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A Simple Guide to "Token Economics" for Beginners

2022-05-26 09:30

Read this article in 13 Minutes

Interpretation of the definition, framework and three research points of Token Economics

Original title: "Deciphering Token Economics: Developing Investment Strategies from Token Supply and Demand"

Original author: Ron @0xnyew

Original compilation: Techflow Intern

Token economics - Twitter crypto circles often throw this term, but people never explain it except "DYOR". Here is a simple guide to "Token Economics" for beginners.

In this guide, I'll cover:

- Definition of Token Economics;

- A framework for analyzing Token economics;

- 3 key points for studying Token economics;

Definition of Token Economics

In short, supply and demand. The relationship between supply and demand is actually the most basic level of token economics. Willing buyers and willing sellers trade tokens.

A Simple Framework for Analyzing Token Economics

- How many tokens are currently on the market?

- What is the total token supply?

- How will market supply change over time?

- Who will get most of the supply? When can they sell?

To answer them, we need to look at the data. The metrics you need to know are:

(1) Supply

Circulating Supply: the number of Tokens currently on the market

Total Supply: the total number of Tokens created on the blockchain

Max Supply: the maximum number of tokens that can exist

What do they mean? Please see the picture below

We need to know:

- Amount not yet unlocked;

- Quantity released to the market;

- Amount already destroyed (by burning, we'll talk about that later);

Why should you care?

It helps us stay on top of current and future supply. In addition, the reaction of the market can be predicted in advance.

- What if the supply was reduced by 50%? Rare is more expensive!

- What if a supply of 100 million flooded the market? The ship is sinking!

Now let's put this into practice. Here are 4 tokens in different situations. what can you observe Think about the 3 metrics we just talked about.

At first glance, we know that:

- Each coin has a maximum supply, except ETH;

- The majority of BTC’s supply is in circulation (approximately 91%);

- BNB comes in second, while AVAX has the least circulating supply;

What does this tell you?

- BTC: Maximum supply with low inflation expectations, meaning "no hidden (bad) surprises";

- Avax & BNB: limited supply, but some have not yet entered the market, which means "potential time bomb";

- ETH: Infinite supply, means "infinite money printing machine"

What if we dig deeper? The truth under the veil:

- BTC: low and stable inflation (9% increase/118 years = 0.07% per year on average);

- AVAX: WARNING (50% not yet unlocked from total supply, 63% of max supply locked);

- BNB: 50% locked and 34% will be destroyed;

- ETH: 1-2% annual inflation, easier to digest despite infinite supply;

So by simply looking at these numbers and digging a little more, we can: guess overall market sentiment and expectations, adjust the time frame for holding tokens based on current and future supply.

(2) Market value

Market Cap, abbreviated as MC: current price * circulating supply, the total market value that can be bought in the current public sale;

Fully Diluted Market Cap (Fully Diluted Market Cap), abbreviated FDMC: current price * maximum supply, the total market value of all future purchases. (Note: FDMC is interchangeable with FDV, Fully Diluted Valuation: fully diluted valuation);

MC/FDMC Ratio : A simple ratio that measures inflation. It tells us the proportion of the current market value that can be bought to the total future market value. If it is closer to 1, it means that future inflation is lower. We will be reassured that most (maximum) supply has entered the market. If it is close to 0, it means high inflation in the future.

Now that we should have a rough idea of supply, we can easily divide these tokens into 4 groups based on inflation and supply caps:

1) Inflation + Cap

Bitcoin: inflation + cap

There is a total supply of 21 million which is capped and no one can change that. Miner rewards are cut in half every four years, and over time, less and less supply flows into the market and the release dries up, which is why it’s called digital gold.

2) Inflation + Uncapped

Dogecoin: Uncapped Inflation

There is no upper limit on circulation, and 5 billion Dogecoins will enter the market every year. Inflation will drop (due to base growth), but the money printing machine will never stop. An interesting thing is that everyone on the planet can own one billion Dogecoins, but there will still be 125 billion Tokens left.

3) Deflation + Cap

Binance Coin: Deflation, capped

The upper limit is 200 million, and the plan is to reduce it to 100 million. There is a burning mechanism. Binance destroys tokens by sending them to frozen addresses that no one can access, making them never available for supply.

4) Deflation + Uncapped

There is no Token here, Ethereum plans to reduce the supply through EIP-1559 (burning fee) and proof-of-stake consensus (locking Token), however, it still emits 1-2% annual inflation. Before the merger happened, ETH and Dogecoin had similar inflation rates.

Three research points

Supply data is important, but we can't hit the buy button just by doing this research, but figure out: Who owns the supply? When will they be available for sale?

The answer comes down to allocation, vesting schedule, and market configuration.

(1) How was it originally assigned?

- Pre-mining: insiders keep a portion for themselves before going public;

- Fair distribution: Everyone buys/compete in the market.

So, who gets the bigger share?

The theory of light hands - the lower the cost base, the lighter the hands

The same $1 X Token, but 1x, 10x or 100x winners, because the entry price is different. The lower the price they get in, the more comfortable they will be. So who has the lowest cost base? Of course the team. Tokens are created out of thin air and distributed to themselves, so their cost base is effectively zero. At a price of $1, they make a paper profit of $1 for each token they own. But that also comes with a huge responsibility and they need to work hard.