# What are Tokenomics?

_**Hint:** Doing proper crypto research involves many different steps to gather the right data, do the calculations and interpret everything. OrbAnalytics is build, to support you with that. So this is just an example writeup on one of our process steps, on how to analyze a token._&#x20;

**Tokenomics is a made-up word from "token" and "economics" and describes the economic mechanisms of a cryptocurrency. From the total number of tokens available, to their initial distribution, to economic incentives to regulate supply and demand.**

Tokenomics are one of the most important long-term success factors for a project. Projects with poor tokenomics will often fail.

But let's start with an example.

### Is Token XYZ a good investment?&#x20;

This is one of the most common questions I hear ... so let's take a quick look at an example.

Let's take a quick look at three cryptocurrencies that everyone has probably heard of and their notional prices:

* Bitcoin - price $40,000&#x20;
* Dogecoin - price 0.10$&#x20;
* Ethereum - price 2.600$&#x20;

The exciting question for you as an investor is:

Which cryptocurrency is "cheap" and which one should you buy at that price to make a long-term profit?

The obvious answer I often hear to this question is Dogecoin is cheap. But is it really?

The answer up front is No. It is not cheap and of the cryptos mentioned above, it is actually the most expensive in the long run. For an evaluation, however, we need a few more details and that leads us to tokenomics.

At the end of the article, you can answer the question from above and hopefully you will never buy one of these cryptocurrencies and many others as an investment.

### How is the price of a cryptocurrency created?&#x20;

**The price of a cryptocurrency is created by supply and demand. The same principle as in all markets.**

If supply is high and demand is low, then the price goes down.&#x20;

When supply is low and demand is high, the price goes up.&#x20;

Elsewhere, we will take a closer look at how the Exchanges work to determine prices and balance supply and demand.

For now, it's just important:

Supply and demand are therefore the interesting factors to assess the price of a cryptocurrency.

**As an investor, we are looking for a cryptocurrency with low supply and high / increasing demand.**

### The supply of cryptocurrencies: Number, inflation, distribution&#x20;

The supply of cryptocurrencies is largely controlled by the following three factors of tokenomics.

#### Number of tokens (maximum / current)

The first factor is the number of coins. Here, it is further divided into the maximum number of all tokens that ever exist and the number of tokens currently in circulation.

The favorite example that is always mentioned at this point is Bitcoin. There is only a maximum of the 21 million and will never be more. Mostly this statement is decorated with some exclamation marks to support the importance and to say that the value must always increase.

We will leave out the exclamation marks today and hold firm:

There are coins that have a fixed maximum number and of which there will probably never be more. This is also referred to as deflationary tokens, which means that if demand increases, the price of the currency must also increase. Bitcoin is an example of a deflationary token with a maximum number of 21 million.

The opposite of this are inflationary tokens with no fixed supply where new tokens are created regularly (or sometimes can be created anytime by the owner!) such as Dogecoin of which there are currently about 130 billion and where 5 billion are added annually. Usually this tokens show up with a "mint function" warning in token analytics tools.&#x20;

We'll look at the topic of inflation in more detail in a moment, but first we'll look at some details about the number of tokens.

There are two values to consider when looking at the number of tokens:

The maximum number: for Bitcoin, for example, 21 million. The number currently in circulation: for Bitcoin, e.g., currently 19,000. Note: Bitcoin mining regularly adds new Bitcoins and in the next 120 years or so the remaining 2,000 will be distributed.

From these metrics, there are two other important values for evaluating cryptocurrencies:

1. **The Market Capitalization**: calculated from the number of tokens in circulation multiplied by the price of the token.&#x20;
2. **The Fully Diluted Valuation (FDV)**: The valuation of the currency at the current price if all tokens were in circulation. So if a token currently costs 10 USD and there are currently 10,000 tokens in circulation out of a maximum of 100,000 that are maximally available, then the market capitalization is 100,000 USD and the FDV is 1,000,000.

