How to Spot the Best DeFi Projects: A Dive into Tokenomics And Beyond
Savvy investors understand that the DeFi landscape houses a plethora of opportunities. And they actively seek and explore them.
But how are these top traders able to stay on the right side of the market more often than not?
There are many criteria, tools, and methods to analyse projects. But one simple and fundamental concept you must learn is tokenomics.
It's not magic or anything fancy. But it's a great start in identifying good projects.
Understanding a Project's Goals
Tokenomics simply refers to the economic design and principles of a given token. Before diving into any DeFi project, carefully evaluate the distribution models for the underlying tokens.
Additionally, you should research the team itself to know more about their goals, visions, and roadmap for achieving them.
Here's a simple roadmap to guide you in token evaluation:
1. Project's Whitepaper
Begin by reading the white paper. A project's whitepaper is essentially their blueprint. Here, the team outlines their vision, mission, and technical roadmap.
Things you need to do:
- Pay close attention to the problem the project aims to solve and how.
- Assess the team's experience, especially in blockchain and the DeFi niche.
- Look for a clear explanation of the token's utility within the ecosystem. How does it incentivize user participation and drive network effects?
2. Investigating Tokenomics: Supply, Distribution, and Utility
Simply put, tokenomics helps you assess a token's value based on potential demand/supply dynamics. I have written a more detailed article on the topic here.
A summary of the gist – when analysing tokenomics, you must keep several factors in mind:
i. Total Supply
What is the total number of tokens that will ever exist? A limited supply can contribute to potential token value appreciation. But an overly inflated supply might cause token dilution — supply vs. demand.
ii. Token Distribution
Examine how the tokens are distributed. You want to see a balanced distribution among developers, team members, investors, and the community.
To reduce the risk of excessive control by any single entity or a massive dump at launch, the token must be fairly distributed.
iii. Token Utility
The token's utility within the project's ecosystem is another pointer to its potential value.
Does it grant voting rights, access to exclusive features, or serve as a medium of exchange within the DeFi application?
A clear and valuable use case means the token's value is likely to appreciate long-term.
3. Liquidity and Trading Activity
Check the token's liquidity on reputable DEXs (Dexscreener is an excellent tool for this). High liquidity is attractive to traders because it's easier to swap tokens without significant price impact.
Trading Activity
What is the token's trading volume on DEXs? The volume refers to all buy and sell orders at a given time frame. Healthy and consistent trading activity means there's enough market interest in the token, so you are less likely to get stuck with illiquid tokens.
Community Engagement and Social Proof
Another strong sign of a good project is an active community. You need to engage with the project's official forums, social media channels, and developer discussions to gauge community sentiment. The importance of this can not be overstated.
Beware of influencers or hype surrounding a project. Sometimes, the individuals pushing a project can give you hints regarding its genuineness.
Always do your own research and prioritise projects with a solid foundation and a clear value proposition.
Independent Audits and Security Assessments
Top projects usually have security measures in place to protect user funds and mitigate potential exploits. Look for projects that have undergone independent audits by reputable security firms. These audits help identify potential vulnerabilities in smart contracts that could lead to hacks and loss of funds.
Beyond the Checklist
This may not be an exhaustive list, but it's a solid framework. DeFi is a rapidly evolving landscape, we may need to get even more creative with our assessments.
But the core points are: understand the project goals, how the team wants to achieve them, and the people behind the whole move. Stay informed about regulatory developments and emerging trends in the ecosystem as well.
Always remember: Don't just chase blindly after the "next big thing." You will lose your way the overwhelming majority of the time. Investing in DeFi projects requires a combination of research, patience, and a healthy dose of scepticism.
Deep Dive into DeFi Project Evaluation: Beyond Tokenomics
While tokenomics is, in my opinion, the backbone of a DeFi project, a more comprehensive evaluation requires going deeper into several other critical aspects.
Okay, so you have seen the project's tokenomics. It's all shiny, and you are eager to ape in because your instinct tells you that you have found your big break.
Hold on…
Before you invest in that project, understand that there are other reasons it could fail.
Consider these 'checkpoints', if you will, before making that investment:
1. What is the Project Roadmap?
A well-defined roadmap outlines the project's development stages, key milestones, and future product releases. Most projects include their roadmap on their websites for interested parties to read. Read it!
It must be clear and feasible.
Ask yourself:
- Does it break down development goals into achievable steps?
- Are there realistic timelines associated with each milestone?
