As you begin performing due diligence on crypto projects you find appealing, you will surely come across the issue of tokenomics. In short, tokenomics, or token economics as it is often referred to, is the way in which the tokens of a crypto project are distributed.
As you’ll find after reading this post, the tokenomics of a project can be quite consequential to the performance of both the company and its cryptos. As a result, tokenomics is a topic that should be one of the most important considerations in your research for project investments. In many cases, a suspicious tokenomics structure can be what forces you to reject one opportunity and move on to another.
Understanding the tokenomics of a project lets you know where portions of the total supply of a crypto are supposed to go, and in what ratio. It also reveals how the tokens are used within the ecosystem of the project itself and how it may function between other projects in a broader ecosystem, such as in DeFi. This information is important to know because it can reveal the likelihood of an impending exit scam or private sale dump, and how the use cases justify the supply and distribution.
With distribution and supply comes demand. If there is no demand for a token or its network, then its value drops. Like you learned in middle school economics, if demand is high and supply is low, price goes up; conversely, low demand and high supply drives down price in an open free market. The same economic principles apply to cryptocurrency.
In this Learn post, we’re going to show you the many components of tokenomics that you should pay attention to when conducting research. We will use examples from various projects and highlight the favorable and not-so-favorable aspects of their tokenomics to give you the clearest idea of what to watch out for. Bear in mind that while we examine the models from these projects, we are not promoting or denigrating any project in crypto.
So, let’s dive in and learn about tokenomics!
Distribution Revealing Intended Uses
The main point of focus in tokenomics is the distribution of the coins you’re looking at. The way in which a crypto is distributed reveals more than just who owns what - it tells you how the coins are intended to be used both within the project’s ecosystem and externally. With blockchain, verifying that the tokenomics are being carried out as expected is quite easy - there is nowhere for the coins to hide.
Based on the image below of the tokenomics of Hedget, you can see that the tokenomics of a reputable project has a lot of moving parts. Let’s use this image as the base for what you should keep an eye out for in any tokenomics schedule you might come across. We will use others to evaluate various aspects as well.
You can see that well-conceived projects put a tremendous amount of effort into the tokenomics of their coins.
The first thing you should look out for happens to be the easiest one to evaluate. Token sales include all private rounds, seed rounds, and public sales. The seed round is the first round of fundraising a company will do to help build equity that it can then borrow against for a loan and leverage for other assets. Private rounds include special privileged accredited investors and their agents, while public rounds include most folks in the crypto space.
The token sales are vital in helping young projects gain the funds they need to survive in the short term while developing their solutions for initial release - and hopefully increase the value of their tokens.
You would typically want to see as low a number as possible on this one. There are many reasons for this. First of all, having too many tokens allocated for token sales, especially the private and seed rounds, means that at some point those coins are going to enter circulation and dilute the price of the coin. Look at Solana for an example of a project with too many sale rounds, and arguably an excessive allocation for all those sales.
Secondly, if token sales take up too much (15% or more) of the total supply, the community and the project have fewer coins in their control, which is arguably where they should be. Furthermore, the majority of token sale tokens should be for public sales. The caveat to this is that if a project does too little private fundraising from firms with a lot of capital, their progress may be slower due to a lack of initial resources.
The third point is tied into the first - with too many private and seed round tokens come lockups or vesting periods. Any token without a fair launch will see a disparity between those who accumulated pre and post launch. Those who got in pre-launch will likely have a vesting period where they will not have access to their tokens for a fixed period of time after the initial launch. Therefore, in addition to monitoring the total amount of tokens earmarked for token sales, you will need to pay attention to the vesting period of these tokens as it will affect the timing of your buys.
You don’t want to buy a token a day before a major unlock and then get dumped on!
- Be careful of a high ratio of token sale tokens. 0% is ideal, but anything over 15% is suspicious.
- Consider the circulating supply and how much the community has access to.
- Beware the unlock periods!
Team allocations are the portion of the total supply used to pay the team of the project. These allocations are the team’s payroll checks!
In more centralized companies, and even DeFi projects with centralized core teams, you might see slightly higher team allocations. For example, the team allocation for AXSis 21% of the total supply with vesting periods. This amount is a fair allocation and appears to be well within the acceptable average. Considering how successful the project has become, one could argue that its allocation is well-deserved.
In some DeFi projects, you might see team allocations as low as 0% if the project performed a fair launch, like in the case of Elongate Deluxe. This is unusual however and would require some special investigation into what use the coin has at all. If the community has total control, what does the project intend to do? How will the devs and core team be fairly compensated?
The team allocations may only seem too high or too low after it becomes apparent what the project is really about. For example, a 5% allocation may seem suspiciously low unless the project plans to shutdown its core foundation and let a DAO operate the project.
