Key Focuses and Indicators of Token Economics

Recently, it seems that many people have been rushing into various popular “dirt dogs,” especially MemeCoins on Solana. Although MemeCoins do not focus on value or technology and are entirely driven by market sentiment, many people enter this field with the purpose of making quick money, so I very much understand the behavior of FOMOing into dirt dogs. Moreover, due to its higher speed, low transaction fees, and the current popularity of its ecosystem, the Solana network has apparently become the preferred choice for many MemeCoins.

Last month (February 1st), we also published an article introducing a process for issuing MemeCoins on the Solana chain without any coding foundation. As of writing this article, we can also observe through some on-chain data platforms that there are about 24,000 MemeCoins with liquidity pools on Solana (excluding those that have already rug-pulled), and this number is still increasing daily. As shown in the following figure.

These past few days, I’ve seen some folks jokingly saying in groups: “Value investing is nothing; all-in on Meme and live in the palace” (this is a joke).

But how should I put it, on one side, some MemeCoins on Solana are continuously becoming popular and creating FOMO, while on the other side, the market as a whole has been making some corrections. Don’t you think this atmosphere is quite intriguing? If you only see people around you rushing into dirt dogs and making money without seeing anything else, then I can only say that there might be some issues with your information channels, which could be a dangerous signal for you.

In the previous article, in order to keep everyone as calm and rational as possible and avoid falling into a mindless all-in state, we have already introduced some specific ideas, on-chain tools, and methods for finding potential MemeCoins. In the next few days, we will not talk too much about MemeCoins anymore. Actually, what needed to be said has already been mentioned quite a few times before, and all that’s left is to wish everyone well.

In an article a few days ago, we shared a “Project Research Template,” which is divided into 7 major categories and 30 options, aiming to help everyone conduct a comprehensive investigation and study of a particular project. Moreover, I noticed that some friends took this seriously, as I’ve seen new comments in the backend related to this.

Many of these comments were about the “Token” and “Metrics” sections. Therefore, in this issue, we will focus on these questions and provide a new summary of the basic knowledge of token economics and some common metrics.

Last year, we briefly summarized knowledge in this area, mainly introducing the concept of token economics and its five uses. So, what is token economics? It can be understood as a combination of economics and tokens, which is the study of how cryptocurrency projects manage the supply, use, and value of tokens. In layman’s terms, it means that project teams set the supply amount, distribution method, and usage of the tokens they issue in a reasonable manner to ensure the project’s success.

Next, we will continue to summarize and share from the perspectives of supply, distribution, and demand.

1. Token Supply

Several friends recently asked about the unlocking of ARB tokens. Through on-chain tools, we can directly observe that ARB will unlock tokens worth 2.13 billion USD, with 76.62% of its supply entering the market on March 16th, the date this article was written. As shown in the following figure.

With the significant unlocking of ARB tokens, if these unlocked tokens enter the market for sale but the buying demand does not keep up, there is a high probability of significant price fluctuations, possibly falling faster than one might expect.

Fortunately, we are currently in a bull market where there is always some demand, so the unlocking of ARB tokens might not lead to the extreme price drops some are worried about. You might even see some positive news that further stimulates and creates demand for ARB.

Therefore, understanding the supply and demand of a token is very necessary. Regarding supply, you need to know the specific number of tokens currently in circulation, the total supply, and the major holders, etc. For this information, we can use on-chain tools like CoinMarketCap, Coingecko, Bubblemaps, Arkham, and others for research.

Market Cap (Mcap): Refers to the market value, which is the number of tokens in circulation multiplied by the current price of the token.

Fully Diluted Valuation (FDV): Refers to the fully diluted valuation, which is the total number of tokens multiplied by the current price of the token.

Circulating Supply: Refers to the volume of tokens that are currently freely circulating in the market.

Total Supply: Refers to the total amount of the token that has been released to date, including tokens that are freely circulating and those that are locked up in various mechanisms.

Max Supply: Refers to the total amount of the token that will be released, which corresponds to the FDV mentioned above.

Of course, some tokens do not have a so-called Max Supply because they are designed with inflation in mind, where their supply will continuously increase as more tokens are minted and issued. However, to counteract inflation, some projects also design a burning mechanism to destroy a certain amount of tokens. For instance, ETH is known as an inflationary token with no supply cap, but with Ethereum’s transition from Proof of Work (PoW) to Proof of Stake (PoS), its tokenomics have undergone fundamental changes, and now the rate at which ETH is burned has turned it into a deflationary token, as illustrated below.

