Start the conversation
In traditional equities, analysts have many mechanisms to help determine what the value of an individual stock should be, even if other factors or market conditions are causing it to trade higher or lower than that. Price/earnings ratio, price/sales, price/book, qualitative features of the individual company... the list goes on.
The point is, savvy investors make sure they have all the tools they need to uncover high-profit opportunities while avoiding money-losing trainwrecks.
But given how new cryptocurrency investing is, we don't have decades of applied methods to draw on when we're evaluating a particular token. So how does a crypto investor figure out what the true value of a token is?
Essentially, the best way to do it is to understand the fundamental elements of how cryptos are designed. In a word: tokenomics.
"Tokenomics" is such a new term that you won't find it in any dictionary. Even crypto experts disagree on the exact definition, which just goes to show how early we are in the crypto revolution.
At its most basic level, tokenomics is a blend of "token" and "economics." Some see the term as encompassing every aspect of a cryptocurrency, while others see it as focusing specifically on the mechanics of token creation and distribution.
I tend to favor the latter and use it as a key measure for separating worthy crypto projects from the junk.
Tokenomics is a vital component of assessing a coin's true value, and as you'll see, it's also a major factor in determining a token's price.
Today, we're going to break down the elements of tokenomics so you can easily understand what goes into it and how you can use it to evaluate new crypto profit opportunities for yourself...
Element No. 1: Method of Creation
Creating a cryptocurrency can be done in several different ways. Many cryptos use some combination of these methods:
- The first is proof of work (PoW) mining, which was pioneered by Bitcoin (BTC). In PoW mining, network security is linked to coin creation. Miners earn a reward of new tokens for solving a math problem and earning the right to process the next block in the blockchain.
- The second is pre-mining, in which tokens are mined on the blockchain prior to the network's launch. Closely related is insta-mining, in which a large number of coins are mined in the first few hours or days of launch.
- Finally, there's creation of coins by earning rewards as a proof of stake (PoS) validator. Anyone can "stake" or lock their tokens on the network in return for a chance of being awarded a block to validate. Whoever is awarded the block earns a reward of newly minted tokens. Cardano (ADA) is an example of a PoS crypto.
What you want to watch for here is the rate at which new coins are created - the rate of inflation. Higher rates of inflation will work against the price of the coin.
In the case of pre-mined coins, you also want to look at how much of the total supply was created beforehand and how (or if) new coins are created post-launch. Note that it's not unusual for a project to pre-mine or insta-mine some coins to create startup liquidity; that is, to loan tokens to exchanges so the coin can be traded.
Element No. 2: Burning and Deflationary Measures
Just as important as how new tokens are created is whether there's a mechanism for destroying them, called "burning." This may sound bad, but it's actually great for investors. The burning of tokens is deflationary in that it reduces supply and makes the remaining tokens more valuable. It's somewhat similar to when a company buys back stock to reduce the number of shares outstanding.
Not all cryptocurrencies have a burning mechanism. Bitcoin does not, although it's thought that several million bitcoins are lost forever - effectively burning them.
Ethereum (ETH), last year, introduced a burning mechanism to its code that sent part of each block reward to a dead address (it has no private key, so all ETH sent there is lost forever). More than 1.3 million ETH, worth $5 billion, was burned in 2021.
Sometimes developers will simply burn a big batch of tokens by sending it to a dead address. One of the most dramatic burns took place last year when Shiba Inu (SHIB)'s team sent Ethereum founder Vitalik Buterin 500 trillion SHIB - half of the total supply. Buterin burned 90% of them while sending the remainder to the India Covid Relief Fund.
Element No. 3: Supply
Supply simply refers to the number of tokens, which plays a key role in determining the price of a token. The bigger the supply, the lower the price is likely to be.
This is the main reason you see such wild discrepancies in the prices of tokens. Bitcoin has a relatively low supply. So far, 19 million have been mined, with the supply capped at a maximum of 21 million. Scarcity plays a big part in the price of Bitcoin being in the tens of thousands ($41,125 as I write this).
