How to Use Tokenomics To Find the Best Crypto Projects

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Intro

A major reason many people get recked when investing in crypto is that they are unable to tell the difference between a solid project and a bad one with poor fundamentals. Learning tokenomics is your best path to escaping that awful reality. In this article, I will cover all you need to start analysing tokens like an expert.

Here’s what you will learn in this article:

i. What is tokenomics?

ii. Components of tokenomics

iii. Terms you should know

iv. Going beyond tokenomics

v. How projects control excess supply

What is Tokenomics?

Tokenomics is the economics of a cryptocurrency or blockchain project (Token + Economics). Simply put, it considers how the project’s digital tokens are designed, distributed, and used.

A good understanding of tokenomics can help you, as an investor, evaluate the long-term viability of a project.

But as with all tools in crypto, nothing is a magic wand. Some projects may have ‘perfect’ tokenomics and still fail. So there are other factors beyond tokenomics that you need to consider as well.

That said, it’s wiser to bet on a project with a 10 million token supply well distributed across its ecosystem than one with a 100 billion supply and 70% allocated to the team.

You will understand why in the course of the article.

Components of Tokenomics

Here’s a breakdown of what tokenomics typically looks at:

1. Supply and Demand

It’s a basic tenet of human psychology that, in most cases, scarcity drives up value. Supply and demand are well-discussed concepts in economics.

Does that imply that a huge supply is an expressway to failure? Not really. Many tokens with billions in circulation at TGE (Token Generation Event) still go on to do well. As I said, there are many factors to consider.

But at its core, tokenomics seeks to investigate the supply and demand dynamics of a token. It goes further to help us gauge the sincerity of a project and whether it’s worth our time — and if yes, the best time to key in.

How to Consider Supply vs. Demand

When trying to assess supply and its potential impact on demand, there are three key factors to keep in mind:

• the total number of tokens created (maximum supply)
• the number of tokens currently in circulation (circulating supply)
• and how new tokens are generated/released

A limited supply can make a token more valuable over time. Bitcoin, for instance, has just a 21 million maximum supply, which adds to its desirability.

Dogecoin has a total supply of 200 billion. Such a token getting to $1 is difficult because the market cap would be $200 billion at that price.

2. Distribution

Distribution refers to how the tokens are initially circulated. Some common distribution methods include selling tokens through an initial coin offering (ICO) or rewarding users for participating in the network through airdrops.

Distribution is an extremely important factor to consider. If a project has:

• nearly all of its tokens allocated to the team
• none or little assigned to community incentives or airdrops
• little kept for ecosystem growth initiatives

Then, it’s a possible sign that such a project has no long-term growth objective in mind—in other words, it’s likely a cash grab aiming to enrich a few.

We want to see a balanced allocation that reflects the project’s goals. For instance, consider the Injective protocol’s token distribution below.

Cryptorank

3. Utility

This refers to the purpose of the token within the project’s ecosystem. That a project has just 10 tokens in circulation does not guarantee it will become valuable with time.

Value is, more often than not, attached to utility — think benefits. The more benefits, the higher the value and demand for the token.

When investigating a token, consider if:

• it gives holders access to exclusive features or services, e.g., staking rewards
• it can be used to pay for transaction fees
• you are better off holding another token

A project with well-designed tokenomics that incentivizes holding tokens is a more promising investment than one with no clear use case and excess supply. The obvious exception to this rule is meme coins. Those rely heavily on sentiments and euphoria, so anything really goes.

Tokenomics Terms You Should Know

Now that we understand the basic premise of tokenomics, let’s discuss the metrics used in the process, and how to create actionable plans for analysing tokens.

Market cap and Fully Diluted Valuation (FDV) are two important metrics used to assess a cryptocurrency’s viability, but they look at different aspects. Here’s how they can influence a coin’s potential:

Market Capitalization (MCap)

This represents the total market value of all circulating tokens of a cryptocurrency. It’s calculated by multiplying the current circulating supply of tokens by the current price per token.

MCAP = Tokens In Circulation x Current Market Price

A higher market cap generally indicates a more established and trusted project, but it doesn’t necessarily mean it’s a better investment.

Fully Diluted Valuation (FDV)

FDV defines the total market value of a cryptocurrency if all of its tokens are in circulation (most projects do not release total supply at once, more on the topic later.)

It’s calculated by multiplying the total token supply (circulating and locked tokens) by the current price per token.

FDV = Max Supply × Current Market Price

FDV can give you an idea of a project’s potential market cap if all tokens are unlocked and sold.

How they affect viability:

Market Cap: A high market cap often indicates a strong community and investor confidence. But it can also limit the room for significant price growth. A token at 100 billion MCAP is unlikely to do a 100x run.

