What makes a cryptocurrency valuable and interesting to buyers? It’s not just the price alone that influences a crypto’s popularity, but also its quality. While some coins or tokens can get off to a flying start and generate lots of profits for early investors, many don’t live up to the hype. As a new investor, it could be difficult to evaluate which projects are genuine and have the potential to grow into a sensible long-term investment.
That’s where tokenomics comes in; it can give you a good insight into whether the project is worth investing in or not.
Let's dive into what tokenomics means, why it’s important to the success of a crypto project, and how to identify a project with good tokenomics.
Tokenomics is the technical-economic feature that decides how the tokens of a crypto project will operate. To put it simply, anything that impacts the value of a token is a part of its tokenomics. It includes specifics like how many tokens exist or will be added in the future; how they will be distributed; how many are being burned; the project's utility, etc.
Tokenomics is determined at the very beginning of a project and is often worked into the blockchain codes by its developers. It also adds a lot of transparency and trust.
Here’s what you should look out for when analyzing tokenomics:
This is a key feature in a crypto’s tokenomics. The supply of a crypto project can either be limited or unlimited. An example of this is Bitcoin, which has capped its maximum coins that can ever be mined at 21 million. Ethereum, on the other hand, has an unlimited supply, although it has a maximum supply that can be mined in a year.
The importance of purchasing a fixed or a limited supply token is that it almost guarantees a way to profit from future value. It is simply understanding the economics of high demand and low supply that in turn drives value.
In the case of an unlimited supply chain of tokens, profiting becomes harder if the project does not get enough users, which would drive its value. It is generally risky to invest in projects with an unlimited token supply. Even projects like Ethereum, which has an unlimited supply, operate on a yearly limited supply.
Token Allocation and Distribution
Tokens are usually generated in two ways — they either come pre-mined (like Ripple) or get released through a fair launch (like DOGE and Bitcoin). Before going public, pre-mined tokens are usually minted by some exclusive addresses. These include the project owners, developers, and early investors, and some are put away in treasury. If you are investing in a pre-mined token, check what percentage is held by the creators. If it’s bulk of the supply, then it can be a red flag and investing in such a project can be risky. On the other hand, fair launch tokens don’t give out any private allocations before launch and are fully owned and governed by the community.
Mining and Staking
Mining and staking impact how a cryptocurrency functions. Mining helps Proof-of-Work (PoW) networks like Bitcoin to validate transactions, and by extension, engender the project's safety. Miners solve complex computational puzzles and receive tokens as a reward, helping keep the network decentralized. Staking uses the Proof-of-Stake (PoS) mechanism and was designed as an alternative to Proof-of-Work, which causes a huge strain on the environment because of mining. Staking requires investors to lock their coins in a smart contract. The locked tokens provide validation to the network, while investors earn rewards based on how many tokens they staked, and for how long.
As an investor, you should take into account the amount of cryptocurrency held in rewards for stakers and miners. Also, in the case of staking, you should find out the minimum number of tokens you would need to buy for staking. This can be compared to making investments with fiat currency—the more you invest, the higher the returns. This can also give you compounding returns, where your assets' earnings generate even more earnings.
This feature does not necessarily impact the initial or potential value of a crypto project. However, most cryptos are adopting a governance-style tokenomics model, which simply gives the holders the power to contribute to the decision-making process. Anyone who holds a governance token gets voting rights that can influence its future protocols and rules. This creates real decentralisation—instead of a core group of owners, developers, and early investors being in the driver’s seat, token holders can also vote to decide how the project should operate. This kind of governance system can protect an investor’s interests and prevent a major stakeholder from making arbitrary decisions.
Utility tokens are like store credits. If you purchase a product from a store, you earn credit points that can be redeemed to buy more products or, in some cases, exchanged for money. In the same way, utility tokens fulfill a real-world utility. For example, the Basic Attention Token (BAT) can be used as a payment method for content creators and publishers, and Golem (GNT) allows users to rent their computing power.
Utility tokens can create a cycle of incentives for both investors and creators—investors earn rewards by using the token, and the project earns more support that helps push it forward, which in turn can increase its value.
The current market price of a token can fluctuate wildly based on a lot of external factors. That doesn’t mean that a particular token’s future is bleak. If it has strong tokenomics, it can grow into a promising investment. Read about a project’s tokenomics in its whitepaper and on the website before deciding to invest.