Do this one thing before adding a new crypto to your portfolio
Within the crypto market, it can sometimes be difficult to assess the underlying value of a new crypto. There are usually no cash flows or income streams to evaluate, and often little or no hard metrics for how a particular crypto is performing.
That is why the first step in the investment process should be to understand the tokenomics of a new crypto. Tokenomics – a combination of “token” and “economics” – refers to the various factors that affect the economic value of a crypto token. These factors include how crypto tokens are created, how they are distributed within the crypto market, and how they are removed from circulation. These economic factors are usually described in the white paper of the crypto. In a time of market uncertainty and volatility, having a good grasp of tokenomics can save you from investing in an overly speculative crypto.
The Tokenomics of Meme Coins
A big mistake that many investors make is using market capitalization as a primary yardstick to judge the relative attractiveness of a certain crypto. They will check the list of the best cryptos by market cap, note that meme coins Dogecoin (DOGE 5.15%) and Shiba Inu (SHIB 4.74%) both rank in the top 20, concluding that they are potentially good investments.
But as billionaire investor Mark Cuban has pointed out, market cap is a number that can be easily manipulated in the crypto world. All you need to do is create a massive supply of 1 billion coins. Even if a crypto trades for just $1, it can still achieve an impressive market cap of billions of dollars.
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A good example is Shiba Inu, which currently has a market cap of over $5.5 billion, ranking it as the 14th largest crypto. It is roughly equivalent to one share which Hertz Global Holdings (NASDAQ: HTZ)which also has a market value of 5.5 billion dollars.
But check out the total circulating coin supply of the Shiba Inu. The number is breathtaking — there are over 549 trillion coins in circulation, and as a result Shiba Inu is still trading at a ridiculously low price of $0.00001. As a result of the huge coin supply, Shiba Inu is never going to be a good long-term investment until it can “burn” hundreds of trillions of coins – which is almost impossible.
The Tokenomics of VC Backed Coins
If there is one lesson from FTX (FTT 7.56%) meltdown last year, is that tokenomics can also be used to assess the future value of a crypto. The best example here is Solana (SUN 5.25%)which was a crypto darling heading into 2022. But as the financial condition surrounding FTX continued to deteriorate in November, crypto investors took a closer look at who owned the Solana tokens.
In connection with the VC funding of Solana, former FTX CEO Sam Bankman-Fried and various entities connected to FTX (such as hedge fund Alameda Research) were major owners of Solana coins. As a result, when FTX imploded, fears grew that these entities would suddenly dump all their Solana coins in a panicked bid for liquidity. Even if that didn’t happen, Solana was one of the worst crypto performers in 2022.
That is why so much attention was paid to hot new crypto Aptos (APT 6.41%) when it began trading late last year. Like Solana, Aptos was a VC-funded crypto backed by Sam Bankman-Fried and FTX. When Aptos launched, there was huge concern that insiders could control too much of the coin’s total supply, with a large share of the total circulating supply going to developers, private investors and the Aptos Foundation.
According to the Aptos white paper, the total supply of Aptos is a staggering 1 billion coins. Right now there are only 172 million coins in circulation, so there are more than 800 million coins left! In comparison, the total limited lifetime supply of Bitcoin (BTC 11.21%) is only 21 million coins.
Given the dubious tokenomics involved here, I’m still not on board with investing in Aptos, even though it’s up 190% this year. The way I see it, the massive coin supply of Aptos is going to completely overwhelm the market in the coming years. And when the 12-month “lockup” of coins allocated to private investors ends in October, there could be massive selling by insiders as they try to lock in big profits.
Important investment options
A big takeaway here, of course, is that you should definitely do your homework whenever you hear about a coin that’s about to hit the big one. Bad tokenomics can completely dilute the value of a coin to the point where even a good crypto project is not worth investing in. Therefore, I remain deeply skeptical of any crypto with a circulating supply of 1 billion coins or more. The next time you hear about a hot new crypto with a billion dollar market cap, the first thing you should do is check out how many coins are in circulation.