These values, number of tokens in circulation, maximum number, market capitalization and FDV make a crucial difference in the valuation of cryptocurrencies. You can find these values for example on Coingecko ([ https://coingecko.com/](https://coingecko.com/) ).

YFI, for example, only has a total of 36,666 tokens of which 35,692 are in circulation and currently has a price of about 18,981.57 USD. The market capitalization is about 678 million USD and the FDV (fully diluted valuation) is about 696 million USD.

However, Dogecoin has about 132 billion coins in circulation, the total supply is infinite! (An exclamation point is in order here then ... ) and the market capitalization at a price of about 0.11 USD is 15.4 billion USD.

So Doge is effectively much more expensive than YFI, even if one coin costs only 0.11 USD compared to the almost 19,000 USD of YFI.

Another aspect derived from the number and the market capitalization is the possible increase in value, which is interesting for us as investors.

A project that currently has a market capitalization of 1 million USD only needs another million and the price has doubled.

Bitcoin currently has a market capitalization of about 740 billion. So here it needs another 740 billion USD of capital for the price to double.

The chance for high profits is therefore much greater for a project with a low market capitalization, but so is the risk.

**For now, it is important for you: The price of a cryptocurrency does not matter!**

**When evaluating crypto projects, you first look at the four values: number of tokens in circulation, maximum number, market capitalization and FDV.**

#### Inflation&#x20;

Inflation is what our governments are currently doing to FIAT currencies like the euro or the dollar. They are always printing new money with no value in return. This effectively decreases the purchasing power every year. There is no maximum number of Euros or Dollars. So you can always create more as you please.

**This is called inflationary currencies. They have no maximum number and new coins are created (minted) regularly.**

Here we already see the importance of tokenomics. If the number is not limited, then the probability that the price will increase is logically lower.

Dogecoin is an example of an inflationary coin, except that the maximum number does not increase quite as arbitrarily as with FIAT currencies; instead, 10,000 new Dogecoins are created per block, which equates to about 5 billion per year. This corresponds to an inflation rate of about 4-5% currently.

Inflation is not necessarily bad, because a means of payment is supposed to be spent, and that is easier if it does not increase in value as massively as Bitcoin, for example. There will likely never be a dogecoin pizza day.

However, inflation is usually bad for a long term investment because only if the demand for Dogecoin grows by more than 5% every year would the price increase at all. If we then combine that with what we know about the current market capitalization and the number of tokens, it becomes a bit clearer why Dogecoin might not be suitable as an investment. It still might be a funny meme though, so no offense here.&#x20;

#### Distribution&#x20;

The third important point of tokenomics is distribution.

Token distribution tells who has how many tokens, how they were distributed initially, and how future tokens will be distributed, if applicable.

For example, if early investors or the development team hold too large a number, that's not good.

They could sell their tokens at any time and thus strongly influence the market.

In Bitcoin, for example, Satoshi Nakamoto's wallet holds about 1 million Bitcoin. If he or she were to resurface at some point and sell those, it would greatly lower prices in the short term.

When distributing them, you should simply make sure that the tokens are distributed as widely and fairly as possible.

A first hint can be given by the respective Blockchain Explorer, which shows the number of active wallets. On the website of the projects you can usually also find the initial token distribution to investors, developers or the community. If the developers have a lot of tokens here, for example more than 25%, that would already be a warning sign for me.

Note: The issue of distribution is much more complex because tokens are sometimes locked in, staked or because there is a "vesting period" that determines when and how many tokens can be sold at all. Sometimes tokens are also made available for liquidity mining, there are airdrops and countless other details. It's best to read about this in the book, and we'll look at some more practical examples later on the page.

### The demand for cryptocurrencies: Utility, Investment, Memes, Game Theory

&#x20;As mentioned above, the price of a cryptocurrency is created by supply and demand.

We have now looked at the supply side of tokenomics. However, that alone is not enough. After all, if no one wants to buy my tokens, it's all for naught. Therefore, we now look at how tokenomics affects demand.

Note: There are many other factors that influence the demand for a token, but we will only look at tokenomics here, and even then only a subset, because there are simply far too many possibilities.

