defined by the underlying protocol.
These crypto projects are essentially creating their own micro economies with the goal of becoming self-sustaining. This is why it is so important to define the tokenomics properly or else you may find yourself in a scenario where the token price goes haywire rendering the project unusable.
With that said, let’s dig into some specific metrics that you can evaluate for each project.
1. Market Capitalization
To get an asset’s market capitalization you just take a token’s price and multiply it with its circulating supply. This is a much better way to compare tokens instead of focusing on the raw price.
For example XRP and MATIC are both around $0.62- $0.78 per coin. But XRP has around a 33 billion dollar market cap whereas MATIC has only about 7.2 billion dollar market cap. You see the huge difference? That is why market cap is the better indicator of a token’s economic valuation.
Keep in mind that market capitalization also gives us a sense for how easy it is to manipulate a token’s price in either direction — the lower the market cap, the easier it is to manipulate.
Another related metric here is the “Fully Diluted Market Cap.” This is just using the maximum supply of a token instead of the currently circulating supply to do the calculation.
Remember some projects have tokens locked up for later distribution. Some investors are turned off when they look at a project’s fully diluted market cap and they see a huge number like even larger than Ethereum’s market cap.
But most investors would not pay too much attention to that because (A) that just means that a small percentage of their tokens are currently available and (B) it does not tell you anything about the release schedule or if there’s any deflationary pressure, etc.
All of those matter and can affect future valuation though so it does not make sense to just assume that the price and all those other factors will remain the same as more tokens are released into circulation.
2. Max Supply
Basically some tokens do not have its full supply available at launch. They lock up some for vesting purposes so that early investors can’t dump all at once or they keep some for staking rewards that are released over a long period of time.
This metric gives you an idea of how many more tokens need to be absorbed by the market in the future.
Keep in mind that some projects do not have a cap on future inflation, so in that case, they do not have a maximum supply.
3. Monetary Policy
Monetary policy has to do with the inflation or deflation of the token supply — (1) how fast are tokens released in the future, (2) how does that rate change over time, (3) are there any deflationary pressures like burning of the fees and (4) how do all those things come together to affect the overall supply.
Keep in mind that there is not one right monetary policy — inflation is not always a bad thing as it could really help incentivize stakers that keep the network decentralized and secure — and having a ton of deflation does not guarantee price performance either.
Monetary policy is like a glove, it needs to fit a project’s goals and not be arbitrarily set just because some other project did it that way.
4. Token Distribution
Token Distribution also known as (1) how are the tokens split up and (2) what each chunk is for.
You can imagine each token supply being represented by a pie chart where different sections represent tokens for the team, for stakers, for the community, etc.
It is especially important to know how the tokens were split up at launch and this is called the “initial token distribution.”
Because if a small number of insiders hold a lot of the tokens then its price is at much higher risk of manipulation like sudden dumps or unnatural pumps.
Ideally every project would be a completely fair launch which just means that everyone gets a chance to buy tokens from the get-go because in that case, the tokens are distributed more widely from the beginning. But alas that is not always realistic, so if there is a pre-mine, you should take a closer look at some other details.
5. Private Sale Prices
Most crypto projects that raise money through token sales do not just have one single round that’s the same price for everybody. Instead they often do multiple rounds with different rules in terms of allocation price.
These earliest rounds are generally reserved for private investors like venture capitalists and they of course get in at the lowest price per token. That is why it is so important to find out these details so that you can know what price these private investors got in at and how many tokens they received in return. You can use this info to gauge their willingness to sell at any given price level by calculating how much they are in profit.
For example let’s say that we are in the middle of a deep bear market and all of our bags are in the negative.
But private investors may still be in massive profits because they got in at such low prices. This means that the selling pressure for that particular project may not be over anytime soon until most of them end up selling in order to lock in their profits.
6. Unlock Schedules
Some projects lock up some of their tokens and then release them over time.
The unlock schedule specifies what percentage is released to who and at what intervals.
For example crypto projects may set a vesting schedule for early investors. Instead of letting them get 100% of the tokens immediately after launch, they may get 25% in the first year, 25% in the second year and so forth until they receive their entire balance.
7. Token Utility
Last but not least you cannot evaluate a project’s tokenomics without understanding its token utility as well. There six common areas where people frequently use their tokens:
- Payments: Used as a currency for goods and services (e.g., Bitcoin).
- Transaction Fees: Used to pay for network transactions (e.g., Ethereum).
- Access to Services: Used to access specific network services (e.g., Filecoin).
- Discounts or Cashback: Offering fee discounts or cashback on platform usage (e.g., Binance Coin).
- Staking: Used for staking and participating in network validation (e.g., Proof of Stake networks).
- Governance: Grants holders the ability to influence network decisions and proposals (e.g., DeFi projects).
In an ideal world, tokens offer true utility within their ecosystem and people are incentivized to hold or use the token for reasons beyond speculation.
Hopefully you now have a better idea of what to look for when you evaluate a project’s tokenomics. No project is going to be perfect in all of the categories mentioned earlier so it is ultimately up to you to evaluate them holistically and make a judgment call.
Frequently Asked Questions (FAQs):
Tokenomics is a blend of the words “token” and “economics” and it refers to the financial framework and workings of a cryptocurrency or a token project. It covers elements such as the token’s availability, how it’s distributed, what purposes it serves and policies regarding inflation.
Tokenomics has a big factor on the value of tokens like how long a project can keep going and how much trust people have in it. If the tokenomics is not well thought out then it can cause the token’s price to swing all over the place and make it hard for people to get on board with the project.
Token distribution is all about how the tokens were distributed among various groups like the team, the stakers and the community. If the initial distribution gives a big advantage to the insiders it can make the token’s price at risk to manipulation.
Monetary policy is all about things like how the token supply increases or decreases, how quickly new tokens are released and the forces that push the value up or down.