On the other extreme, you have a coin like Shiba Inu. When it launched in August 2020, it had a supply of 1 quadrillion coins - that's equal to 1,000 trillion. Even after sending half to Buterin, the circulating supply is 549 trillion. This is why the SHIB price has four zeros after the decimal point: $0.00002672 (the SHIB price as I write this).
That said, a tokens' supply is not as simple as a single number. There are a few nuances you need to be aware of.
Here's how to distinguish between the different types of supply:
- Circulating supply: This is how many units of the token are available. It includes any tokens that could theoretically move between wallets, be spent, or be traded. However, circulating supply can be slightly misleading in that it includes coins that haven't moved in years as well as those that are lost (the private key is lost or forgotten). This is the number used to calculate a token's "market cap," which is circulating supply times current price.
- Total supply: The total supply is all tokens that exist on the blockchain, including those that were created by are not available to move, be spent, or traded. These are tokens "locked" for some purpose. Examples include tokens held in reserve by the developers for community allocations (like airdrops), to help fund the development of the project, or to pay for future rewards. Investors need to realize that most locked tokens will become part of the circulating supply at some point, which could negatively affect the price.
- Maximum supply: The maximum number of tokens is a hard cap on how many can ever be created. Bitcoin's maximum supply, for example, is 21 million. Many cryptos do not have a maximum supply. That's a concern because it opens the door to endless coin minting, which is inflationary and will cause the token to lose value over time.
Element No. 4: Allocation
We've touched on some of this already. Allocation (also referred to as distribution) is how the project developers decided to split up the initial batch of tokens and what happens to any locked tokens over time.
You'll want to ask these questions when evaluating a new crypto to invest in:
- Did the developers reserve a large chunk (15% or more) for themselves? The less the developers keep, the better.
- What percentage was released to the public?
- What percentage, if any, was allocated to major backers of the project?
- What percentage, if any, was allocated to the project itself (often called a foundation)?
- What percentage, if any, was reserved for future distributions such as airdrops and staking rewards?
- How many of these tokens will become part of the circulating supply in the future? What does the release schedule (when locked tokens will be released into circulation) look like?
When researching a coin, try to find a pie chart that shows the initial distribution. You may see tokens allocate for all sorts of purposes. For example, here's what the NEAR Protocol (NEAR) pie chart looks like:
NEAR has a very thorough breakdown of its tokenomics on its website, which is the kind of transparency that potential investors should expect in a trustworthy project.
Element No. 5: Governance
Some tokens include a governance element. Anyone who owns some amount of the token gets a say in how that project is governed. It's an extra feature that can add value to a token by creating demand. Usually, the number of votes you get is determined by the number of tokens you own.
The use of tokens for governance is on the rise thanks to the rise in popularity of DAOs (decentralized autonomous organizations). Token holders of DAOs get to decide on all sorts of things, from allocating venture capital to collaborating on a new perfume.
Less sexy, but perhaps more important, are votes to decide on proposed changes to the project itself. Such changes often have a direct bearing on the tokenomics. Having a voice in such decisions is like proxy voting with your shares of stock - but more likely to affect the outcome.
The team at Alternative Wealth Network specializes in evaluating the tokenomics of various cryptos, making sure that you always know the best tokens to watch and have opportunities for the biggest potential profit plays.
You can go here to learn how to access their complete model portfolio. Our complete panel of experts, including yours truly, has hand selected these recommendations for sheer profit potential. We're particularly excited about two small coins that could each soar more than 5,000% in the next five years. Take a look...
About the Author
David Zeiler, Associate Editor for Money Morning at Money Map Press, has been a journalist for more than 35 years, including 18 spent at The Baltimore Sun. He has worked as a writer, editor, and page designer at different times in his career. He's interviewed a number of well-known personalities - ranging from punk rock icon Joey Ramone to Apple Inc. co-founder Steve Wozniak.
Over the course of his journalistic career, Dave has covered many diverse subjects. Since arriving at Money Morning in 2011, he has focused primarily on technology. He's an expert on both Apple and cryptocurrencies. He started writing about Apple for The Sun in the mid-1990s, and had an Apple blog on The Sun's web site from 2007-2009. Dave's been writing about Bitcoin since 2011 - long before most people had even heard of it. He even mined it for a short time.
Dave has a BA in English and Mass Communications from Loyola University Maryland.