How to determine if a project has a good or bad tokenomics

One of the most critical metrics for evaluating the potential of a cryptocurrency is its tokenomics.

You can use the tokenomics data, to determine whether a coin is worth buying; holding for the short; medium, or long term; or if it’s best to stake it.

What is tokenomics

Tokenomics refers to the economic design and characteristics of a token. It is a combination of the words “token” and “economics” which aims to understand every aspect of a token that affects its value.

From creation to distribution and application, every single aspect of a token is essential for an investor to understand whether or not it’ll be a good investment.

The different aspects of tokenomics

If you want to take a holistic view of tokenomics you should be looking at its:

  1. Generation
  2. Token type
  3. Supply
  4. Allocations
  5. Vesting periods
  6. Distribution
  7. Inflationary mechanism (minting)
  8. Deflationary mechanism (burning)
  9. Use cases

Let’s examine each of these below.

1. Generation

At the token generation level, you want to know whether the contract is verified or not. Ideally, you should only be dealing with tokens with a verified contract.

Furthermore, verify whether the admin has renounced the token contract ownership or not. If the admin maintains ownership, it means they can generate new tokens whenever they want.

This isn’t very safe as it requires you to trust the admin to know to mint new tokens and dump them on the market. Thus creating an exit scam.

Finally, you want to know whether the token is fully premined or the remaining supply will be generated on a block-by-block basis until the maximum supply is reached.

2. Token type

Every cryptocurrency out there is either a “currency”, a utility token, or security. Find out what type of token the one you want to invest in is, and take note of the legal implications.

A security token will be the more controversial of the three due to more stringent regulations.

3. Supply

There’re three aspects of a token supply that are very important for you to understand before investing in them.

They are, the:

  1. Maximum Supply
  2. Total supply
  3. Circulating supply

1. Maximum Supply

Does the token have a limited, fixed or unlimited supply?

Limited or fixed supply is usually better than unlimited tokens because, for the unlimited supply tokens, the continuously increasing supply will dilute your investment as demand is not infinite.

However, it doesn’t mean that unlimited supply is entirely bad, and in some cases, it’s only temporary until the project developers understand how many tokens they need.

For example, after over one year of operating with unlimited supply, the PancakeSwap team finally set a CAKE (750 million).

For some projects, token supply is something they cannot fully decide upon until a certain stage, as you can see with CAKE above.

But there are only a few such cases, and most greedy developers will never set a cap on their token supply, even when the time comes for it.

However, there’re exceptions for the likes of Ethereum, which may have an unlimited supply, but due to their strong market and tokenomics design, they can sustain their value in the long term.

2. Total supply

Total supply refers to the amount of the token that’s been generated or minted, including both the circulating supply and any tokens that are being locked up for any reason.

The total supply number will increase as new tokens are generated and can reduce due to burning.

Ideally, uu want to invest in a token that the majority of the supply has been generated, meaning there’s less future inflation.

But even better, is the one where all or nearly all of the supply has been generated and is in circulation.

3. Circulating supply

Circulating supply refers to the amount of the token that’s been released into the market and is being traded by the public.

The closer the circulating supply is to the total and maximum supply, the less the expected dilution or inflation.

4. Allocations

The next thing to look at is how to token supply is allocated to the various stakeholders of the project

For example, how much of the supply goes to the project developers, advisors, private investors, and other insiders?

And then look at how much goes to the public through presales or IDOs; liquidity pool; ecosystem and community development; etc.

The more of the supply that goes to the public, the more decentralised the token will be and the better for the project and investors.

You want to be cautious of projects in that the majority of the tokens are held by the founders, private sale investors, and insiders.

It’s a perfect recipe for centralisation and market manipulation.

Ideally, the token should be widely distributed with the public holding most of the supply.

5. Vesting periods

The vesting period usually refers to how long the team or private investors  have to wait to be able to receive or sell their tokens.

It’s used to assure investors that the team or early investors are committed to the project and is in it for the long term.

6. Distribution

Some projects like decentralised exchanges (DEXes) usually distribute their token to liquidity providers on their platform.

Other projects may choose to distribute theirs through an airdrop (proactively or retroactively).

Furthermore, others have a staking program that allows you to stake their token to earn more of the same.

Whatever distribution system the team has set in place it should be fair and transparent.

7. Inflationary mechanism (minting)

How are new tokens are being generated?

The standard way most new tokens are created is through block emissions or mining on a block-by-block basis.

These new tokens being minted increases the supply or inflation and will only stop when the token reaches its maximum supply.

For tokens without a fixed maximum supply, new coins will be generated indefinitely, and that’s why they usually have higher inflation.

The higher the emission rate, like how many new tokens are being generated per block, the higher the inflation will be.

Do you see the demand for the token outpacing the inflation or supply increase?

If your answer is yes, then you can safely assume the value will increase or at least not drop significantly.

However, if there’s not enough demand to accommodate the increase in supply, you can expect the price of the token to do poorly until the inflation stops.

With this information, you can structure your investment or portfolio accordingly.

8. Deflationary mechanism (burning)

Some projects buy back and burn a certain amount of their token regularly or randomly in an attempt to reduce supply or inflation and support its value.

If the token has a fixed supply, this will make it deflationary, especially when the amount being burned is greater than the number of new tokens being minted in every block.

Even with an unlimited supply token, if more tokens are being burned than new ones are generated it will also be deflationary.

9. Use cases

The most important aspect of tokenomics is a token’s use cases or utility.

What is the token being used for that ensures that there’ll be consistent or growing demand to support its value?

The more use cases a token has, the more you can expect that the value will increase over time as the project grows and vice versa.

Why is it important to look at Tokenomics before investing?

Leave a Comment

Your email address will not be published. Required fields are marked *