Understanding token metrics - how to read a crypto token
As with everything in life, crypto investments can be rewarding if you go in with your eyes open. If you want to invest in a token, how do you decide if it’s a good bet? In this article, we take a look at several metrics that can be helpful to evaluate.
People invest in hopes of getting good returns. Lately, tokens (cryptocurrencies) have emerged as a popular asset class. Some of them have delivered spectacular returns in a short period, making investors wealthy beyond imagination. This has made tokens very attractive to investors.
On the other hand, tokens are very volatile and, therefore, a risky investment. Almost every government has cautioned people against dabbling in crypto. Most investment professionals tell investors to only invest the money they can afford to lose in crypto.
As with everything in life, crypto investments can be rewarding if you go in with your eyes open. If you want to invest in a token, how do you decide if it’s a good bet? You can evaluate it using several metrics that we will describe here.
The Market Capitalization (or Market Cap) of a project is the total value of all existing tokens. To calculate it, multiply the current token price by the number of tokens in circulation. The Market Cap is the amount needed for an investor to buy all minted tokens.
The Market Cap metric indicates how much money people have invested in the token. If this number is large, the token price may be stable but is unlikely to see massive gains. However, if the cap is small, the token has the scope to grow significantly, but could be a riskier investment.
Be careful not to use the Market Cap metric in isolation. If an unprofitable project creates 100 million units and someone trades a single token for $1, the token’s market cap is $100 million. This is obviously a distorted valuation. So, use this metric along with others, like the 24-hour volume.
Bitcoin has the largest market cap by far – its value is around $750 billion.
The 24-hour Volume metric measures the monetary value of all completed trades during the last 24 hours. It is a yardstick of several factors.
First, it is an indicator of liquidity, i.e., how easy it is to buy or trade the token. A high volume proves that you can buy or sell the token freely.
Second, it is a measure of investor confidence. If high, the implication is that many investors have a favorable opinion of the token.
Third, a high volume suggests a good demand for the asset. Thus, its value is likely to increase. On the other hand, a low volume might indicate a token project that has been abandoned or has other problems.
There are three measures of supply: maximum supply, circulating supply, and total supply.
The max supply is the total number of tokens that can ever be issued. For Bitcoin, this number is 21 million. If a token with a limited supply grows in popularity, the growing demand may drive up prices. However, for many tokens, like Ethereum, there is no maximum supply limit.
The circulating supply is the total number of tokens issued and in circulation. These are the tokens listed on the blockchain that can be bought and sold. If the project increases the circulating supply steadily over time, it is a sign of demand for the token. Its price may increase. Bitcoin’s circulating supply is about 19 million.
Sometimes, when a project launches a new token, it does not distribute all the tokens it creates. It earmarks some tokens for use later, like rewarding employees or attracting investors. The project then puts the remaining tokens into circulation. In this case, the total supply is the sum of the reserved amount and the number in circulation.
We will see how the token supply affects its price later in the Token Model section.
Some investors try to “time the market” by buying when the token price is low or selling when the price is high compared to the recent trends. Suppose an investor has researched a token and is planning to buy it. The token price might have ranged between $80 and $120 over the past year. The investor might try to time the purchase when the token is closer to $80 than $120.
However, you should not make a buying decision based only on price. There is no reason to think that a token valued at $0.15 is worth buying over one valued at $25000.
A very important metric to keep an eye on is the token liquidity. The token liquidity designates how much value is in the liquidity pool, and is very closely correlated with the price impact of trades. As a rule of thumb, the higher the liquidity, the lower the price impact and vice versa. Tokens with low liquidity are more risky than tokens with high liquidity, and when investing in low liquidity tokens, one risks not being able to easily sell them again.
The initial allocation and distribution of tokens
A project can create tokens in one of two ways.
In a fair launch, the entire community has an equal opportunity to buy tokens. There is no private allocation before going public. This increases trust in the token.
But in pre-sale, the project generates tokens and distributes them to a select group before the network goes public. Potential investors should check if any holder (wallet) is hoarding a considerable number of tokens. If so, there is a risk that these whales could dump their holding, causing the price to crash.
Bitcoin is an example of a fairly launched token, where not a single coin was pre-mined. On the other hand, the Ripple token XRP was 100% pre-mined before launch.
Every token works on an inflationary or deflationary model.
A token that does not have a maximum supply will continue to be produced forever. Hence, the number of tokens will keep increasing. This may lead to inflation – a decrease in the token value. This kind of token is an inflationary token.
However, such a supply policy benefits newcomers because there is a steady supply of newly minted tokens.
A deflationary token either has a maximum supply or a decreasing supply. Some projects have rules by which they burn (remove from circulation) a certain number of tokens at set intervals. This reduces the number of available tokens. As the number of tokens decreases, their value is likely to increase.
But some investors may consider a rigid cap to be detrimental to the adoption of the token. Driven by scarcity, users may prefer to hoard tokens instead of using them. This model also disproportionately favors early investors.
The Binance token, BNB, burns tokens every quarter. It will continue doing this until it reaches a target of burning 100 million tokens (out of the initial total supply of 200 million). The burns are encoded in a smart contract on the Binance blockchain. Therefore, they happen automatically. Binance does this to create a deflationary effect.
So far, we have discussed the fundamental metrics for evaluating a token. There are some secondary metrics that investors can also consider. We will discuss them now.
Active addresses: This is the total number of wallets created to store the token.
Users: The total number of people who are actually using the token.
A token with many users and active addresses has a high potential for network effects. (Network effect refers to the increase in the usefulness of some service as more users join). Thus, it could rise in value.
All-time high and low: These are the highest and lowest prices paid for the token. These fluctuations may signal that the token has reached its bottom or peak. So, they may not fall or rise in the short term. But if a token has crossed its earlier high and is still surging, momentum may push it even higher. It may be the right time to buy.
Making an informed decision
Many websites provide these metrics and update them daily. Coinbase, Cointree, Coindesk, and Coinmarketcap are some of them.
Hopefully, this article will have helped you understand what metrics to use when evaluating a token. While applying these metrics is not the same as getting investment advice, it will help you make a more informed decision.
Interested in delving deeper into DeFi and Crypto? Make sure to check out the rest of our crypto-focused articles below!
Crypto & Learning
Hungry for knowledge? Here you can get acquainted with blockchain, wallet security, DeFi and much more.
PUBLISHED 11TH AUGUST 2022
DeFi 101 - Part 2: Participating In DeFi The enter Way
DeFi is a fast-growing sub-sector in the blockchain industry. In the previous article, we discussed lending and liquidity provision. In this installment, we discuss other ways of participating in DeFi, and how enter offers amazing rewards for participation within its DeFi ecosystem.