How to Analyze Tokenomics: A Guide for Retail Investors

As the Web3 space continues to grow, one of the most important aspects that retail investors must understand is tokenomics. Tokenomics, or the economics of a project’s token, plays a pivotal role in determining the sustainability and success of a project. Yet, for many new investors, understanding how to analyze tokenomics can be a daunting task. This guide will break down the key components of tokenomics, providing you with the tools to make informed decisions when investing in blockchain projects.

By the end of this article, you’ll know what to look for in a project’s tokenomics and how to perform a basic analysis to assess its potential. You'll also find a link below to an exclusive 30-min interview with the tokenomics specialist to dive deeper on the analysis & Alphas selection.

What Is Tokenomics and Why Does It Matter?

At its core, tokenomics refers to the structure and behavior of a project’s token within its ecosystem. This includes how tokens are distributed, their utility within the project, inflation rates, and incentives for both early and long-term holders. In Web3, the token is the lifeblood of a project—it fuels the economy, governance, and incentives for users and participants.

Why does tokenomics matter for investors?

Poorly designed tokenomics can lead to token dumps, inflation, and a devaluation of the asset you’re investing in. On the other hand, well-thought-out tokenomics can foster a thriving ecosystem, drive adoption, and ensure long-term value for token holders.

Key Elements to Consider When Analyzing Tokenomics

1. Token Supply: Circulating vs. Total Supply

One of the first things to look at is token supply, which is broken down into two main categories:

• Circulating Supply: The number of tokens that are currently available and traded in the market.
• Total Supply: The total number of tokens that exist, including those locked or set to be released over time.

Why it matters: A high circulating supply relative to the total supply can indicate less room for inflation, while a large number of tokens yet to be released can signal potential future price drops as new tokens flood the market. Always check if tokens are subject to vesting schedules or lockups, which can delay their entry into circulation.

Good Example: Polkadot (DOT)

Polkadot managed its token supply carefully, especially following its 2020 token redenomination, which increased the total supply by 100x. Despite this major increase, the project avoided a price crash by gradually introducing tokens into circulation through a well-structured release plan, maintaining stability in the market.

Bad Example: Terra (LUNA)

On the flip side, Terra (LUNA) serves as a cautionary tale. When Terra’s algorithmic stablecoin, UST, lost its peg to the dollar in 2022, the protocol started minting an excessive number of LUNA tokens to stabilize UST. LUNA’s supply ballooned from 350 million to over 6 trillion in days, leading to a total price collapse and devastating investor losses. This illustrates how uncontrolled token inflation can destroy a project.

2. Token Distribution: Who Owns What?

Token distribution refers to how the initial token supply is allocated. Typically, tokens are distributed among founders, developers, investors, and the community.

• Founders and Team: Look at the proportion of tokens allocated to the team. If the team holds a significant percentage of tokens, there’s a risk of a sell-off once their tokens unlock.
• Early Investors: Tokens allocated to early investors often come with vesting schedules. Ensure that the lockup periods are long enough to prevent early investors from dumping their tokens when they unlock.
• Community and Ecosystem: Healthy tokenomics should allocate a fair share of tokens to the community for rewards, governance, and ecosystem growth.

Good Example: Uniswap (UNI)

Uniswap's 2020 airdrop distributed tokens to early users who had genuinely interacted with the platform. This decentralized distribution helped build a loyal community, and the governance structure gave users a say in the protocol’s development, leading to long-term user engagement.

Bad Example: Internet Computer (ICP)

In contrast, Internet Computer (ICP) faced major backlash due to its token distribution. During the launch, a significant percentage of ICP tokens were allocated to insiders, venture capitalists, and early investors, while retail investors had little access. As the tokens vested, these insiders dumped their holdings, leading to a price crash of over 95% within months of launch, hurting retail investors and undermining the project’s trust.

3. Token Utility: What Is the Token Used For?

A token’s utility refers to what users can actually do with it within the ecosystem. A token with strong utility is more likely to have long-term value because users have an incentive to hold and use it.

Common token utilities include:

• Governance: The token gives holders voting rights to influence the future of the project.
• Staking: Users can stake tokens to earn rewards or participate in securing the network.
• Payments: The token can be used as a currency within the platform.
• Access: Tokens may unlock premium features or services within the ecosystem.

Good Example: Aave (AAVE)

Aave’s token has clear utility. AAVE can be used for governance, allowing token holders to vote on protocol updates and parameters. Additionally, users can stake their AAVE tokens to earn rewards and help secure the network, creating both short-term and long-term incentives to hold the token.

