Crypto token valuation 101
By the end, you will know what different types of tokens are, what their utility, and how to assign value to a crypto token
A cryptocurrency is nothing but a fungible digital asset that can be traded for its value. It is called currency because it acts as a medium of exchange, the same as fiat currencies. The only difference is that all transactions are digital in cryptocurrency and are recorded inside a blockchain. The blockchain holds the transaction history and is the single source of truth for all actions.
Value creation involves two things, the utility you are providing and the demand for that utility to yield a return on money. Crypto tokens are no different than real money; their valuation depends on their supply-demand in the market. Most of the time, there is not enough data on its past performance; hence it is valued the same as a startup based on its potential market size and reach in the future
Cryptocurrencies gain value on exchange platforms basis the demand and supply of their tokens. So to see the actual value of a token, we need to see how these demand and supply changes. But before we get there, let's understand the types of crypto tokens out there.
Types of crypto tokens
An inflationary token (like fiat money) doesn't have a max limit. Their community highly drives their growth, and they can produce new tokens to reward validators and delegators in their network. New tokens are introduced to the network through mining, staking, etc. As the supply of the token increases, its value decreases. For example, Most proof-of-stake tokens like ETH are inflationary token
A deflationary token model is where the rate of supply of coins decreases over time instead of increasing. Deflation means the value of each coin will rise if the demand remains consistent. However, they are generally capped at a max value, and their rate of mining new coins decrease with time.
For example, Bitcoin is currently around 17 Million in circulation and can be mined max till 21 million by 2140.
Dual coins are used for crypto projects offering two types of tokens. The main idea behind creating tokens is to avoid compliance issues with government regulations and divide the project's ecosystem into two tokens for better usability.
Typically, one token is used as a security token to raise investment for the crypto project. The other token is used to fulfill specific roles or activities. These roles usually differ from one task to another.
For example– MakerDAO's MKR and DAI where one token is used for funding within the ecosystem and the other as a utility token.
Utility of crypto tokens
Monetary Value -
The utility of a token comes from its use as a monetary system. It can be exchanged for goods and services. Since any central authority does not control cryptocurrencies, it has several regulatory advantages like little to no processing fees and less government control and regulation. This makes cryptocurrencies more portable, inflation-resistant, and transparent. The value of a token is mainly dependent on its utility, and if the transaction rate is fast, more businesses will adopt it, leading to an increase in demand.
Store of value -
In deflationary coins like Bitcoin, their utility comes by being stored value for the future because of their scarcity, the same as gold in the real world.
Ownership stake -
Users buy and sell cryptocurrencies the same as they would buy and sell company shares. Stock gives you ownership in a company, whereas a crypto token grants you ownership of that cryptocurrency. The supply of a cryptocurrency depends on how many new coins are being mined and how many current owners want to sell their coins.
But like any other market, their value fluctuates based on the market's perception at any given time. These fluctuations are primarily rooted in the details tied to supply and demand factors.
How to value a crypto token
To get a detailed insight into a token's value, you should look at its tokenomics, and this can give you an idea of whether you should consider investing in it or not. The tokenomics for a particular crypto token is usually discussed in the project whitepaper and will help you understand its functionality, objective, allocation policy, and more.
Key metrics to look for a crypto token's worth
The Allocation and Distribution of Tokens:
There are two basic ways most crypto tokens are generated: pre-mined or released through a fair launch. If the token is well distributed to as many participants as possible, the project is legitimate and genuinely cares about further development.
The Supply of the Token:
There's the circulating supply, the total supply, and the max supply. The circulating supply of a token is the number of tokens that have been issued so far and are currently in circulation. The total token supply is the number of tokens that exist at present, excluding any that might have gotten burned. And finally, the max supply of a token is the maximum number of tokens that can ever be generated.
The entire amount of funds that have been invested in that crypto project so far. Along with the market cap, check the fully diluted market cap of a project, which is the theoretical market cap if the max supply of the token was already in circulation. This will give you an idea of how you should value a token in the future when maximum coins are in circulation. The higher a token's market cap and lower its circulating supply, the more valuable it could be in the future. There are other factors like coin burn, lockup, and buybacks, which decide a coin's value in the short term, but you should keep an eye on other factors like coin utility and market perception about its value in the future.