September 10, 2024 Welcome back to our blog and, more specifically, to the second part of our quest to understand the ins and outs of fundamental analysis related to cryptocurrencies.
In this blog post, we’ll explore one of the most important aspects of analyzing cryptocurrency tokenomics. Tokenomics refers to the financial structures of a crypto project, specifically the economic framework that stands behind the currency and its ecosystem.
As we delve into another topic involving data interpretation, this is a reminder that all the information presented in this blog post is intended solely for educational purposes and should not be considered a call to action or financial advice. Traders must consider their financial status, trading goals, and risk tolerance before employing any crypto trading strategy. Cryptocurrency trading involves inherited risks; consulting with a qualified financial advisor before making decisions is highly recommended.
The term Tokenomics is derived from the merging of tokens and economics. While tokenomics is interpreted differently across the world of cryptos, it generally refers to studying and evaluating a cryptocurrency’s economic model and financial logic.
Every blockchain has a tokenomics structure designed to support its ecosystem, prevent the devaluation of its native currency, and encourage various activities across the blockchain.
Our guiding principle when examining a crypto’s tokenomics is that good tokenomics are crucial for the long-term success of its native currency. Vice versa, cryptos that fail the test are less likely to be successful in the future.
Unlike the fiat economy, where central banks frequently change the rules of their tokenomics and commonly print money at first sight of potential turbulence, crypto tokenomics are practically set in stone. In the crypto world, the rules of tokenomics are implemented through lines of codes that are publicized and available for inspection by the public. As such, these rules cannot be modified easily. On top of that, similar to the case of Bitcoin halving, it is not uncommon that the rules of tokenomics create predictable events for traders to prepare for.
Through understanding the economics and financial structure of crypto, traders can better grasp the different factors that affect the price of a crypto – supply, demand, security, utility, and the value proposition of the crypto and its ecosystem.
The bottom line is that traders must fully understand a cryptocurrency’s tokenomics to make informed trading or investing decisions.
According to the rules of classic economics, the price of an asset is set when supply and demand find an equilibrium, and the world of cryptos is no exception. This is why traders evaluate crypto tokenomics and should focus on features that affect crypto’s supply and demand.
Generally speaking, we would like to find a tokenomics structure that supports the ongoing growth of intrinsic crypto demand while creating some supply scarcity. More specifically, in an ideal scenario, we wish to find cryptos with strong and stable demand that are not fully met by the supply side of the equation.
Without further ado, here are the key features and characteristics that traders should examine when reviewing the tokenomics of a cryptocurrency:
Understanding the forces that affect supply is crucial to tokenomics. Luckily for traders, it is the easiest metric to evaluate cryptos.
The first thing to look at when sizing up the supply of cryptos is its maximum supply.
Maximum Supply is a number that represents the total amount of currencies that will ever exist for a specific crypto. For example, the maximum number of Bitcoins (BTC) that would ever exist is 21 million. This means new Bitcoins won’t be created once it reaches that number.
Cryptos with limited supply, like Bitcoin, are often called deflationary cryptos. This means that, in theory, their price shouldn’t deteriorate over time because of an overwhelming supply that can’t find enough buyers to keep prices from going down.
On the other hand, cryptos with an unlimited supply of tokens are considered to be inflationary cryptos. While this might create some selling pressure due to the ongoing supply growth, it also has its fair share of benefits. Most notably, many experts suggest that a deflationary supply offers better support for further expansion of its ecosystem.
The other metric we must consider when calculating a crypto’s supply is its circulating supply. This number refers to the actual number of liquid tokens, meaning the total supply of cryptos that can be traded on different markets and exchanges.
The two measurements, max, and circulating supply, are essential when calculating crypto’s market capitalization. Crypto’s market cap is calculated by multiplying its current market price with its circulating supply. We’ll get crypto’s fully diluted market cap when multiplying its market price with its max supply.
Both metrics, max cap, and fully diluted market cap, are essential for determining the total value of a crypto ecosystem, its potential for further growth, and future price appreciation. In many cases, an excellent way to estimate whether a crypto could reach a particular price mark is to assess whether that crypto is capable of growing to the matching market cap.
After determining the number of tokens in supply and their total amount, we will examine how the cryptos are distributed among different community members. Specifically, we will see that the tokens are divided fairly among the ecosystem participants.
The most straightforward way of studying a crypto’s distribution is to look at the number of addresses registered on the blockchain and how many each wallet holds. Since most crypto projects are open-source platforms, this data is easy to find and free of charge. When the distribution of tokens is not readily available or transparent, we see this as an immediate red flag.
A more concentrated crypto distribution, where a small number of accounts hold most of the tokens, is considered a riskier investment because uneven distributions are more likely to suffer from selling pressure that pushes the price down and other market manipulations.
Many crypto experts suggest that to grasp the true nature of crypto, it’s also essential to look at how it was first launched and its initial coin offering (ICO). Ideally, we’d prefer cryptos where most of their tokens were first released to the general public, not just early investors and other insiders.
In this blog post, we’ll refer to the term mechanism as the economic structure and monetary policy of crypto and any potential effects they might have on supply and demand.
Generally speaking, there are a few common mechanisms in the world of cryptos that traders should be aware of:
When discussing the demand for crypto in the context of tokenomics, we are not referring to changes in demand based on market dynamics across different exchanges or other technical analysis readings.
Instead, we are searching for any practical usage the token has in and out of its ecosystem. By doing so, we are trying to discover factors that could create intrinsic demand for the tokens based on their utility.
When assessing a token’s utility, looking for real-life use cases is the best place to start your research. Reviewing the mechanism of the crypto that we covered earlier, with a focus on its incentive programs, is also very important.
Other utility features that traders should be looking for are the token’s other roles in its ecosystem. These may vary, from voting rights on future project developments and other governance rights to paying up for different activities within the network in the form of gas fees and many more. On top of that, any other feature the token has, like the ability to deploy smart contracts, could provide us with insight into the strengths of a crypto that can support organic growth in demand.
In this blog post, we’ve demonstrated to traders the importance of reviewing crypto tokenomics to make more informed financial decisions.
Choosing the best avenue of tokenomics is open to interpretation and subject to each trader’s preferences. However, we hope that after reading this article, you better understand the essential conditions needed to achieve good tokenomics and how to evaluate them.
More importantly, we hope we’ve given you the proper tools to identify red flags and avoid less attractive crypto projects. These include cryptos that fail to present a clear roadmap and consistent token supply, even and fair distribution of coins, faulty economic structure and mechanism, and enough utility to support demand.
If you enjoyed the reading, stay tuned for our next blog post, in which we’ll discuss the on-chain analysis and how it can help analyze tokenomics and other fundamentals.
For now, check out our vast range of advanced crypto bots, enabling you to use everything you’ve learned through automation.