2.Token Distribution:

Before officially launching a token, project teams design their token economics and distribute the tokens differently, such as allocating a portion directly to team members or foundations, investors, or community users.

Taking Optimism (OP) as an example:

OP’s initial total supply is 4,294,967,296 tokens, and it will inflate at a rate of 2% per year. As shown in the figure, in terms of specific distribution, 25% of the tokens are allocated to the ecosystem fund (for stimulating the development funds of the collective ecosystem), 20% to retroactive public goods funding, 19% to users (via airdrops), 19% to core contributors, and 17% to investors.

The distribution of tokens is a concern for many, and understandably so. A fair distribution design is beneficial for long-term development. If most of the tokens are allocated to the project team and investors, it essentially sets up a scenario for harvesting profits from the community, which is not favorable for the token price.

To avoid such suspicions, some projects lock the tokens allocated to team founders, team members, or investors, such as a one-year lock or linear release, to mitigate the pressure on the price due to potential sell-offs. Regardless, if the token distribution design is unreasonable, the project is likely not worth trading.

Specific distribution details can usually be found on the project’s official website or whitepaper. For token unlocks and linear releases, tools like TokenUnlocks, CryptoRank, and others can be used to track this information, as shown below.

3. Demand for Tokens

After thoroughly researching the supply and distribution of tokens, our next step is to consider their demand. If you are reading this article now, you are in luck because the crypto market is currently in a bull market, which is characterized by high demand. Especially during a bull market, whoever can generate the most attention (through topics/hype) essentially creates the most demand.

Regarding demand, we can simply categorize it into two types:

• Demand Created by Attention (Topics/Hype): For example, in recent days, many people have been rushing into various “Shiba Inus” on Solana, mainly driven by hype. The FOMO (Fear Of Missing Out) among users can cause some of these tokens to double or even increase by multiples within a day. However, this kind of demand is often short-term; once the hype dies down, what’s left often isn’t valuable.

• Demand Created by Fundamentals: Projects with strong fundamentals tend to create long-term value (investment value). However, during the crazy periods of a bull market, these projects may not perform as well in the short term compared to the popular MemeCoins and other projects. But in the long run, projects with strong fundamentals will ultimately “rescue” you from the repercussions of rash investments in less solid projects. It’s why it’s often recommended to allocate at least 50% of your portfolio to more stable investments like Bitcoin and Ethereum, as they can “save” you even if your other investments deplete.

As for choosing between attention and fundamentals, there isn’t a fixed strategy; it mainly depends on where the money flows. Since hot money is always profit-seeking and won’t stay in one area for too long, the market experiences what is known as sector rotation. For example, hot money enters a sector, raising the prices of some projects (even low-quality ones) to attract investors. Once enough investors have entered, the hot money exits and looks for the next sector. This cycle repeats, and many investors are harvested repeatedly in this process of chasing hot spots.

4. Common Indicators for Evaluating Projects

Besides tokenomics, we also need to pay attention to other aspects to better understand the potential of a token (project). We will continue to outline some of the most common and useful indicators:

• TVL (Total Value Locked): TVL is a core metric commonly used for DeFi projects, representing the total value of assets locked in the protocol. In a sense, a higher TVL suggests a potentially better development prospect for the project because it indicates that people are willing to lock their crypto assets in the protocol. This willingness usually stems from trust in the protocol and the desire to exchange this locking for various value rewards offered by the protocol (such as yield or token rewards).

• Mcap/TVL Ratio: This ratio is obtained by dividing the market capitalization by TVL. A lower ratio typically indicates that the project may be undervalued.

t money enters a field and continues to raise the prices of some projects (even some junk projects) in this field to attract a large number of leeks to enter the market. When the leeks are almost gone, the hot money will withdraw and go Find your next area. This is repeated, and many leeks are harvested over and over again in this process of constantly tracking hot spots.

5. Some common indicators for judging projects

In addition to token economics, we actually need to pay attention to other aspects to better understand the potential of this token (project).

