Beginners Guide : Tokenomics

Crypto Inflation, Vesting and Unlock Schedules

Jun 04, 2022

If you’re here, it’s probably because you have some understanding of inflation and how it is hurting your purchasing power in your native fiat currency. The escape to crypto is often predicated on an attempt to escape inflation, and this is an honest instinct. As we discussed in the Beginners Guide to Crypto, the inflation rate for bitcoin is low (currently 1.699%) and every day it is decreasing, which is the opposite of fiat currencies who’s inflation rate is always increasing.

But when most people arrive in this space they see that 1 bitcoin costs $30,000 (or however much it costs when you read this) and they often find themselves discouraged and wanting to buy something with a lower price tag with the hopes that they can buy something that is going to moon like bitcoin did over the past decade. And new entrants into this space are often tricked into buying tokens with double digit inflation rates, or large lump sums of total supply being unlocked which early investors then dump on to the markets. The new people that are suckered into these types of purchases typically find themselves unable to keep up or outpace the growth they could have had if they had just invested in Bitcoin or Ethereum and find themselves even more discouraged as they are now behind.

This post aims to help you to analyze the inflation rate, unlock schedules, potential vested parties and others who may be receiving the lions share of the inflation before you. Broadly, this subject is known as Tokenomics.

1. Basic Tokenomics

Before you invest in anything in the crypto space, there are some absolute basics you should know about the project and the math behind it. Yes, this is true even for Bitcoin and Ethereum, you should not be taking my word for it but having a look for yourself as well. You wouldn’t give $500 to a stranger just because he seems trustworthy, so too should you not be trusting your investments off of my words alone.

The absolute basics that you should know are the following.

Circulating Supply - How many total tokens are in circulation.

Maximum Supply - How many total tokens will ever be in circulation. Understand that some tokens do not have a supply cap, this isn’t necessarily a bad thing so long as you know what the planned final inflation rate is.

Inflation Rate - What is the current inflation rate of the token. Is that inflation rate going down or up? What will it be next year, and is there a final inflation rate, or will it’s release schedule eventually get to a 0% inflation rate? Some tokens are deflationary and have a decreasing total supply. It’s also important to note that some tokens have variable inflation rates depending on network usage as well and aren’t fixed.

Current Price - How much is a single token selling for. Note that a token can have multiple prices as it may be being bought and sold in a number of different marketplaces.

Market Cap - Short for ‘Market Capitalization’; This is the Current price multiplied by the Circulating Supply

Fully Diluted Value - This is the Current price multiplied by the maximum supply. Or, what the market cap would be if all token emissions were currently circulating.

Now lets break these out into a spreadsheet for some examples so that you can see how we assess investments. The examples below will be a few tokens we have discussed on this substack before. We will be using CoinMarketCap.com to collect this basic data.

This chart is not the end all be all for these protocols and you’ll need to collect more information to understand these numbers in context. But from here you can at least start to understand a bit more about each respective investment. Market Cap and Fully Diluted Value are the two most important to understand. The difference between these two is one of the reasons why brand new projects are often not worth investing in. For those of you who are paid subscribers, you may remember several examples from the Advanced Defi Guide #1 about valuing new launch tokenomics. The example in Section 2 had barely 3,000 tokens in circulation and was trading around $50 a token. It’s market cap at the time would have been $150,000 with an FDV of ~$200,000,000. This protocol was not worth $200 million at launch, and it’s very clear that as token inflation occurred, it’s price would have to come down so that the market cap would continue to make sense. Projects like Bitcoin that are fairly close to their maximum supply at present, do not have a very large delta between their circulating supply and maximum supply, and so there is no reasonable expectation for price to come down during the rest of the 128 years throughout which new bitcoins will be produced.

After you understand the market cap and FDV, you need to have a clear understanding of the inflation rate. Bitcoin and Stacks ($STX) have fairly clear inflation rates that are fixed and decrease at well understood and steady rates. These are outlined in the whitepaper. Other projects, like Ethereum and Cosmos do not have fixed inflation rates. Ethereum for instance pays miners with ETH, a portion of these fees are paid by people paying for transactions, and a portion is new inflation minted to pay the miners. At the same time a portion of the fees paid to miners are burned (sent to an inaccessible wallet address, this is called a burn address) and removed from circulation forever. Since these values are all variables, inflation on Ethereum can only be understood in hindsight similar to the US CPI. In Q1 of 2022, the inflation rate of Ethereum grew at a rate of 0.51% annualized.

Cosmos ($ATOM) also does not have a fixed inflation rate. They instead intend to provide stakers with enough incentives so that 67% of the circulating supply of $ATOM is staked. How do they intend to do this? They keep increasing the staking rewards when less than 67% of the supply is staked, and they keep decreasing the staking rewards when more than 67% of the supply is staked. This bottoms out at 7% inflation rate, and tops out at a 20% inflation rate. Currently the inflation rate is 11.49%, but this changes everytime a new block is solved on the network, so it may be higher or lower when you are reading this.

