101: Basics Before Investing - Part 1
Introduction
Tokens present a new investment avenue that does not follow the same traditional principles as existing alternative investments. While serious projects can provide investors with astronomical returns, the other end of the spectrum is riddled with outright scams. In reality, most projects fall somewhere between the two extremes.
In this series, I’ll be covering and analyzing various aspects before coming to a concrete decision on a token. Though I don’t deny the existence of elements like luck and chance in these investment projects, the characteristics I describe may help you avoid extremely expensive pitfalls in seemingly-great projects.
Due to the limited liquidity of any token, most of this overview will focus on assessing the current and future supply of the token, as well as its changes over time.
1. Token Distribution
The distribution of tokens is often detailed in their block explorer. In order to examine the token distribution for ERC-20 tokens, follow this link: https://etherscan.io/token/0xdd974d5c2e2928dea5f71b9825b8b646686bd200#balances
The first step in this process involves figuring out how many tokens the company is still holding and if they are sold aggressively on the open market. This same idea also applies to founders/advisory/seed token holders, but is often significantly harder to gather information on because the token issuer isn’t transparent. Consider this a major red flag!
While this may not be an easy task, it is a necessary step to take prior to investing. This may appear obvious, but don’t be fooled — many potential investors fail to realize the importance of this step. Please be aware that skipping this piece of the process can be detrimental.
An intelligent way to begin your research is by googling the terms “[Project Name] Whitepaper” or “[Project Name] token distribution”. If this search method is ineffective, use the search function in the project’s Telegram channel. It’s likely that many of these questions have been asked before by other curious individuals in the group.
Once you have gathered this initial information, the deeper research can begin.
Today, we’ll be using Kyber Network as an example. Kyber announced its token distribution on August 25th, 2017. They stated that 61.06% will be sold to the public, 19.47% will remain with the company, and 19.47% will be given to founders/advisors/seed Investors.
The top holder is Kyber (company reserve), retaining 14.4622% of the total token supply. This percentage is equal to approximately $16 million at the current price level. The wallet also contains an additional 14,411 ETH, which gives it a combined value of almost $20 million. As an investor, this is exactly what we would like to see: a multi year-long runway.
If you’d like to dig a bit deeper, you can also check exactly where the previous company’s tokens ended up.
Don’t forget that plenty of ICO companies spent an exorbitant amount of money during the chaotic 2017–2018 market. At the time, spending $200k for a single sponsorship slot at a conference wasn’t uncommon.
The vesting period for founders and advisors was 2 years. This period ended in September 2019, so it’s impossible for us to complete further research past this point. For projects that recently issued their tokens, this step is far easier.
We can use Etherscan to discover where the majority of coins are being held. Are the tokens in an exchange, or are they divided into personal wallets? We want the majority of coins to be held in personal wallets; this is usually an indication that fewer people are likely to sell once the price moves up.
Once we have identified the top holders, we can now set an alarm for these wallets on Etherscan to receive an email notification whenever a transaction is taking place. In order to do this, create an account and click on the “Add New” in the top right of the page.
This is especially useful if you are interested in day trading. Let me give you an example:
In this example, we are assuming that Kyber is sending $2.5 million worth of KNC to Binance. Before the KNCs arrive (12 confirmation), you will receive an email from Etherscan notifying you of an outgoing transaction. This is your chance to sell your position or even go short.
Once the price has dropped 2–5%, you are slowly buying back in and increasing your overall KNC holdings. While this doesn’t always work, it should give you an edge to make this alone a profitable strategy. Keep in mind that the outgoing transaction should be significant — ideally, it should amount to 1% or more of the total circulating supply.
2. Token Release Schedule
Low circulating supply and high concentrated holdings between the top holders are generally not a good sign. The newer the project, the more time you should spend on that topic in order to ensure that you are not overlooking any red flags.
A large percentage of tokens coming into circulation usually ends up with a dump, resulting in buyers drying up a few weeks prior to the release.
Before investing, make sure that your reasoning is strong enough at a given time; you must understand that the market needs to absorb the additional distributed amount without the token price being lowered. If not, wait until this happens and attempt to get in at a good price.
Patience is the key to successful investing.
The token issuer should provide the token release schedule. If you can’t easily locate this schedule by googling or searching through their communication channels, reach out to the team directly.
If no answers are provided after following up with the team on multiple occasions, consider canceling your investment. You don’t want to invest in a team that can’t provide basic information to their investors.
3. Token Economics
Is the project’s token economics sound? If not, is the team considering changing them in the near future? Many projects have done this very successfully in the past. While advanced investors can anticipate token economic changes, this requires extensive knowledge about the team. We’ll go into greater detail about this in Part 2.
Recent examples of projects who changed their token economics after launch:
SNX - Synthetix announced its monetary policy changes on February 15th, 2019. This was followed by a price increase of 1,291% within 9 months. The price is currently up 580% from the announcement date.
KNC - On December 17th, 2019, Kyber Network announced an upgrade to its token model. The price went up 208% up within three months and is currently up 85% from the announcement date
These examples should give you a sense of how important token economics is. Do not underestimate this. There are many great projects out there, but due to bad token economics, they are not likely to capture any value, even if the project is beginning to gain traction with its first 10,000 users.
4. Inflation
In their early days, some coins tend to have a high inflation rate. Be sure to check that rate before buying. If you continue with your purchase, participate in the network and stake as well — otherwise, your holdings will get diluted.
5. Advanced Research Tools
One useful tool that I like to use is https://www.intotheblock.com/. It comes with a 7-day free trial and was highly beneficial to me (this is not a paid advertisement — I’m just a happy customer). One particular statistic that I like to examine is the Global In/Out of the Money.
With this statistic, your goal is to see most of the people out of the money rather than in the money. People in the money are more likely to sell and take profit than those who have been holding out of the money for years.
On the other hand, https://messari.io/ provides reliable data and market intelligence. This service makes it easier to check yearly inflation (staking), tokens staked, and much more.
Additionally, the Messari team currently publishes one of the best research articles in the industry on a number of topics. This research periodical comes with the pro subscription. If you have $30 per month to invest in your research, I recommend that you give it a try, but by no means is it necessary to get started.
Conclusion:
I hope that this guide has given you a comprehensive overview of what to consider before making an investment. While this is a great compilation of information, it is certainly not the only source you should check before investing in a project. I’ll cover further points in Part 2.
Stay tuned and happy investing!
