How To Analyze Crypto Tokenomics to Make Investment Decisions

Navigating the crypto market successfully isn’t a wheel of fortune. People who consistently win and make profits off their investments are people who have deep knowledge and understanding of the assets they are investing in.

Cryptocurrency analysis is commonly divided into fundamental and technical analysis, both of which involve using present and past data to predict the future of cryptocurrencies.

Tokenomics, short for Token Economics, is a subset of fundamental analysis that helps you gain detailed insights into a crypto asset’s economics, understanding a cryptocurrency’s demand and supply dynamics and factors that can affect it. All of these directly influence their value and potential for growth, and a proper understanding of the underlying principles that shape a token’s worth will enable you to make well-informed investment decisions.

In this article, we’ll extensively discuss crypto tokenomics, which will add extra firepower to your fundamental analysis and provide better insights needed to make strategic decisions while navigating your cryptocurrency investments.

Understanding Tokenomics

The value of every existing currency is tied to the economics of the issuing body. In the case of fiat currencies like the U.S. dollar and the Chinese yuan, their values are tied to the economic policies of their respective countries.

Things like export and import ratios, interest rates, gross domestic product (GDP), and many more factors can all affect the strength of a nation’s currency.

Similarly, tokenomic components such as supply dynamics, utility, distribution mechanism, and emission schedule can affect a cryptocurrency’s supply and demand and, consequently, its strength.

To put it simply, we can say that tokenomics refers to the factors that impact a token’s use, functionality, and sustainability, all of which can affect its perceived value and, consequently, its demand.

As an economic rule of thumb, the more a currency is in demand, the stronger it is; as long as demand consistently outweighs supply and scarcity is induced, then the value is retained.

In subsequent sections, we’ll discuss tokenomic factors that can help guide your investment decisions.

Supply Dynamics

Indeed, the demand for a cryptocurrency determines its value; however, this is not in isolation. A cryptocurrency’s supply can determine how scarce it can be, and when in the right proportions with a crypto asset’s demand, it can shoot up its value.

A crypto asset typically has three types of supply: total supply, circulating supply, and maximum supply

• Total Supply: This represents the maximum number of tokens that can ever be created in a cryptocurrency’s ecosystem. It provides an upper limit, ensuring scarcity and potentially driving up demand.
• Circulating Supply: This is the number of tokens circulating in the market. It’s the portion of the total supply available for trading and use. The circulating supply directly influences the liquidity and pricing of a cryptocurrency.
• Max Supply: Max supply is the theoretical upper limit of tokens that can be in circulation at any point. In some cases, a cryptocurrency may not reach its maximum supply for many years, if at all.

Impact of Supply Dynamics on Token Value

As mentioned earlier, a limited supply of a crypto asset, relative to its demand, tends to drive up the price of a token. As a result, investors often perceive assets with smaller supplies as more valuable and less prone to inflation.

Some cryptocurrencies also have deflationary mechanisms like burning, halving, staking & lockups, etc.

All of these can reduce the supply, and consequently raise the value of the said crypto asset, provided that the asset remains in demand.

To illustrate the concept of supply dynamics, we can compare the supply schedules of Bitcoin and Ethereum.

Bitcoin has a total supply of 21 million, meaning that all the tokens that can ever be mined are 21 million. Initially, whenever a Bitcoin block is mined, miners receive 25 BTC as a reward; however, Bitcoin creator(s), Satoshi Nakamoto, included a halving algorithm, such that BTC mining rewards will be halved after every 210,000 blocks mined. As a result, the supply available to the public is regularly reduced, inducing scarcity.

Currently, the Bitcoin mining reward is 6.25 BTC (after two halving events), and it is expected to reduce to 3.125 BTC after the next halving, expected in April 2024. This deflationary mechanism has helped to ensure that only fractions of the leftover supply are mined, and it is expected that the last BTC will be mined in another 117 years.

This supply schedule has helped Bitcoin maintain scarcity and value within the crypto market.

On the other hand, Ethereum was created with an infinite supply; hence, there is no limit to the number of Ethereum tokens that can be created.