- Is it an overly ambitious or vague roadmap with red flags?
- How is the project different?
There are many existing challenges in the DeFi space. And innovative teams are devising novel approaches to tackle them head-on or augment existing solutions.
For a non-memecoin project to perform well, it must have a solid use case and USP.
Consider these questions:
- Does it offer a unique solution, or does it simply replicate existing models?
- Are they making efforts to differentiate themselves?
- Look for projects with innovative strategies that aim to solve real problems and differentiate themselves from the competition.
Sustainability and Long-Term Vision
A strong roadmap goes beyond short-term token price gains. To evaluate the overall commitment to long-term growth, here are some questions that need answers:
- Is the project loud about its plans to achieve long-term sustainability?
- Is there a clear vision for user adoption and network growth?
- Are there mechanisms in place to ensure the project's ongoing development and value proposition?
2. Team Background and Expertise
Always do well to research the team behind the project. It goes without saying that well-known teams are less likely to put their reputation on the line.
Does the team have a proven track record in blockchain technology-related niches?
Look for founders and developers with relevant experience and a strong reputation within the crypto community — you might not always get this, but it's a huge plus.
Transparency and Communication
Lack of transparency is one of the fastest ways to lose public interest in Web 3. Good teams aim for transparency. Evaluate the team's communication channels and engagement with the community.
- Are they transparent about their token distribution, progress, launch, etc.?
- Do they actively address community concerns?
A responsive and transparent team inspires trust and confidence in the project's vision. It is a clear sign of good faith. Even good projects can quickly be perceived as fraudulent because they aren't open or fail to communicate their processes more effectively.
Team Token Allocation
As I already mentioned, carefully examine how the project's tokens are distributed to the team. We discuss more about token distribution in the tokenomics article.
Main takeaway: A reasonable allocation with lockup periods or vesting (restrictions on selling) demonstrates the team's commitment to the long-term success of the project.
Excessive token allocation to the team should be an obvious red flag.
For example, below is the token allocation for the Zeus network.
40% for community-centric endeavours and only 25% for the team. This is solid in my books.
3. Community Engagement and Social Proof
As a rule of thumb, a strong and active community is a vital indicator of project health. Join the project's official forums, social media channels, and developer discussions to get a feel of the general sentiment.
A passionate and engaged community that actively contributes to developments and discussions is where you want to be.
Social Media Hype vs. Organic Growth
Regardless of what you may hear, there are good influencers that consistently promote quality projects.
But be wary of projects relying solely on social media influencers or paid promotions.
Nothing beats organic community growth through genuine interest and user engagement. Projects built this way are more sustainable in the long run.
4. Independent Reviews and Analysis
When searching for valuable insights and different perspectives to consider beyond the project's marketing materials, audits do a great job.
Top projects conduct audits – independent reviews and analyses of the project by reputable sources within the DeFi space. They showcase the results to bolster community confidence in them.
Potential Risks and Mitigation Strategies
Here are some considerations you must have in mind when investing in DeFi projects and how you can avoid them.
Smart Contract Vulnerabilities
Smart contracts are the backbone of DeFi applications, but they can also be vulnerable to hacks or exploits. Your best bets are projects that have undergone independent audits by reputable security firms to identify and address potential vulnerabilities.
Rug Pulls and Scams
Unfortunately, DeFi is fertile ground for scams. Avoid projects with unrealistic promises, suspicious teams, or a lack of transparency. This is where your research skills come in handy. As a beginner, opt for projects with a proven track record or, at the very least, a strong community.
Regulatory Uncertainty
The regulatory terrain surrounding DeFi is still evolving, given the age and nature of the industry.
It's in your best interest to stay informed about potential regulatory changes that could impact the project's operations or token value.
Projects with a focus on compliance and regulatory considerations usually demonstrate a responsible approach.
Market Volatility
Being almost purely speculative, the cryptocurrency market is inherently volatile. Be prepared for potential price fluctuations and invest only what you can afford to lose.
In the end, DeFi projects with strong fundamentals and a focus on long-term utility are better positioned to weather market downturns.
Conclusion
The factors I listed, alongside tokenomics, can equip you with a comprehensive framework for evaluating DeFi projects. I personally use this approach, and the results have been worth the time spent.
Remember, due diligence is absolutely necessary for survival here; Develop the ability to research – don't be someone else's exit liquidity.
You should always feel free to ask questions and prioritise projects that align with your risk tolerance and investment goals.
