Token economics is a combination of two words: Token and Economics. It covers aspects such as the issuance, supply, distribution, and liquidity provision of tokens. Understanding token economics is one of the most important skills in the crypto field. If you don’t have a deep understanding of the token economics of a project, you can only be swayed by the market or follow the trend of investment, which often makes it difficult to achieve investment success.
Understanding the Importance of Token Economics
The token economics of a project indicates to potential investors that the developers of the cryptocurrency have built a strong ecosystem for it. Well-constructed token economics means that over time, the demand for such digital assets will increase exponentially, and investors will have the potential to generate significant returns on their investments.
Investors delve into token economics to discern whether cryptocurrencies have sustainable economic models. Thoughtful token economics are critical to the longevity and success of crypto projects, and can significantly impact a cryptocurrency’s appeal and value to investors. For example, a poorly designed economic model can lead to inflation if supply far exceeds demand, making the value of the token decrease over time.
Indicators that investors should pay attention to
1. Market Cap
Market capitalization is the total value of all circulating tokens in the current market. It is an important indicator for evaluating the size of the token market and potential growth space.
2. Overall dilution of value
FDV refers to the total value of all tokens (including unissued tokens). It helps investors understand the full potential of the token and the future market size.
3. Circulating Amount and Total Supply
The circulating supply is the number of tokens actually circulating in the market, while the total supply is the maximum number of tokens set when the project is created. These two data help investors evaluate the scarcity and potential growth of tokens. For example, there will only be 21,000,000 Bitcoins forever, and its current circulating supply is 19,719,000.
4. Inflation and Deflation
Understanding whether a token is inflationary or deflationary is crucial to assessing its long-term value. Inflationary tokens may decrease in value due to an increase in supply, while deflationary tokens may increase in value due to a decrease in supply. For example, the issuance of Bitcoin is halved every 4 years or so, which introduces a deflationary mechanism to Bitcoin's economic model.
5. Allocation and Distribution Mechanism
The allocation and distribution mechanism of tokens, such as pre-mining and fair issuance, directly affects the liquidity and price stability of tokens in the market. Understanding the allocation of tokens, especially the vesting period and cliff period, can help investors assess market risks.
The role of token economics in investment decisions
Token economics is crucial because traditional asset valuation methods (such as those for stocks or bonds) cannot be directly applied to the world of cryptocurrencies. Each cryptocurrency has a unique set of rules involving supply, issuance, and other technical factors. Therefore, token economics is something that investors must research before making an investment decision.
By diving deeper into token economics, investors can better understand the sustainability and potential value of a project, allowing them to make more informed investment decisions.
The following is a complete Chinese guide on token economics compiled by the editor based on the tweets of crypto KOL Cyclop on social media X.
Getting started with tokens
When you first start researching a potential token, for example on the coinmarketcap.com coin market, you’ll see something like this:
Market capitalization (MC): The total value of all circulating tokens in the current market.
Total Supply: The total amount of tokens that can ever exist.
Circulation: The number of tokens currently circulating in the market.
Fully Diluted Value (FDV): The total value of all tokens (including unissued tokens).
Understanding these basic supply metrics can help you assess a token’s potential. But to do that, you need to have a deep understanding of how they work and how they affect price.
Supply Type
There are two supply paths for tokens:
Inflation: Token supply can increase, which is called a release. This usually results in a decrease in the value of the token, but if the release is slower and in smaller quantities, the impact may not be significant.
Deflation: The supply of tokens decreases over time. This happens when projects buy back tokens and burn them. In theory, decreasing supply should increase value, but this is only theoretical.
Assignment and Distribution
The main factor that determines the issuance and lifespan of tokens is the method of allocation and distribution. There are two main methods:
Pre-mine: distributed among early investors, team, advisors, etc.
Fair distribution: Everyone has equal access to purchase.
Most projects adopt the pre-mining method, the key of which is to understand the distribution and unlocking of tokens.
Important indicators
TGE (Token Generation Day) Distribution: Percentage of tokens distributed to all individuals listed above (10-20%).
Cliff: The period after TGE and before the next vesting (token lock-up period).
Vesting: Gradually release a certain percentage of tokens every month.
Token distribution usually has the following recipient types:
Private sales (investors, KOLs, etc.)
Public Offering (Retail Investors)
marketing
Ecosystem (rights, rewards, etc.)
airdrop
How did they sell the tokens?
If the TGE is 100% and 50% of the tokens are allocated to investors, then investors can sell the tokens at any time, and retail investors may become the ones who take over the exit liquidity.
Recently, some projects have adopted a method with a smaller TGE percentage (up to 20%), followed by a few months of cliff and vesting over 12 months. This method is more suitable for the long-term success of the project, so it is very important to verify all these details before investing.
Another key factor for any token to be successful today is demand. This is why projects incentivize retail investors to buy specific tokens. For example, despite high inflation, people still buy dollars because they need it to live.
Demand driven
Demand is a key factor for any token to be successful. The following four factors can drive demand for a token:
Store of value: Cryptocurrencies can be used as a means of storing value. For example, Bitcoin is often compared to "digital gold."
Community-driven: The power of the community can strongly drive demand, the rise of Meme tokens is an example.
Utility Effect: When holding a token provides some utility, it stimulates demand, such as staking tokens.
Value Accumulation: Encourage long-term holding of tokens by rewarding stakeholders.
To incentivize holders, there are multiple ways to reduce selling pressure:
VeToken
By holding tokens, you can obtain VeTokens, where "Ve" stands for voting custody. The longer you hold, the greater the accumulated voting power, which can influence project decisions.
Mining
The more you hold, the higher the mining efficiency. Token holders can increase their yield by locking up their tokens.
Key checks before investing
Before investing, the following points need to be analyzed in detail:
Total Supply and Circulating Supply: Understand the scarcity of your token.
Allocation and distribution: Ensure that the allocation method is reasonable and avoid concentrated holding.
Lock-up period/unlock date: Understand when the tokens will enter the market.
Release Percentage: Analyze the number of tokens unlocked each time.
Demand: Assess the market demand for the token.
Through such an analysis, you can better determine whether the project is worth investing in. Although projects with poor token economics may also rise, and projects with good token economics may also fall, such an analysis can significantly improve your investment success rate.