Conversely, 35% may seem exorbitantly high until some time goes by and the team has grown to include top talent in their respective fields and the project becomes a top performer. You may be able to determine this by reviewing other aspects of the project in question.
- A team allocation of around 20% seems to be the current average.
- Team allocations represent team salary, and vesting periods are standard.
- Determine the fairness of a team allocation by factoring in other aspects of the project.
The advisor allocation goes to, you guessed it, advisors of the project. While this allocation may sometimes be lumped in with another allocation, other times it stands alone. This allocation should represent one of the smallest proportions of the total token supply.
In the case of 1inch, the advisor allocation is just 5% of the total supply. This appears to be above the average in the industry. An advisor allocation higher than about 7% is suspicious and should warrant further investigation.
Foundation / Ecosystem
The allocation for a foundation or for the ecosystem of the project are essentially the same thing. The foundation is the operating body for a project while the ecosystem refers to the general operations of a project - like operating costs for a non-crypto company. This allocation does not exist on many tokenomics structures.
These allocations are important for the day-to-day operations of a project. These funds are typically used by the foundation or core team to help grow the community around a project. That’s why in some cases this allocation may be considered marketing. These funds are used to help organize online and offline meetups, have the right staff on hand to engage with the community in different regions, and cover legal and various other operating fees.
You could refer to these funds as the lifeblood of the project. These funds are usually managed by the foundation or centrally by the core team. If mismanaged, not only would it be a major scandal in the community, but it would also reflect poorly on the individuals responsible. You typically won’t see small amounts allocated here, but, quite frankly, and again, especially in DeFi, the smaller the better. Unless the core team is highly competent and proven successful, it shouldn’t be trusted with large sums of cash.
Staking Rewards, or Inflation and Deflation
Creating an ecosystem with a cryptocurrency and blockchain project requires an awareness that the ecosystem is much more than just the sum of its parts. The ecosystem is essentially an internal economy, with much of the nuance of a national economy including the risks and benefits of inflation and interest.
These days, crypto projects in DeFi and on CEX are capitalizing on the draw that staking rewards creates for them. You can deposit your tokens on the platform to strengthen its efficiency, usually the native token from the ecosystem, and earn rewards for your time and digital property. You get more tokens without needing to trade anything, and the project ensures the stability of its platform. Win-win, right?
Well, the issue of inflation arises at this point. With more free rewards comes a dilution of the value of the tokens, like the US Dollar or any inflating currency. More dollars are introduced into circulation every year, thereby increasing the total supply and diluting their value.
A well-designed tokenomics system will take inflation from staking rewards into account. The number of tokens allocated for staking rewards can vary widely, but should fall in line with the roadmap and overall vision of the project.
If you have found a crypto project that has very little emphasis on staking, but which has allocated 30% to staking rewards, this is a red flag; conversely, if staking rewards is a major part of the project, like on a DEX, the allocation should be large, like the 21% 1INCH yield farming allocation plus their 30% allocation for network security.
On the other hand, there are burn mechanisms in some projects. This type of tokenomics is deflationary - the total supply decreases over time. Presumably, this makes the value of the token increase over time, and usually disincentivizes sellers.
A good example of deflationary tokenomics is Elongate Deluxe. Under this system, each transaction bears a 4.2% tax which gets redistributed to holders, plus .69% being locked in the liquidity pool for traders and .11% being sent to a ‘black hole’ wallet. The black hole wallet is essentially the burn mechanism, since those tokens are locked and unusable.
Deflationary tokenomics encourages participation in the ecosystem, as holders have a marked disincentive to trade. For holders, voting on governance issues bears more profits than selling. Of course, all of this is moot in fair-launch projects that issue all their tokens at their IEO on a DEX.
- Deflationary tokenomics encourage you to stake and earn rewards that outpace deflation.
- Inflationary tokenomics encourage robust participation in the ecosystem rather than trading.
- Both types should have long-term visions outlined by their roadmap and community outreach.
Hopefully after this outline of various aspects of tokenomics, you see that tokenomics require far more scrutiny than many other aspects of a project. Your research should absolutely include a deep understanding of how the tokens are planned on being spent, and an inquiry with the core team about any adjustments that may or have been made.
Sometimes tokenomics structures change. When this happens, you need to find out exactly what happened and why they changed because it may turn your positive outlook negative!
You may also find that some aspects of a project’s tokenomics require an understanding of the roadmap and whitepaper. This highlights the notion that you should familiarize yourself with these documents in order to know what the project is all about.
Although this post is coming to a close, there are far more complicated aspects of tokenomics that require explanation. We will be back with more on them later, but for now, make sure you avoid the common pitfalls of rug pulls and shitcoins by reading about their tokenomics!