The jackpot is finding a good token with a low MCAP. But while a less established project has more potential for growth, it also carries a higher risk of failure.

FDV: FDV helps you compare tokens with different circulating supplies. For example, a coin with a lower current market cap but a high FDV might not be a good investment if reaching the FDV seems unlikely due to a large locked token supply (supply decreases the value.)

Here’s an analogy: Imagine market cap as the current market value of all the houses in a neighbourhood, and FDV as the total value if all the vacant plots were also developed into houses and sold at the current market price.

The problem is that, with so many houses, the price per house will likely decrease. This means the initial project MCAP will not be realised.

The market cap and FDV do a good job of helping us understand a cryptocurrency’s current state and its potential for future growth.

However, it’s important to remember that they are just two factors among many to consider when evaluating viability. Other factors, like the project’s team, technology, and adoption rate, also play a significant role. So let’s discuss them.

Beyond Market Cap and FDV: My Token Viability Checklist

In this section, we will consider a comprehensive approach to assessing a token. You can create a checklist based on these questions and whip it out when something catches your attention. The good part is that as you get more experienced in the industry, the process becomes less mechanical and more spontaneous.

1. Get to know the team

There are three major factors to consider here: experience, expertise and communication.

Pay attention to projects with teams experienced in blockchain technology, relevant industries, and business development. A strong track record in previous projects is a plus.

Next up, how does the team interact with its community?

Ask yourself:

• Does the team actively communicate with the community?
• Are they transparent about their goals and roadmap?

Where to look: the project's social media channels like Discord, Twitter, and Telegram.

2. Find out who is backing the team

While not always the case, good projects often have funding rounds with top VCs and private investors.

The names betting their money on a project’s success can serve as a pointer.

Where to look: Crypotorank.io

3. Review the technology & innovation

The best projects solve problems, and they do that in novel and impressive ways. For me, the project has to:

• offer a unique solution to a real-world problem
• have a strong underlying technology with the potential for scalability and security

Active development is also important since the DeFi landscape is constantly evolving, and good projects should evolve too.

• Is the project actively being developed?
• Is there a clear roadmap for future development?

Where to look: the project whitepaper, social media channels

4. Assess the potential Adoption Rate

Don’t be a bag holder of trash nobody wants. There should be an observable effort by the team to ensure their token reaches more people.

• Is the coin being used for its intended purpose within a growing ecosystem?
• Are there established partnerships or integrations with other platforms?

A budding community where users are enthusiastic about a token is expected to grow. More users joining means increasing adoption.

• Does the project have a strong and engaged community?
• Is there active development on the project’s forums and social media channels?

5. Find out the project’s ambition: clear utility vs. buzzwords

Aside from meme coins, most tokens with no utility — many exist in this category — are unsurprisingly overlooked. Buzzwords can only fool a few, and not for long. This takes us back to our utility assessment: the token should have a clear use case within the project’s ecosystem. This can be for network transactions, governance voting, or access to exclusive features.

6. Look at the token distribution

Always consider the tokenomics before investing. I have written an entire section based on this topic.

• How are the tokens distributed?
• Is there a fair distribution model or is a large portion controlled by a small group?

Where to look: the project’s website, cryptorank.io

7. Regulation

The regulatory landscape can emphatically impact cryptocurrency projects. In some cases, it may be important to consider:

• how the project navigates the evolving regulatory environment
• the steps being taken by the project to comply with relevant regulations

8. USP should be convincing

Thanks to the proliferation of the industry with dapps of all kinds, the competition in the defi landscape is fierce. Good projects must stand out.

• How does the project compare to similar projects in the market?
• What makes it stand out from the competition?

9. Security of users at heart

You want a project that has no loopholes for exploitation by hackers. This is where audits come in. Consider if the project has been audited by a reputable security firm. Also, find out if there have been any security breaches in the past.

Putting it all Together

Remember, there’s no single factor that guarantees a coin’s success. But with a holistic approach, you can get a more complete picture of a coin’s potential and make better investment decisions.

It goes without saying that the above steps are more of a guide than hard-fast rules. You may not always find projects that check all the boxes. But the knowledge is useful.

Also, try to stay up-to-date on the latest developments in the cryptocurrency space, as factors can change in the blink of an eye.

How Projects Control Supply

Scenario: A Token with 10M MCap and 1B FDV

Although there is more to success than the numbers, based on market dynamics, a token with 10 million MCAP and 1 billion FDV could be a promising project. But having only 1/100th of the coin in circulation is unattractive — to me at least.

Here’s why:

The FDV being 100 times larger than the market cap suggests significant room for growth.

