When investing in cryptocurrencies and tokens, it is easy to fall into the trap of viewing them the same way we view stocks. In reality, the mechanics are very different, and developing a strong fundamental understanding of how each token plays into its parent company’s business plan is absolutely essential as an investor.
Token basics
At its core, a token is just a programmable currency unit that is bolted onto a specific blockchain. Using a software application, a protocol applies smart contract logic to the token and enables it to function as part of a larger ecosystem.
All of this technical jargon is just a fancy way of saying that tokens aren’t claims on income of a company – they are pieces of the ecosystem. There was a worry about Bitcoin being classified as a security (which would have numerous tax implications), but the SEC has ruled it a commodity due to it not representing a share of a company or claim on profits. Most tokens (there are exceptions) are viewed as a commodity.
Cryptoeconomics of a company
Just like it is essential to understand the economics behind a fiat currency (for example money supply, inflation, or what happens if the government spends into a fiscal deficit), you also need to build an understanding of the factors affecting each cryptocurrency you invest in.
Cryptoeconomics is the term generally used to describe the mechanics and specifics of token distribution. This covers everything from the sale to the ownership structure, and can be generalised as the “terms of governance” used on that specific token.
Strong cryptoeconomics are important, but even more important is the way a token interacts with the business model of its parent company. As each business model is required to support a token-based model, they must be strongly linked in a logical way, otherwise the token will have no real value.
Explaining Tokenomics
Tokenomics is all about understanding the utility role of a token. Once you have a use case and purpose, users will start demanding that token. There are many use cases (and more creative twists pop up every day), but the most common ones are: right, value exchange, fee, ownership, and currency.
Many coins have multiple use cases, which adds to their utility and the strength of their tokenomics. You will most quickly understand the currency use case, as this is where Bitcoin operates. Bitcoin is a payment unit in this platform, and users purchase it for this specific reason.
Value exchange tokens are used on marketplace-type platforms to buy and sell products or services. Ethereum (and mostly every cryptotoken) has a fee, as you need to spend ETH to run smart contracts and use the network. Finally, tokens with right use cases allow for voting and product access, and ownership tokens grant users access to property rights, which are usually entangled with non-digital documentation (harder to put into a blockchain). Each of these cases creates demand for the token, which results in a market price emerging.
This is more of a fundamental article about how you should assess less well-known coins. No matter how well an ICO is engineered, companies still need to build viable business models that thrive over the long term. The utility role of a token is absolutely key for your success as an investor in the company, and by learning to break companies down to these fundamentals, your investing (assuming they are long-term plays) will end up being much more profitable.
Conclusion
Do your own diligence (always!) and don’t fall into the fallacy of thinking amazing teams, products, communities, or whatnot are enough to take a cryptocurrency to the moon.
From my experience, pure hype does the trick better, and that can be linked to a great number of things – from amazing marketing teams to solid VC backing. Sometimes, it’s even due to sheer luck.
The reason why fundamentals are important is that, usually, the strongest projects – with all checkboxes ticked – are the ones winning.
Disclaimer: this article shouldn’t be taken as financial advisement; it represents my personal opinion and should not be attributed to Coin Rivet. I have savings invested in cryptocurrency so take whatever I write with a grain of salt. Do not invest what you cannot afford to lose and always read as much as possible about a project before investing.
Disclaimer: The views and opinions expressed by the author should not be considered as financial advice. We do not give advice on financial products.