Initially, Ethereum was launched on a Proof-of-Work consensus algorithm, which mined tokens with some mathematical computations; however, upon moving to a Proof-of-Stake algorithm, Ethereum validators had to stake (lock up) a minimum of 32 ETH to validate transactions on the Ethereum network. Locking up tokens for an extended period automatically eliminates a huge number from circulation, inducing scarcity, and with constant demand, their value will increase.

Despite its newly found deflationary model, some analysts are of the opinion that, due to its high level of utility, Ethereum could have been way more valuable if it had a fixed supply that made it scarce.

Hence, it is commonly agreed that Bitcoin has a better economic model than Ethereum due to its exhaustibility.

Utility and Use Cases

The utility of a cryptocurrency refers to the specific functions it performs within its associated blockchain platform or network.

Some typical use cases for tokens include:

• Means of exchange
• Store of value
• Transaction fees
• For voting in DAO Governance decisions
• To create and execute smart contracts
  And many more.

Bitcoin, the index cryptocurrency, was created as a means of exchange; the first time it was spent was when a computer programmer used 10,000 BTC (worth $30 at the time) to buy two large pizzas. Bitcoin is also used as a store of value to hedge against inflation, earning it the name, “digital gold”.

Ethereum, on the other hand, has a wider range of utilities, as it is used to fuel all transactions on the Ethereum blockchain. These include the creation and execution of smart contracts, voting on governance decisions, and many more.

If a token is launched on the Ethereum network, transaction fees would be paid with ETH. For example, To send $SHIB tokens from my wallet to your wallet, I’d need to have some $ETH tokens for gas.

Similarly, if I intend to buy some NFTs on Blur or OpenSea, I’d need some $ETH for the transaction and the gas fee.

If a smart contract developer intends to launch a new dApp on the Ethereum network, he’ll need some $ETH, and if I, as a user, intend to interact with the smart contract, I’ll need some $ETH.

Ethereum’s wide range of utilities earns it the nickname “digital oil,” as it powers many blockchain processes. Despite Bitcoin holding more than 40% of the entire crypto market share, Ethereum has surpassed Bitcoin in transaction volumes since 2021, a testament to its utility.

Without having to mention it, it is obvious that cryptocurrencies with high utility are constantly in demand and, as a result, highly valuable. Other factors that can speak to the utility of a cryptocurrency include partnerships and adoption by traditional companies and businesses.

Token Distribution Mechanism

Token distribution mechanism refers to how the initial token supply was made available to the public. As a rule of thumb, the more decentralized it is, the stronger a currency is. If a large percentage of a cryptocurrency’s supply is in the hands of a few people, the asset’s economics is in danger, as a few people can determine its supply.

To put it in context, out of Bitcoin’s 21 million tokens, if a single person has 10 million in their wallet, and decides to liquidate their holdings, there will immediately be an excess supply that exceeds the demand, and the prices will crash. As a result, knowing how the initial supply of a token is distributed is important for investors.

Below are common Token launch mechanisms:

• Initial Coin Offering (ICO)
• Airdrops
• Private sale
• Mining

Etc.

Private sales could lead to the centralization of the better part of the tokens to a few investors, who automatically become whales. As a result, they may manipulate the market with coordinated pumps and dumps.

If a large quantity of a token’s initial supply is shared via an airdrop or public sale methods like ICOs, centralization becomes unlikely.

Mining could also lead to centralization, as many people may not have the needed equipment to participate in mining activities.

As an investor, it is important to note the supply schedules of the tokens you want to invest in and how they were distributed. This can provide insights into the presence or absence of whales who can manipulate the market.

Investigating the percentage of tokens held by the team is also important. If the team holds many tokens without “locking” them up, you need to be wary, as some fraudulent developers are always looking to dump tokens on innocent investors.

Conclusion

Understanding Tokenomics and how they can affect the value of cryptocurrencies can put you a step ahead when investing in cryptocurrencies, especially for the long term.

Thankfully, with Cwallet, you can easily see the basic data of a cryptocurrency, including the supply schedule and the daily transaction volume, which provides an insight into the asset’s demand. Even better, Cwallet provides direct links to the contract and website pages so you can see the whale distribution, as well as other information made available by the team.

So, beyond saving your assets on Cwallet, you can also gain meaningful insights to guide your investment decisions at a glance.

Remember that fundamental analysis is king, and with the right knowledge, you can forge your own path to success while investing in cryptocurrencies. Good Luck!