What is Tokenomics?
Tokenomics (token + economics) is a term that encompasses all the aspects that make up the supply and demand of any particular crypto token.
By understanding the supply and demand of a cryptocurrency, we can make educated estimates about how much future buying and selling pressure there might be.
Why is Tokenomics so Important for a Web3 Investor to Understand?
As a Web3 investor, understanding how tokenomics work and knowing how to analyze the tokenomics of any given project is extremely beneficial to gaining an edge over the rest of the market.
This is because tokenomics directly affects the price of a token. If a project has really bad tokenomics, its price growth will be very limited (even negative).
On the other hand, if a project has strong tokenomics, that means the price growth potential is very favorable.
When performing fundamental analysis of a crypto or Web3 project, strength of tokenomics is one of the major factors to consider.
Understanding Supply and Demand
To understand precisely what tokenomics is, you first need to understand what supply and demand are.
Supply and demand refer to the aspects that influence the buying and selling pressures of an asset.
Supply refers to how many units exist of an asset. The lower the supply, the more scarce the asset is.
Demand refers to the desire that people have to purchase the asset.
These two factors put together, supply and demand, create a push-pull on the price of an asset.
High supply, high demand = slightly bullish, the price goes up or neutral.
High supply, low demand = extremely bearish, the price goes down.
Low supply, high demand = extremely bullish, the price goes up.
Low supply, low demand = slightly bearish, the price goes down or neutral.
The Different Aspects of Tokenomics
Demand
Demand basically boils down to whether or not people:
- Want to buy the coin or token
And perhaps more importantly:
- Want to hold onto the coin or token for a long period of time.
Token Utility
When analyzing any crypto or Web3 project, you really want to look into whether or not the token is useful to the protocol and ecosystem.
Useful might even be the wrong word. Crypto protocols and ecosystems that require the use of the native token to function properly are more likely to have a strong, steady, intrinsic demand for the token.
Whereas crypto projects that don’t require the use of the native token for the protocol or ecosystem to function, would intrinsically have less use, and therefore less demand to own the token.
A lot of projects require the use of their native tokens to perform transactions on their respective chains.
When someone wants to perform a transaction on Ethereum, for example, a small bit of Ether (ETH) is used as “gas” to facilitate the transaction. That small bit of Ether is actually divided into two parts. The miner who facilitates the transaction keeps one part of it, and the other bit of gas is burned—sent to a dead address that nobody can access.
Token Rewards
Many crypto projects provide additional coins or tokens as rewards to users who hold their coin or token.
A lot of these projects who have a Proof of Stake consensus mechanism will incentivize this through a process called staking.
Staking is when users “lock away” their coins into a smart contract. The smart contract holds onto the coins and sometimes may even use the coins to help secure the blockchain network.
The smart contract is programmed to release coin rewards to the user in the form of interest earned based on the number of staked coins.
At the end of the lockup period, users have their initial stake returned to them and they get to keep their rewarded coins as well.
Staking is just one form of token reward. Other blockchain networks based on Proof of Work consensus will provide token rewards to miners who secure the network with their computing power.
Recently, a couple of projects have started providing scheduled token airdrops to their users as a form of dividend. The rewarded tokens are “air dropped” into the wallets of existing token holders. The rewarded dividends come from the value captured by the fee mechanism of the blockchain.
Airdrops aren’t necessarily exclusive to the native token of the blockchain either. Some projects will airdrop tokens from new DApps, NFTs, or other new projects in the broader ecosystem.
Governance
Governance is the concept that the people who own the coin or token of a project, get a proportional say in how the project should be run.
So for example, if you own 0.1% of the token supply of a project that uses fair governance, then you would have 0.1% of the say on where the project is headed.
Projects who’ve implemented governance vote on each decision that comes the project’s way. Once again, your voting power is relative to the amount of coins you hold.
Coin/Token Burns
Some projects use scheduled token burns or have smart contract token burn mechanisms based on their chosen tokenomic and incentive model.
Token burns are typically bullish for the price of a coin as the burning procedure permanently reduces the supply, thus making the coin more scarce.
Supply
When performing due diligence on the supply of a project, there are a few key questions to ask that can be answered by the metrics found just below.
The questions are:
- How many coins are there?
- How many coins will there be in the future?
- What is the rate that new coins will be released?
Knowing this info is imperative to help determine if the project is worth investing in for the mid-long term.
Circulating Supply
The number of coins that are currently available for trade in the public markets and/or currently owned by the general public.
Total Supply
Total supply is the same as circulating supply except it also includes any coins that may exist on the blockchain, but are not currently circulating in public markets. For example, teams that build a project or invest early in a project may have coins locked up in escrow for a period of time.
Max Supply
The maximum amount of coins that will ever exist on the blockchain.
Most projects have a max supply but some may have an uncapped supply.
Market Cap
Market Capitalization is the total dollar value of the circulating supply of a given cryptocurrency.
