Tokenomics 101
390 days since Bitcoin had a new all-time high, since that time it's been mostly down only.
However, I still think there are huge opportunities for people that are active in the space to actually make it. But you got to put in the work. And the bear market is the best time for that.
Pat yourself on the back if you're still here, 90% of the players already left. You can be among the 10% that has a chance of making it in the next bull run.
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Tokenomics 101
Many people talk about tokenomics, but only some people understand it.
If you’re considering whether or not to buy a crypto asset, understanding tokenomics is one of the most useful first steps you can take to make a good decision.
This newsletter goes through the basics so you could learn how to analyze a project for yourself.
To understand if a coin should go up or down in price we have to understand supply and demand.
To understand this better let’s do an example with Bitcoin ($BTC).
Let’s start with the supply side.
Supply
1) How many $BTC tokens exist?
Answer: 19.2M $BTC
2) How many tokens will ever exist?
Answer: 21M $BTC
3) How often are new tokens being released on the market?
Answer: The increase in a token's supply over time is called emissions and the speed of emissions is important. You can find info about this in the token's whitepaper. Emissions can come from staking rewards/airdrops, and token unlocks.
Every 10 minutes, Bitcoin miners verify one block of bitcoin transactions. The current reward for verifying one block of bitcoin is 6.25 bitcoins. So, approximately 900 bitcoins are released into the market every day.
On average, the blocks created will keep “halving” every four years (called "the halving"), until eventually only 0.000000001 Bitcoin are awarded per block “mined” by the year 2140.
In other words, by the early 2030s, nearly 97% of Bitcoin is expected to be unearthed. The remaining 3% will come into existence over the following century, until 2140.
This means that the token price should increase if there are fewer coins that exist, and vice versa the price should go down if more tokens exist.
For $BTC this is pretty easy to understand, but when we look at other tokens, eg. $ETH it is a little more complicated because there’s no cap on how many Ethereum tokens can exist.
Important metrics to know about
Circulating supply: number of tokens existing today
Total supply: Onchain supply minus burned tokens
Max supply: The maximum number of tokens that can exist
Market cap: Today’s token price x Circulating Supply
Fully Diluted Market Cap: Today’s token price x Max Supply
Another essential thing to consider with the supply side is the token allocation. This isn’t a big deal with $BTC. But something to think about when you evaluate a new token that you consider buying.
Also:
1) Are there whales out there that own most of the tokens?
2) How is the unlocking schedule?
3) Did the protocol give most of its tokens to the early investors in the seed round?
My point is: don’t end up rekt investing in shitcoins like $KASTA created by The Moon Carl because you didn’t read up on tokenomics.
IMO, @UnlocksCalendar and @VestLab are good resources to check the unlocking schedule.
To quickly summarize what's important in the supply side, check:
-circulating supply
-total and max supply
-token allocation
-the unlocking schedule.
With that said, supply alone isn’t enough to take a decision if a token is worth buying.
This brings us to demand.
Demand
Okay, so we know that Bitcoin has a fixed supply of 21 million tokens and that the inflation rate in $BTC is approx. 1.6% and trending lower every year.
So why aren’t the price of $BTC $100,000 yet?
Why is it “just” $16K?
Well, the short answer is that having a fixed supply alone does not make $BTC valuable.
People also need to believe $BTC has value, and that it will have value in the future.
Let’s divide demand into 3 components:
Financial utility (ROI on token)
Real Utility (Value)
Speculation
1) Financial utility: How much income/cash flow can you generate by holding the token. For proof-of-stake tokens, you could stake the coins to generate a passive yield.
This is not possible for $BTC, unless you wrap it to $WBTC, but then it’s not normal $BTC anymore. If holding a token benefits the holder by rewarding staking yield or by providing a LP in a yield farm then the demand naturally increases.
But do remember that the yield has to come from somewhere (token inflation), so just be a little skeptical when you see these really high APR projects (think $OHM-fork season in 2021).
2) Real utility: For many projects, the truth is that there is no value. It can be discussed, but eg. Bitcoin has value because it functions as a store of value and a unit of exchange.
Bitcoin is referred to as digital currency and as an alternative to central bank-controlled fiat money. Ethereum is a digital currency that has several purposes through decentralized finance applications (dApps).
You can actually do things with ETH, outside of holding it, sending, or receiving it. To decide if there’s a real utility you have to consider who is on the team, which advisors they have, and their background. Which firms are backing them, what are they building, and are they solving a real problem, etc.
3) Speculation: This includes narratives, memes, and conviction. Basically, a future belief that other people will want to buy it after you.
The speculation aspect of the demand side is hard to analyze and predict. Bitcoin has no ROI and no staking opportunities. But it has a super strong narrative. The belief is that it could be a long-term store of value. Bitcoin also has a huge advantage that it was the first one.
When you hear people talk about crypto the first thing they will mention is $BTC. A strong community can drive demand, so always remember to do research on Twitter and Discord about the community before you invest in something.
IMO the speculation aspect is one of the biggest drivers in crypto. Don’t underestimate how far a token can get with the right narratives, memes, and followers that obey their leaders. Think $DOGE, $SHIB, $ADA, and $XRP.
Most crypto tokens are highly correlated and move together. If you’re holding anything other than $BTC and $ETH it should be based on something on the supply/demand side of tokenomics that makes you think it will outperform them.
Another important aspect in valuing a token is the tokenomcis trilemma between yield, inflation, and lockup period:
Proof-of-stake projects want to give their tokens high staking yield to attract users. But high APR can lead to inflation and selling pressure.
On the other hand, if the staking yield isn’t attractive it can be hard to get users. A way to keep people holding the token is to provide a higher yield the longer the lockup, the drawback is that if the lockup period is too long people will simply avoid the project. Another thing is that one day the unlock will happen which will lead to a huge sell-off because investors want to withdraw profits.
If you think supply/demand is hard to understand just try to think about it in an easy way:
What would happen if the Ethereum Foundation decided to print 100M new $ETH tokens tomorrow? Answer: the price would collapse due to increased supply and reduced demand.
What would happen if Michael Saylor announced that he wanted to buy 100.000 more Bitcoin within the next 6 months? Answer: the price would increase because the supply would decrease and the demand would increase.
Just think about this model below:
The price will always move to an equilibrium based on the supply/demand curve.
Is $ETH worth $100 or $10,000?
Is $BTC completely worthless or worth $300K?
No one really knows, and since crypto doesn’t have an underlying value compared to for example stocks, it remains very hard for investors to land on a price.
Which makes crypto assets very volatile and speculative. But this also leads to gigantic opportunities for the few of us that actually spend time in crypto.
Want To Learn More About Tokenomics?
Here are 4 good threads that have deep-dived into tokenomics:
That’s it!
See you next week.
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