#### Utility / Function&#x20;

The first approach to demand management is the functionality of cryptocurrencies.

Bitcoin was originally once planned as digital cash and intended for payment. However, since the price is highly deflationary and keeps rising, it is generally not wise to pay with it.

For this, just remember the legendary Pizza Day, which once a year celebrates the first real Bitcoin transaction where someone bought two large pizzas for 10,000 Bitcoin. Well as they say, you can't eat money, but still it is probably wiser to use Bitcoin as a store of value.

FIAT currencies like the Euro currently have the highest inflation in decades. This leads to the fact that it is hardly possible on the normal investment market with call money accounts or stocks to even compensate for this inflation. Your money loses more and more value and saving is no longer worthwhile. Some speak here also of the largest expropriation in history ...

Bitcoin offers an interesting way out here, as it is the fastest growing asset in history with over 10,000% returns over the last 10 years. But even more exciting are the myriad opportunities in a wide variety of DeFi projects that provide returns of around 20% per year even without price risk.

So the function of Bitcoin is "store of value" and easy worldwide transfer of value.

The function of DeFi projects are diverse in nature from insurance to smart contracts, metaverse projects, exchanges, art, music streaming, cloud storage, etc.

In principle, I only invest in the long term in projects whose function I recognize and consider meaningful. From there, function is one of the most important aspects of tokenomics for me.

#### Profit&#x20;

The second aspect is the profit I expect from my investment. On the one hand, of course, because the token might go up and on the other hand, especially in the DeFI space, functionality plays a big role there as well.

For example, I can stake tokens and receive a return on my investment. How high this return is is also an important aspect of tokenomics.

So if projects offer a high return or a higher price is expected in the future, demand increases.

For me, the DeFi aspect with the return is currently the more interesting one. Tokens that I can stake to get more tokens sometimes offer, as shown in the Cosmos article, over 100% return + the chance to get countless more free tokens that can be worth thousands of Euros.

#### Memecoins&#x20;

Shiba Inu and co. are sometimes worth billions, even without offering any real function or added value. Nevertheless, the demand is high, but mostly only because they participants do not understand the projects or hope to resell them at a profit.

In some cases, there are very exciting tokenomics here, such as "reflection" tokens.

Safemoon is a well-known example of this that had a market capitalization of over 2 billion in the meantime.

Reflection tokens means that there is usually a buying or selling fee of, say, 10%. This 10% is then distributed to all current owners of the tokens. So if you get in early, you benefit from all those who buy after you and on the other hand also from all those who sell too early.

Basically, I don't think much of Memecoins and think in most cases you should keep your hands off these high-risk gimmicks. However, if you have too much money and are looking for a thrill, feel free to try your luck.

#### Game-theoretical approaches to tokenomics&#x20;

There are countless other exciting ways tokenomics can be designed. But I'd like to share one last example with you.

The project is called Olympus DAO (OHM). Here you get extremely high returns of sometimes up to 8,000% and more, but the token is also highly inflationary, so the apparent return is just a distribution of new tokens. Game theoretically, the concept is ingenious and OHM itself had a market cap of over $4 billion at its peak.

However, OHM and its myriad clones have currently fallen extremely sharply and there is no telling if that will change again. Especially with the clones, I see the odds as very poor. Tokenomics, however, was very exciting and in the short term you could make some good returns.

With something like that, you should always keep your eyes open and be there early, but also take profits in time.

### Conclusion and OrbAnalytics

&#x20;Ok, that was a rather theoretical topic but very important. I hope you now understand what you should look for when buying cryptocurrencies and how to evaluate them realistically and that there are a lot of numbers and calculations involved in doing proper crypto research.&#x20;

This is a time consuming task, especially considering that analyzing the tocenomics is just one step out of many during your research.&#x20;

So how can OrbAnalytics help?

**Basically OrbAnalytics has all the numbers and data, calculates everything for you and shows it to you in a compact easy to understand way.**&#x20;