The simple formula for market cap is:
(Cost of one coin/token) X (Circulating supply) = Market cap
So if the (fictional) coin $ABCXYZ trades at $2, and has a circulating supply of 500 million coins, the market cap would be $1 Billion. ($2) X (500M) = $1 Billion.
Market cap is often used by investors to perform relative analysis—by analyzing the market cap charts, investors can make estimates about the growth potential of any given cryptocurrency.
Initial Token Launch
When a cryptocurrency is first launched, there are a few ways the team can go about it. The two most common ways are:
Fair launch is when the coins are released and sold into the public markets from the get-go. Everyone has a fair chance to purchase the coins at the same initial cost.
Pre-mine or pre-sale is when the team sells coins to private investors or venture capital firms at a discounted cost before allowing the public to have a crack at it at a higher cost.
Web3 investors should know which launch a project has chosen in order to determine how much selling pressure might occur in the future.
This is because if a project has been pre-mined or pre-sold, it means there are most likely coins/tokens that are locked up for a period of time and will come unlocked sometime in the future, thus increasing the circulating supply. Those early investors and VC firms may want to sell their unlocked coins ASAP, especially if they’ve already made a large ROI on their initial low-point cost.
Vested Tokens/Unlocks
Just as was described above, private investors and VC firms who invest early into hot, new projects, oftentimes get their coins/tokens locked up on a vesting schedule.
For example, a VC firm might have their coins locked up for 2-4 years, after which their tokens will unlock slowly every month.
By the time their coins start unlocking, there’s a good chance they’ve made a significant return on investment already (as they usually have excellent due diligence).
So in that case, they may want to immediately start selling their coins as they become unlocked.
They may receive 0.5-10% of their coins every month, although there’s no standard.
As individual investors, it’s our job to seek out information about coin/token vesting schedules to determine the rate at which the coins will unlock (and be added to the circulating supply, thus reducing scarcity).
Is the Token Supply Inflationary or Deflationary? At What Rate?
By comparing the current circulating supply to the future supply (max and total), we can figure this out.
Will more coins/tokens exist in the future? If so, the coin/token is inflationary. Most projects fall into this category.
If there are fewer coins/tokens in the future (from burn mechanisms, etc) then the project is deflationary.
We can also calculate this rate of inflation or deflation based on the token release schedule.
The rate of inflation is very important. If too many coins get released too quickly, selling pressure will mount.
Is the Demand Powerful Enough to Sustain Price Growth?
When we analyze tokenomics, ultimately we’re trying to garner whether or not the demand will outweigh the supply.
As we stated near the top of this article, moderate-high demand combined with a low-moderate supply creates a bullish environment over the long term.
That’s why it’s important to take a look at each individual factor and then put all the pieces together.
For example, if the project you’re analyzing has no actual utility for the coin other than governance, there might be a lack of demand. If that combines with a highly inflationary supply, it’s a recipe for a bearish disaster.
Fully Diluted Valuation
The Fully Diluted Valuation (FDV) is a metric that can tell us a lot about how much buying or selling pressure there could be for any particular coin or token.
This is because FDV is very similar to market capitalization. Market cap measures the current total value of an asset (the price of one coin/token multiplied by the current circulating supply).
Whereas FDV measures the price of one coin/token multiplied by the TOTAL supply—AKA what is the total valuation of the project once all the coins are released (via vesting schedules and other releases).
Another way to think of it is market cap measures the current value of a project whereas fully diluted valuation measures the future value (using the current price) once the supply is fully distributed.
Market Cap = Current Circulating Supply x Price of 1 Coin
Fully Diluted Valuation = Total Supply x Price of 1 Coin
When the FDV exceeds market cap by many multiples (5-10X or more), it’s a sign that the project is quite inflationary and may experience selling pressure going forward.
Where to Find Tokenomic Information
Please note: Unless you’re a proficient blockchain and/or smart contract developer, you will have to rely on second-hand information. Even the info on a team’s website might be outdated or inaccurate. Reading the code in the blockchain or smart contract is the only way to truly confirm the supply numbers.
If a project gets a code audit from a reputable crypto audit firm, you can trust those numbers as well.
That’s why it’s important to look at multiple sources to corroborate what you find.
That being said, here’s how an everyday crypto investor can find tokenomic information:
The first place to look is on the project’s website. Look in the documentation area, look in the whitepaper, etc. Any project attempting to be transparent should have that info available for prospective investors.
That being said, we can utilize other tools to help piece our analysis together.
Market cap ranking websites usually have most of the supply info.
Additionally, CoinCarp.com typically has detailed supply info like token release schedule and token allocation.
Crypto research firms like Messari, NansenAI, and Dune Analytics are also great places to find both the supply and demand side of tokenomics.
Remember, you have to understand the demand side of things as well. You have to understand the project’s value capture and incentive mechanisms. Sometimes it takes additional resources to really understand it. Resources like Youtube videos, Reddit posts, and whatever else you can get your hands on.
Ultimately, we have to scour for the info sometimes. Sometimes it even takes asking a team leader directly on crypto-Twitter.