Bad Example: BitConnect (BCC)

The infamous BitConnect scam was built around a token with no real utility. The BCC token was supposedly meant for use within a lending platform, but in reality, it was tied to a Ponzi scheme. Once the scheme collapsed, BCC’s value plummeted from nearly $500 to $0, leaving investors with worthless tokens. This is a clear example of how tokens with no genuine utility are prone to collapse.

4. Inflation and Token Release Schedule

Tokenomics must balance inflation (the rate at which new tokens are created) with demand. Inflationary tokens are more likely to suffer price depreciation if the number of tokens in circulation increases faster than the demand for them.

Key questions to ask:

• Is the token supply capped or uncapped?
• What is the annual inflation rate?
• How are new tokens introduced (e.g., staking rewards, mining)?

Good Example: Bitcoin (BTC)

Bitcoin follows a deflationary model with a fixed supply of 21 million coins. Every four years, the halving event cuts the block reward miners receive in half, reducing the rate of new BTC entering circulation. This predictable, deflationary model has helped drive long-term value appreciation.

Bad Example: Axie Infinity (AXS & SLP)

Axie Infinity’s Smooth Love Potion (SLP) suffered from uncontrolled inflation as users earned tokens from gameplay faster than the game’s economy could handle. This created an oversupply of SLP in the market, causing its value to plummet. The inflationary token model made it difficult for Axie to sustain the rewards-based economy, leading to major price drops and dissatisfaction among players. BTW a very often trap for gameFi projects.

5. Incentive Mechanisms

Incentives are designed to encourage specific behaviors within the ecosystem, such as providing liquidity, staking, or participating in governance. Projects with misaligned incentives often see users exploiting the system for short-term gains, leading to unsustainable growth.

Key areas to look at:

• Liquidity Mining: Does the project reward users for providing liquidity to its pools?
• Staking: Are there rewards for staking tokens, and do they create long-term commitment?
• Participation Rewards: Does the token incentivize active participation in governance or network security?

Good Example: SushiSwap (SUSHI)

While initially facing issues, SushiSwap was able to stabilize through its liquidity mining incentives, rewarding users who provided liquidity. SushiSwap also introduced staking options to lock up tokens, creating long-term buy-in and helping mitigate the effects of early token dumps.

Bad Example: EOS (EOS)

EOS raised billions during its ICO but struggled to maintain momentum due to its poorly aligned incentives. Many token holders, frustrated with the project’s lack of progress, sold off their holdings. The large supply of tokens and weak incentive structures failed to foster long-term community engagement, resulting in token price stagnation.

How to Conduct a Basic Tokenomics Analysis

Now that we’ve covered the core components of tokenomics, here’s a step-by-step guide for conducting a basic analysis of a project’s tokenomics:

1. Start with the Whitepaper: Every project should have a whitepaper that outlines its tokenomics. Look for sections on token supply, distribution, inflation, and utility. At AlphaMind you can find and study investment memos where all the most important information is combined and you can see reports  of our specialist. 
2. Check the Token Release Schedule: Ensure that token releases are gradual and come with vesting periods to prevent large sell-offs from early investors or team members.
3. Analyze Utility: Determine if the token has clear and meaningful utility within the ecosystem. If the token is purely speculative, it may not hold long-term value.
4. Evaluate the Team and Early Investor Allocations: Look for a healthy balance in token distribution. If a project has allocated a significant percentage of tokens to its team or early investors, ensure there are vesting schedules in place.
5. Research the Community: See how active the community is. Projects with a strong, engaged community often have more sustainable growth, especially if governance plays a role in decision-making.
6. Understand the Inflation Model: Finally, review the project’s inflation or token release model. A sustainable model ensures that the supply doesn’t grow too quickly and erode token value.

Conclusion: Tokenomics Matter More Than You Think

For retail investors, understanding tokenomics is crucial when deciding where to invest in the Web3 space. Poorly designed tokenomics can lead to price volatility, dumping, and a lack of long-term value, while strong tokenomics can build thriving ecosystems that reward users and investors alike.

By analyzing key factors like supply, distribution, utility, inflation, and incentives, you can make informed decisions and avoid projects with flawed economic models. As the space continues to evolve, tokenomics will remain one of the most important aspects of Web3 success.

Remember: investing in projects with strong, transparent, and fair tokenomics is key to minimizing risks and maximizing your long-term returns in the world of crypto.

If you want to dive deeper into token economy analysis and looking to find the next big Alpha project - watch out in-depth 30-minute interview where AlphaMind co-founder Kate Naimushina sits down with Max Krasnov, Web3 economist & CEO of Coinstruct.tech, to break down how retail investors can effectively analyze tokenomics in IDO projects.