What is Tokenomics?
It’s simply supply and demand for tokens in the crypto space. Fluctuation in crypto prices is largely driven by supply and demand of the tokens in the public markets.
An understanding of both the supply side and demand side of any crypto token could very well help prepare us for potential price swings.
Let’s begin with the supply side.
For any token we’d like to invest in, we must first find the answers to the following questions:
How many tokens are available for trading in the market right now?
How many tokens will ever exist? (Max supply)
How will the token supply in the market change over time?
Who owns large amounts of the tokens and when can they sell?
For questions 1 and 2, information is easily available via websites like coingecko.com
(Bitcoin Price in USD: BTC Live Price Chart & News | CoinGecko)
There are 3 main types of supply:
Circulating Supply (CS) - Total amount tradable in the public market right now
Total Supply (TS) - Total amount of coins that have been created minus coins removed/burned. This applies to tokens that have a burning mechanism to permanently remove tokens from the blockchain to reduce supply.
Max Supply (MS) - Total amount of tokens that can ever be created. This is what is coded at the very beginning.
Let’s look at Bitcoin as an example. Bitcoin doesn’t have any sort of burning mechanism to remove supply of bitcoins from the blockchain. Therefore, its total supply = max supply. Also looking at CS relative to MS, we know that there is a fixed supply of bitcoins and the supply of bitcoins being added onto the market will end soon.
With this, the probability of Bitcoin’s price appreciating is higher than let’s say Dogecoin as long as the demand for Bitcoin continues to rise.
(Dogecoin Price in USD: DOGE Live Price Chart & News | CoinGecko)
Dogecoin on the other hand as no max supply. Its total supply is infinite which means supply can increase as and when with no cap. Looking at this, Dogecoin to the moon would be less likely unless demand exceeds the supply of coins that are created each time.
Use this knowledge to your advantage. As @0xnyew puts it nicely.. assuming unchanged demand
• Supply shrinks by 50%? My precious. AAHHH!! → GOOD!
• 100b supply to flood the market? GTFO! ship’s sinkin! → NOT GOOD!
He gives a simple practical way to guess the overall market perception and expectation so that we can adjust our investment timeframe given present and future supply. It requires some understanding of market capitalization:
Market cap (MC) = Current price x CS → market value if public buys up all circulating supply of tokens
Fully Diluted Market Cap (FDMC) = Current price x MS → market value if public buys all current and future supply of tokens
The simple gauge is this → MC/FDMC. It tells you how excessive the future supply is for current market demand to absorb.
If ratio is closer to 1, Low future inflation. Most (max) supply has entered the market. Price appreciation will likely be governed by demand for tokens.
If ratio is closer to 0, High future inflation. Price will drop if demand is unable to absorb large future supply of tokens incoming.
Questions 3 & 4 require a deeper dive into the tokens. This usually means looking for the info in the token’s whitepaper.
Supply of tokens can change with time for various reasons. One of the most common way supply of tokens in public markets can increase is when early investors and founding members’ tokens are unlocked and they are able to sell in the public market in large quantities.
Just like how shares are given to employees as part of a renumeration package, it is the same just in crypto just in token form.
Usually, there’s a schedule (cliff/graded vesting) for when these tokens are unlocked and can be freely sold in the public market. It is something to note as it could cause price declines if demand is unable to absorb the incoming supply.
Also something to note is the percentage of circulating tokens that the founding team (including early private investors hold) as it could present a risk of price dumps when tremendous quantities of tokens are supplied into public markets.
Here’s a snapshot of a pool of token’s initial token allocations:
Personally, a greater allocation to public sale is preferable for me as it reduces the likelihood of insider trading and retail investors being dumped on.
Besides the founding team, supply of tokens in public markets can also be manipulated by ‘whales’ - i.e. Single wallets holding very large amounts of tokens.
One way to identify these ‘whales’ if any is to use websites like the Ethereum (ETH) Blockchain Explorer (etherscan.io)
Simply follow these steps:
1) Search [token name or address]
2) Scroll down and select “Holders”
3) Select “Token Holders Chart”
Here’s the token USDC for example:
(USD Coin Token Contract and Distribution Chart (etherscan.io))
From here, look out for:
• Number of holders
• How much do top 100 holders collectively own
• Any individual wallet stands out with a huge share of the total supply
Moving onto the Demand side of things…
What gives tokens demand and value? The writers at CakeDefi aptly put it:
Value = Utility * Rarity * People
Rarity is essentially supply. So that leaves us with Utility and People.
Utility is tied to the use case of the token. What is it used for - is it a legit use case? What problem does it solve? What is the Total Addressable Market of the problem being solved? These are the questions that we should ask when looking at a tokens’ utility.
People is simply how many people are using the tokens. The more people using tokens, the greater the demand for the tokens.
Hope this has helped you as much as it has helped me learning about it!
Here are some related Twitter threads on this topic that are brilliant:
take care,
Justin
https://linktr.ee/simpleinvesting