Next, we will continue to sort out some of the most common and commonly used indicators for you:

The first one is TVL (Total value locked)

TVL is a core measurement indicator commonly used in DeFi projects. It translates to the total locked value. You can simply understand it as the total amount of assets held by each protocol.

From a certain perspective, the higher the TVL, the better the development prospects of the project may be, because a high TVL means that people are willing to lock their crypto assets in the protocol. The reason why people do this is, on the one hand, based on their trust in the protocol (Would you entrust your money to someone you don’t trust for safekeeping?), and on the other hand, they hope to use this lock in exchange for various benefits provided by the protocol. Value rewards (such as yield, token rewards, etc.).

So, what is the relationship between this TVL and the market capitalization we mentioned above?

Here we introduce a more commonly used indicator: Mcap/TVL ratio, which is dividing market value by TVL. The smaller the ratio, usually it means that the project may be undervalued.

The second term is “Fees/Revenue”.

“Fees” directly translates to costs or charges, which might be confusing for newcomers. To simplify, we can understand it as the charges paid by users, mainly used to assess whether users are willing to pay to use the protocol, or whether the protocol fits the product-market fit (especially in the absence of token incentives). If that’s still unclear, let me put it in plain language: you can consider “Fees” as the total income generated by the project.

“Revenue” can be understood as the portion of fees retained by the protocol (some protocols may also choose to distribute a part to token holders). To put it simply, it can be seen as the income that belongs to the protocol itself after providing relevant services, also indicating the project’s actual revenue-generating ability.

If we were to explain this with a simple formula, it would be: Fees = Revenue + Other Income Items (different projects might have different revenue design models).

Here, let’s take Raydium (an AMM DEX built on the Solana blockchain) as an example. In this protocol, when users make transactions or exchange tokens, it mainly involves two types of fees (corresponding to two types of income for the protocol), which are:

1. Swap fee: Each time a user exchanges tokens between pools, the platform charges a transaction fee of 0.25% (of which 0.22% is returned to the LP pool, and 0.03% is used to buy back RAY tokens).

2. Network fee: The platform symbolically charges 0.0001 - 0.001 SOL for each transaction.

As can be seen, as long as someone uses the Raydium protocol, it generates a certain income. The more users and the higher the frequency of use, the greater the income generated.

This means that if a project can generate various forms of income and is also willing to use a part of that income for buying back its own tokens or for rewarding token holders, it can positively impact or stimulate the price of its tokens. For example, on February 23 last month, Erin Koen, the governance head of the Uniswap Foundation, proposed to the Uniswap governance forum to use a fee mechanism to reward UNI token holders who had delegated and staked their tokens. Influenced by this news, the price of UNI tokens was immediately driven up, as illustrated in the following diagram.

The third is user growth (number of active addresses, transaction volume)

Besides Total Value Locked (TVL) and fee income, the growth of users is also an important indicator for measuring a project, as well as a significant factor influencing the price of the project’s tokens.

Let’s make a simple comparison between SOL and ETH based on the data from March 15:

In terms of TVL, SOL is at 3.7 billion USD, while ETH is at 52.5 billion USD.

In terms of fees, SOL is at 3.6 million USD, while ETH is at 18.8 million USD.

In terms of revenue, SOL is at 1.8 million USD, while ETH is at 16.8 million USD.

Although there is still a significant gap between SOL and ETH in terms of TVL and Fees/Revenue, SOL’s recent price trend has been relatively strong. Apart from other influencing factors such as Wall Street capital, the rapid growth in SOL’s user base may also be one of the factors contributing to its price increase. As shown in the figure below.

Of course, in addition to the indicators introduced above, there are also many practical indicators, such as the P/S ratio, P/F ratio, etc. Interested friends can also directly use some on-chain tools (such as tokenterminal) to do the corresponding data queries. As shown in the figure below.

Disclaimer:

1. This article is reprinted from Hua Li Hua Wai, and the copyright belongs to the original author Hua Li Hua Wai. If there are any objections to the reprint, please contact the Gate Learn team, and the team will process it as quickly as possible according to the relevant procedures.

2. Disclaimer: The views and opinions expressed in this article are solely those of the author and do not constitute any investment advice.

3. The translations of the article into other languages are done by the Gate Learn team. Without mentioning Gate.io, it is not allowed to copy, spread, or plagiarize the translated articles.