As a potential investor you should understand this and realize that this means that the protocol growth needs to outpace this inflation if we are to see a growth in price. If you are reading my quarterly Crypto Macro Updates, you probably know my thoughts on the matter regarding Cosmos.

Now for an example of a final consideration that we will get into in later sections we’re going to look at Chainlink ($LINK). You may notice that Chainlink has no listed inflation rate despite the fact that less than half of all $LINK are currently in circulation. How will these tokens get into circulation for Chainlink to reach it’s max supply? Well, the chainlink developers are holding the rest of the supply in their wallet. Currently their is no incentive or staking rewards to pay node operators who provide the data that runs the entire Oracle network. So the ChainLink developers give chainlink out on a monthly basis to node operators directly based on the quality of work performed.

At some point in the next 6-12 months this will change as Chainlink intends to provide staking rewards when they roll out CCIP and to tie these rewards to how often data is requested through the Oracle. Basically users pay for data with $LINK, and this $LINK is then provided to stakers and nodes along with protocol inflation. Essentially the more demand there is for oracle services, the more that entities needing this information will have to buy $LINK to pay for it. But for now, the inflation rate is unknown and essentially is just tokens released from the developers wallet to node operators. On some protocols, these developer releases and release dates are known, and can be front-ran by traders, or avoided entirely by investors, as you would expect these tokens to be sold on the open market fairly quickly. As we have been learning in the fiat world, there is nothing worse than to be in a rapidly inflating currency whose inflation is given to another privileged party who then sells out of it before you can increase your own savings. Anyone who has wanted to buy a house or a counter-inflationary asset since mid-2020 has been on the losing end of that transaction. The same thing occurs in crypto within highly inflationary tokens.

2. WhitePaper and Publicly Available Information

The first place you should always start when making a new investment within crypto is by reading the whitepaper. The whitepaper is essentially a standard practice within the crypto space. Whenever any new protocol is released, a whitepaper precedes it and includes all of the necessary details for investors.

Why does this project exist, what does it intend to solve, how does it intend to solve it, who’s involved, how does the token work, what are the basic tokenomics, how will token distributions be allocated, etc.

You should become fairly accustomed with reading these and being able to skim through and extract any relevant information to the point where you could identify the basic project inflation, token allocations, and supply. For a project like Cosmos ($ATOM) above, it has the potential to grow rapidly for 1 or 2 years if the infrastructure play I outlined in my Macro post works out well and to easily outpace it’s inflation rate. But it can never be a long term value store and is instead more of a utility token simply because of it’s high rate of inflation. There is nothing wrong with utility tokens, and they can make good investments or provide utility to the holder, but it is important for you to be able to classify what a token can and can’t do so that you aren’t trying to use a token to do something it was never meant to do.

For an example token we are going to look at the $LOOKS token for the LooksRare NFT platform, which was discussed in the Beginners Guide to DeFi. Typically a good place to start is either on the official website or on a search engine “LooksRare Whitepaper” can help you get started. On the official website you will be looking for a section called “Documents” or “About.”Pre-Launch you will usually find a link to the whitepaper in the discord channel for the project.

On the LooksRare website, all the way at the bottom there is a link to an “About” section of the website. This takes you to a documents page, with several links, we again click on the “About” document which takes us to what is functionally structured like a whitepaper, but does not seem to be called that. In the Tokenomics Section of this document we can come to understand a few things.

Total Supply will be 1 billion $LOOKS when it reaches its maximum supply. The majority of the token supply is reserved to be given to users who buy and sell NFTs on the platform (Volume Rewards). With the 2nd largest reservation to go to users who stake $LOOKS, and the 3rd largest was distributed in an Airdrop when the marketplace was launched to grab customers from the OpenSea NFT exchange. At first glance it seems like most of the token supply is reserved for the users themselves.

But next we need to understand how these tokens will be released and if users will have equal or unequal access to the inflation.

A 720 day sprint to full dilution means a pretty insane rate of inflation over these past 6 months and over the next 18 months until we get to day 720. We can already deduce that the staking rewards (currently ~64% APR) likely will not outpace supply inflation and that staking $LOOKS prior to day 720 would result in a loss of real value as compared to just selling $LOOKS for $ETH.

But we’re still not done understanding the token emission schedule yet. There is a thing that is often done with Team tokens and with Venture Capital tokens called “Vesting,” where they are not allowed to sell their tokens until a certain date. This info is usually in the whitepaper, but can also be found elsewhere on discord, telegram, or twitter. However, I would be careful about asking about them, as it is a good way to get banned.

Lucky for us the $LOOKS whitepaper actually tells us when these tokens unlock for trading.

