What gives cryptocurrencies their value?

Tokenomics are one of the main factors to consider when investing in cryptocurrencies.

Tokenomics= Token + Economics

Tokenomics is simply the quality of a token that creates demand for that token from investors.

Tokenomics will help investors understand the purpose, functionality, uses cases and distribution of a particular token.

Before diving into what gives a token its value, it's important to identify the main difference between a coin and a token. A Crypto coin is native to its own blockchain and is used for the transaction within it(Example: ETH). A token is a distributable token within another blockchain that acts as an incentive for coin users(Eg: ERC20)

Understanding the types of cryptocurrencies

“ You should be taking this technology as seriously as you should have been taking the development of the Internet in the early 1990’s”

- Blythe Masters, Executive JPM

Key Metrics

Most of these metrics can be found on coinmarketcap or Coingecko. Always confirm with the whitepaper to verify their accuracy.

Total token supply: The number of tokens that can ever be issued by a project. The easiest example for this is Bitcoin which has a maximum supply of 21 Million.

Circulating supply: This shows the total number of tokens that have been issued to date and are currently available to trade in the market. One of my personal rules is to only invest in projects that have a circulating supply of more than 50%.

Market capitalisation: Price per token multiplied by the circulating supply.

Fully diluted market cap: Theoretical market cap if all the tokens of the project were already in circulating supply. Better guide on valuation than the market cap.

Allocation and distribution

Fair launch

A Fair launch is a crypto network that is earned, owned and governed by the community from the outset where there is no early access, pre-mine or token allocations.

Examples: Dogecoin, Litecoin, Bitcoin, Yearn Finance

Pre-mine

Pre-mine is when a certain number of coins are created before it is launched to the public. In this process, the coins are mined by developers and allocated to VC funds and the team.

The reasons a coin could be pre-mined include payment for additional development of the project or as means for rewarding the early investors.

While it can be argued that pre-mined coins reward the early investors disproportionately, they are the ones that take the biggest risk after all. Furthermore, pre-mined coins give developers some coins to use within the blockchain. However, pre-mined coins have a bad name due to certain projects not being fully transparent with their pre-mine especially in the 2017 ICO bubble.

Vesting applies mainly to pre-mine tokens which explains how then tokens will be allocated in a certain time period. To increase the

As an example, the uniswap vesting schedule has gradual release over time which increases confidence within investors. If there’s a vesting schedule with a sudden increase in allocation at a particular date, it is an instant red flag as it could cause more volatility. DeFi tokens that offer unimaginable annual returns often have highly inflationary vesting schedules to maintain their returns.

Use Etherscan, BSCscan or any other block explorer to find out how tokens are allocated. Be wary of projects that have wallets that hold a significant % of the total supply. This increases the risk of whales dumping their coins on the market in an instant.

Token Models

Inflationary

Just like the US dollar, an inflationary token will be continually printed/produced over time with no max supply.

Inflation is still a misunderstood concept. Inflation is not the increase in asset prices but the falling of purchasing power. A currency can be the same price and still fall in real value if another 10% of that asset is released into the market.

Most proof of stake tokens such as Ethereum and Polkadot are inflationary to reward network validators and delegators who are responsible for validating transactions within the blockchain network. For example, Cosmos(ATOM) has an inflation rate of 7.5–20% depending on the total amount of coins staked.

While it is not a crypto asset, the USD is an inflationary currency which has

Deflationary model

Bitcoin is the prime example of a deflationary token model. With a max supply of 21 million that has a falling rate of production every 4 years. The rate of production of Bitcoin is cut in half every 4 years, famously known as the Bitcoin halving. Initially, 50 bitcoins were mined every block(10 minutes). After 2020 halving, only 6.25 are currently mined per block.

Furthermore, every year HODLers accidentally lose access to their Bitcoin wallets which further reduces the circulating supply.

While having a max supply will incentivize investors to hold the token, it may also limit the token’s potential to be spent and used in the economy. For example, if Bitcoin keeps rising in value, long term holders would hesitate to pay in Bitcoin which will ultimately weaken its use as a medium of exchange. Instead, it will be used more as a store of value.

To put things into perspective, here’s an example. Cardano (ADA) has a max supply of 45 Billion. Currently, 1 ADA is valued at $1.37 with a market cap of $43.7 Billion. Bitcoin is valued at $34,000 with a market cap of $640.1 Billion. If ADA goes up to $ 25, its market cap would be $659 Billion making it more valuable than Bitcoin even with a lower price. Similarly, Yearn Finance(YFI) has a price of $28,846 USD with a market cap of just $1Billion USD, 640 times less than that of Bitcoin.

Ignoring asset prices and thinking in terms of market cap expansion is important in determining the long term potential of a token or a stock.

Token burning is a popular strategy that removes some tokens from the circulating supply which could have an impact on the price. This is the equivalent of a stock buyback from a listed public company. Binance conducts quarterly burns in their mission to burn 1 million BNB tokens from the supply.

Asset-backed model

Stablecoins such as USDT, BUSD and USDC is pegged against a fiat counterpart such as USD to derive their value.

Stablecoins are popular among traders. However, some tokens such as USDT which doesn’t have 100% cash backing is highly controversial.

Dual token model

In this model, 2 separate tokens are used in the same blockchain where one is used as the funding option and the other is used for utility. This new type of model is a result of regulations imposed on unregulated ICO’s. Apart from the added safety of dual tokens, they also allow projects to be more flexible as both tokens can each have their own properties.

Examples: Vechain and VechainThor(VET/VTHO), MakerDAO(MKR/DAI)

For Vechain, VET is the primary token of the blockchain where its main function is to transfer value across the blockchain and trigger smart contracts. VTHO, the ‘energy’ token functions as gas to power the smart contract transactions. Each VET generates VTHO at a rate of 0.000432 per day. users can stake VET to generate VTHO.

Conclusion

Tokenomics are important, but not the only thing you should look out for when reviewing a project.

Other factors to consider,

• Project team (History, past projects, social media)
• Developer activity (Github)
• Community (Twitter, Lunarcrush)
• Technical analysis
• Utility

Finally, I’ll you with this quote from John McAfee(1945–2021) on the potential of blockchain. RIP.

Well, in 2014 I decided that the blockchain was probably the most revolutionary software technology that I had seen in my 50 years of doing computer science.

Thank you for reading. Hopefully, this comes in handy when reviewing your next token.

Twitter: @PereraAshain