How to determine if a project has a good or bad tokenomics
One of the most critical metrics for evaluating the potential of a cryptocurrency is its tokenomics.
You can use the tokenomics data, to determine whether a coin is worth buying; holding for the short; medium, or long term; or if it's best to stake it.
What is tokenomics
Tokenomics refers to the economic design and characteristics of a token. It is a combination of the words "token" and "economics" which aims to understand every aspect of a token that affects its value.
From creation to distribution and application, every single aspect of a token is essential for an investor to understand whether or not it'll be a good investment.
The different aspects of tokenomics
If you want to take a holistic view of tokenomics you should be looking at its:
Let's examine each of these below.
1. Generation
At the token generation level, you want to know whether the contract is verified or not. Ideally, you should only be dealing with tokens with a verified contract.
Furthermore, verify whether the admin has renounced the token contract ownership or not. If the admin maintains ownership, it means they can generate new tokens whenever they want.
This isn't very safe as it requires you to trust the admin to know to mint new tokens and dump them on the market. Thus creating an exit scam.
Finally, you want to know whether the token is fully premined or the remaining supply will be generated on a block-by-block basis until the maximum supply is reached.
2. Token type
Every cryptocurrency out there is either a "currency", a utility token, or security. Find out what type of token the one you want to invest in is, and take note of the legal implications.
A security token will be the more controversial of the three due to more stringent regulations.
3. Supply
There're three aspects of a token supply that are very important for you to understand before investing in them.
They are, the:
Maximum Supply
Total supply
Circulating supply
1. Maximum Supply
Does the token have a limited, fixed or unlimited supply?
Limited or fixed supply is usually better than unlimited tokens because, for the unlimited supply tokens, the continuously increasing supply will dilute your investment as demand is not infinite.
However, it doesn't mean that unlimited supply is entirely bad, and in some cases, it's only temporary until the project developers understand how many tokens they need.
For example, after over one year of operating with unlimited supply, the PancakeSwap team finally set a CAKE (750 million).
For some projects, token supply is something they cannot fully decide upon until a certain stage, as you can see with CAKE above.
But there are only a few such cases, and most greedy developers will never set a cap on their token supply, even when the time comes for it.
However, there're exceptions for the likes of Ethereum, which may have an unlimited supply, but due to their strong market and tokenomics design, they can sustain their value in the long term.
2. Total supply
Total supply refers to the amount of the token that's been generated or minted, including both the circulating supply and any tokens that are being locked up for any reason.
The total supply number will increase as new tokens are generated and can reduce due to burning.
Ideally, uu want to invest in a token that the majority of the supply has been generated, meaning there's less future inflation.
But even better, is the one where all or nearly all of the supply has been generated and is in circulation.
3. Circulating supply
Circulating supply refers to the amount of the token that's been released into the market and is being traded by the public.
The closer the circulating supply is to the total and maximum supply, the less the expected dilution or inflation.
4. Allocations
The next thing to look at is how to token supply is allocated to the various stakeholders of the project
For example, how much of the supply goes to the project developers, advisors, private investors, and other insiders?
And then look at how much goes to the public through presales or IDOs; liquidity pool; ecosystem and community development; etc.
The more of the supply that goes to the public, the more decentralised the token will be and the better for the project and investors.
You want to be cautious of projects in that the majority of the tokens are held by the founders, private sale investors, and insiders.
It's a perfect recipe for centralisation and market manipulation.
Ideally, the token should be widely distributed with the public holding most of the supply.
5. Vesting periods
The vesting period usually refers to how long the team or private investors have to wait to be able to receive or sell their tokens.
It's used to assure investors that the team or early investors are committed to the project and is in it for the long term.
6. Distribution
Some projects like decentralised exchanges (DEXes) usually distribute their token to liquidity providers on their platform.
Other projects may choose to distribute theirs through an airdrop (proactively or retroactively).
Furthermore, others have a staking program that allows you to stake their token to earn more of the same.
Whatever distribution system the team has set in place it should be fair and transparent.
7. Inflationary mechanism (minting)
How are new tokens are being generated?
The standard way most new tokens are created is through block emissions or mining on a block-by-block basis.
These new tokens being minted increases the supply or inflation and will only stop when the token reaches its maximum supply.
For tokens without a fixed maximum supply, new coins will be generated indefinitely, and that's why they usually have higher inflation.
The higher the emission rate, like how many new tokens are being generated per block, the higher the inflation will be.
Do you see the demand for the token outpacing the inflation or supply increase?
If your answer is yes, then you can safely assume the value will increase or at least not drop significantly.
However, if there's not enough demand to accommodate the increase in supply, you can expect the price of the token to do poorly until the inflation stops.
With this information, you can structure your investment or portfolio accordingly.
8. Deflationary mechanism (burning)
Some projects buy back and burn a certain amount of their token regularly or randomly in an attempt to reduce supply or inflation and support its value.
If the token has a fixed supply, this will make it deflationary, especially when the amount being burned is greater than the number of new tokens being minted in every block.
Even with an unlimited supply token, if more tokens are being burned than new ones are generated it will also be deflationary.
9. Use cases
The most important aspect of tokenomics is a token's use cases or utility.
What is the token being used for that ensures that there'll be consistent or growing demand to support its value?
The more use cases a token has, the more you can expect that the value will increase over time as the project grows and vice versa.
Why is it important to look at Tokenomics before investing?
Because it will help you decide whether you should buy the token now or not, and it can also help you design and structure your investment accordingly.
For example, a token with only 10% of its 1 billion maximum supply is in cirulation and has a fully dilluted valuation (FDV) of say $5 billion is going to dump hard as it's highly overvalued.
As the remaining supply gets minted and released, the price will continue to drop systematically until it reaches a reasonable valuation.
The real value of the token may be many Xs down from the current level. So for such tokens, you want to wait and buy in at a much later time when most of it has been released.
Furthermore, for a token that have seen more than half of its supply alreased released into the market, and the valuation is just normal or submotimal, you want to buy and stake it.
Take advantage of what's left of the inflation to grow your stakc of the token because when inflation stops, assuming demand is sustained, the value should be a lot higher.
What makes a good tokenomics?
There're several things that makes up a good tokenomics. Here're a few important ones:
The token has a fixed or maximum supply. Unlimited tokens are a moneygrab.
It should be fairly distributed with most of the allocations going to the public.
The token should have real use cases that generates demand for it.
There's no hidden mint function and admin shouldn't be able to mint new tokens.
Vesting periods should be transparent and verificable.
What happens when a crypto reaches max supply?
Naturally, when a token reaches its maximum supply, the value should increase as inflation ceases and demained is maintained.
But it may not play out all that positively for reasons below:
Firstly, investors are mostly interested in a token because they can earn more of it through staking with high APR.
So, when there's no more new tokens being minted and distributed to stakers, this people usually move on to the next project that offers staking.
Thus reducing the existing demand for the token. So, instead of the price increasing, it might actually decrease as reward seekers move onto something else.
However, this can be easily solved by continuing the staking program with the platform's revenue.
Conclusion
Tokenomics refers to everything about a token that affects its value, such as supply, use cases, etc.
In this post, we have discussed indepth the various aspects of tkenomics and what to look for in a good tokenomics.
What do you think makes a good or bad tokenomics? Share with us in the comments section below.
