Decoding Token Economics: Formulating Investment Strategies from Token Supply and Demand

Written by: Ron @0xnyew

Compiled by: Techflow Intern

Token Economics ------ This term is often thrown around in the Twitter crypto circle, but people have never explained it beyond "DYOR." Here is a simple guide to "Token Economics" aimed at beginners.

In this guide, I will cover:

• Definition of Token Economics;

• 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 fundamental aspect of token economics, where willing buyers and willing sellers trade tokens.

A Simple Framework for Analyzing Token Economics

• How many tokens are currently in the market?

• What is the total supply of tokens?

• How will market supply change over time?

• Who will hold most of the supply? When can they sell?

To answer these questions, we need to look at the data. The metrics you need to understand are:

(1) Supply

• Circulating Supply: The number of tokens currently available in 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 diagram below.

We need to know:

• - The number of tokens that are not yet unlocked;

• - The number of tokens that have already been released to the market;

• - The number of tokens that have been burned (through burning, which we will discuss later);

Why Should We Care About This?

It helps us grasp the current and future supply. Additionally, it allows us to predict market reactions in advance.

• - What if the supply decreases by 50%? Scarcity increases value!

• - What if 100 million tokens flood the market? The ship is going down!

Now let’s put this into practice. Here are tokens from 4 different scenarios. What can you observe? Think about the 3 metrics we just discussed.

At first glance, we know:

• Each coin has a max supply, except for ETH;

• Most of BTC's supply is in circulation (about 91%);

• BNB ranks second, while AVAX has the least circulating supply relative to its total supply;

What does this tell you?

• BTC: Has a low inflation expectation with a max supply, meaning "no hidden (bad) surprises";

• Avax & BNB: Limited supply, but some has not yet entered the market, meaning "potential time bombs";

• ETH: Unlimited supply, meaning "an infinite printing machine."

What if we dig deeper? The truth beneath the surface:

• BTC: Low and stable inflation (new supply of 9% over 118 years = average of 0.07% per year);

• AVAX: Warning (50% has not been unlocked from the total supply, 63% of max supply is locked);

• BNB: 50% locked and will also burn 34%;

• ETH: Annual inflation rate of 1-2%, although the supply is unlimited, it is easier to digest;

Thus, by simply looking at these numbers and digging deeper, we can: speculate on the overall market sentiment and expectations, and adjust the time frame for holding tokens based on current and future supply.

(2) Market Capitalization

• Market Cap (MC): Current price * Circulating Supply, the total market cap of what is currently publicly available;

• Fully Diluted Market Cap (FDMC): Current price * Max Supply, the total market cap of what could be available in the future. (Note: FDMC can be interchanged with FDV, Fully Diluted Valuation);

• MC/FDMC Ratio: A simple ratio to measure inflation. It tells us what proportion of the current market cap is made up of the future total market cap. If it is closer to 1, it indicates lower future inflation. Most (max) supply has entered the market, which gives us reassurance. If it is closer to 0, it indicates high future inflation.

Now we should have a rough understanding of supply, and we can easily categorize these tokens into 4 groups based on inflation and supply limits:

1) Inflation + Limit

Bitcoin: Inflation + Limit

Total supply is 21 million, which is capped, and no one can change that. Miner rewards are halved every four years, and over time, the supply flowing into the market decreases, leading to a gradual drying up of releases, which is why it is referred to as digital gold.

2) Inflation + No Limit

Dogecoin: Unlimited Inflation

There is no cap on the issuance, with 5 billion Dogecoins entering the market each year. The inflation rate will decrease (due to base growth), but the printing machine will never stop. An interesting fact is that everyone on Earth could own a billion Dogecoins, yet there would still be 125 billion tokens left.

3) Deflation + Limit

Binance Coin: Deflation, with a Limit

The cap is 200 million, planned to reduce to 100 million, with a burning mechanism in place. Binance destroys tokens by sending them to a frozen address that no one can access, making them permanently unavailable.

4) Deflation + No Limit

There are no tokens here; Ethereum plans to reduce supply through EIP-1559 (burning fees) and proof-of-stake consensus (locking tokens), however, it still emits 1-2% inflation annually. Before the merge occurred, the inflation rates of ETH and Dogecoin were similar.

Three Key Points for Study

Supply data is important, but we cannot just stop our research here and hit the buy button; we need to figure out: who holds the supply? When can they sell?

The answer boils down to distribution, vesting schedule, and market allocation.

(1) How Was It Initially Distributed?

• Pre-mined: Insiders reserved a portion for themselves before the listing;

• Fair Release: Everyone buys/competes in the market.

So, who got a larger share?

Light Hands Theory ------ The lower the cost basis, the lighter the hands

For the same $1 X token, however, winners of 1x, 10x, or 100x, because of different entry prices. The lower their entry price, the more comfortable they are. So who has the lowest cost basis? Of course, the team. The tokens are created out of thin air and distributed to themselves, so their cost basis is effectively zero. At a price of $1, they earn $1 in paper profit for each token they own. But this also comes with a huge responsibility; they need to work hard to operate.

(2) When Can They Sell?

Tokens enter the market in two phases:

• Cliff: A specific period after the first token release.

• Vesting: Amounts that are slowly unlocked over time.

(3) Are There Whales in the Public Market?

Use a blockchain explorer to obtain this information.

Example: Steps to query Uniswap Token on etherscan:

1) Search for [Token Name/Contract Address];

2) Scroll down and select "Holders";

3) Select "Token Holder Chart";

4) Chart of the top 100 token holders;

(4) Things to Watch Out For

• Number of holders;

• How much the top 100 holders collectively own;

• Any individual wallet holding a significant share of the total supply;

We can even go whale hunting and learn from their order strategies.