But this is only true if all the tokens were released and acquired at the current market price. The project’s market value could potentially reach $1 billion.

However, there’s no guarantee that all tokens will be released or acquired at the current price. The project needs a strong use case and adoption to reach its FDV.

Won’t unlocking to full supply dump price? You may ask.

You guessed right. Unlocking all the coins would indeed increase the circulating supply. And according to our basic principles of supply and demand, this could lead to a decrease in the value of each individual coin, especially if the new tokens are all released at once.

Below is a breakdown:

Increased Supply/sell pressure

When all coins are unlocked and available for trading, it creates more competition among sellers — there’s too much to sell.

This can put downward pressure on the price, as there might be more sellers than buyers at the given price point.

Demand Matters

The impact of token unlocks on price depends on the overall demand for the token. If the project has a strong use case and a positive outlook, the increased supply might be absorbed by the market without a significant price drop. Yes, this happens too.

Investors might still be willing to buy even if the price dips slightly because they believe in the project’s long-term potential.

However, not all coins meet the above expectations. It’s possible to have a strong use case and adoption rate but suffer from the setbacks of excess supply. Luckily, several mechanisms are usually in place to help projects mitigate the supply problem. We will consider them in the next section.

Supply and Demand Control Mechanisms in DeFi

In tokenomics, a couple of mechanisms are useful in influencing the market demand for a cryptocurrency, ultimately affecting its price. Think of these as ways to control inflation in Defi.

They include:

• Burning
• Halving
• Vesting

Burning

Burning refers to permanently removing a certain number of tokens from circulation. To burn tokens, the holder sends them to an address with no keys, making it impossible for anyone to withdraw them.

This essentially takes the tokens out of the supply, reducing the total number of tokens available.

Why Burn?

Deflationary Pressure

By reducing supply, burning can create scarcity. Going back to our economic principles, this can lead to an increase in price over time.

Control Inflation

Burning can help manage the token’s inflation rate, especially if new tokens are constantly being created. By removing some tokens, the overall inflationary effect is lessened.

Increase Demand/Utility

Burning can serve as a way to increase the utility of the remaining tokens. If there are fewer tokens available, each token becomes more important for users to interact with the network or access certain features.

Examples: Some notable projects that utilise burning mechanisms include Binance Coin (BNB) and Ethereum (ETH).

BNB burns a portion of its tokens every quarter based on trading volume. Ethereum implemented a burning mechanism in EIP-1559, where a small portion of transaction fees are burned.

Vesting

Vesting is a process where tokens are gradually released to token holders over a set period. The idea is to prevent large amounts of tokens from being dumped into the market all at once, which could cause a price crash.

Projects implement vesting for a few reasons:

1. Preventative Measure

Vesting helps fight price manipulation by preventing early investors or team members from selling all their tokens immediately. This is common in the landscape. Hence, a gradual release creates a more controlled flow of tokens into the market.

2. Team Commitment

Vesting can encourage the project team to stay committed to the project for the long term. If they are only able to access their tokens gradually, they are more likely to work hard to ensure the value increases.

3. Community Building

Vesting can help promote a stronger community by rewarding early supporters who believe in the project’s vision. Receiving tokens over time can encourage them to stay involved and contribute to the project’s growth.

Examples: Vesting is a common practice in most projects’ Initial Coin Offerings (ICOs) and Token Generation Events. Each project can have a different vesting schedule, but it’s typically spread out over months or even years.

Halving

Halving is an event where the block reward for mining new tokens in a Proof-of-Work (PoW) blockchain is cut in half. This directly reduces the rate at which new tokens are introduced into circulation.

Why Halving?

Bitcoin, the most famous PoW blockchain, is the prime example of halving. Halving is written into Bitcoin’s code and occurs automatically every four years. The purpose of halving is to:

1. Control Inflation

Halving is a way to manage inflation in cryptocurrencies that rely on mining. The rate at which new coins are created is slowed down with reduced block rewards.

2. Maintain Scarcity

Bitcoin has a finite supply of 21 million coins. Halving helps ensure this finite supply is released into circulation at a predictable rate.

Impact of Halving

Historically, halving events lead to price increases for bitcoin due to the reduced supply of new coins entering the market. However, the actual impact can be influenced by various factors like news, market demand and overall economic conditions.

CONCLUSION

There are no true guarantees when choosing projects to invest in; however, the best traders all implement a systematic approach. At the very least, this serves as a risk mitigation strategy; on the other hand, such an informed process can lead to great gains. It is always better to err on the side of caution. Adopt the strategies in this article to spot good projects with solid fundamentals and a higher probability of success.