On Day 180 (June 10th 2022), a significant amount of tokens will unlock for certain users to be able to sell for the first time. This unlock amounts to 33M tokens in the strategic sale (we’ll discuss this more in Section 3), 33M tokens allocated for the development team, and a portion of the tokens allocated for the DAO treasury of the LooksRare protocol. If you are a user of $LOOKS or hold some of the tokens, it would behoove you to front run this unlock and sell all of your token 24-48 hours before the unlock. You can always buy them back later for cheap if you like the project. It’s incredibly important for you as a user to use the publicly available sources of information (Twitter, Discord, Telegram, official website, and whitepaper) to identify and outline not only the basics of the project, but also the key milestones and unlock dates so that you aren’t holding a token while some faceless Venture Capital Fund market sells 33 million tokens and dilutes the hell out of your position. I have nothing against VC funds, and all is fair in finance, especially when information is openly provided like this to anyone who looks. I simply want to make sure that when you do decide to venture away from BTC and ETH, that you remember to set basic calendar notifications or alarms for yourself to remember to front-run these guys.

EDIT June 30th - Hindsight

Lets take a look back at $LOOKS and see how it performed immediately after June 10th.

One thing that immediately stands out at you is how degenerative the token price is. This is a reflection of the blindingly fast rush this token is on to max supply by day 720. You have to understand that this tokens price will continue to degenerate until it gets near day 720.

Looking just at the unlock date, we see that token price declined at an accelerated rate in the 3 days after the token unlock with 50% of value lost from the unlock in that 3 day period. I wouldn’t recommend anyone hold $LOOKS, but if you intended to hold $LOOKS, you could have increased your stack significantly by selling it before the unlock and then re-buying it after the unlock. It’s quite likely that a lot of people are doing that. There is a discord server that I have joined recently called TokenUnlocks, the invite link is here. People are getting wise to this and are gaming the VC token unlocks. In the month after the unlock we saw price triple, and then return to it’s pre-unlock price. This is evident of traders front-running the entire unlock, probably shorting this on leverage and trading after the unlock as well.

I suspect that as time passes we will see more and more market distortions around unlock dates because users are becoming more and more wise to how price is typically impacted. The bigger thing to internalize here is that tokens with an unlock schedule are typically very inflationary, and are not long holds at all, but instead tokens to game in the short term.

3. Venture Capital Activities

I alluded to this in the earlier section, but Venture Capital plays a large role in many launches of new projects within the crypto space. It is in fact quite rare for VC’s to not be involved in a new project in some form or fashion. Venture Capital typically performs the role of providing seed capital to new project launches and they do this an early token sale. In the $LOOKS whitepaper above this was called a “Strategic Sale.” The details of these sales are subject to confidentiality, and we only really can ever know about them if someone leaks them to the public either through legal inexperience of the involved parties, corporate espionage, or a breach of contract. I do not know how much the Venture Capital funds behind LooksRare paid per token, but I do know that all 33 million will unlock in about a week, and it’s quite likely that these Funds will secure profits on their investment by selling them all with the quickness.

Here is a quick Twitter thread that covers the rate at which some big crypto VC funds have been selling their tokens after unlocks to give you a picture of how quickly these funds typically sell their positions and what portion of these funds actually hodl on to tokens.

Andrew T @Blockanalia

(1/x) It's DUMPOOOOOOR szn, anon Prices are shit, but unlocks from early-stage investment vesting schedules are making things even worse with major funds dumping millions in already-depressed assets Let's look at a recent example and analyze how you can protect yourself

I do not know which VC fund(s) is/are behind LooksRare, but it honestly doesn’t even matter who it is. All we really need to know is that there is at least one, and the entirety of the tokens they purchased to fund the project unlocks on June 10th. You want to beat them to the sale before they inevitable dilute the token value, because in order to stay in business, they have to make money.

How They Make Money

You probably have already gotten a picture for how VC funds make money, and in the crypto space it is essentially brainless work for the big funds if you can successfully build social media hype. There are new projects launching all the time, and for big VC funds they come to you and you simply have to parse through them and validate which ones have significant groundwork laid and which aren’t ready yet. Step in as an advisor, manage the project launch, make sure the social media game is on point with an active discord and twitter, insure the smart contract is properly audited, it is in fact more difficult than I’m making it seem, but once you’ve done it a few times it becomes almost automatic. The big risk is maintaining project interest for long enough for your tokens to be fully vested so that you are able to sell them on the market. The biggest risk for a VC fund is that after making the initial investment, and spending time and money on the early project lifecycle that the project price falls below your purchase price.

There is a substack called UnlocksCalendar, that is tracking this information. They seem to have an uncanny level of access to many of the details of what should be quite confidential agreements, and are charging $50/month for access. I am not paying for this, but am making you aware of the resource if this is something you’re interested in. As I’ve stated before, you can typically find a portion of this information in publicly available spaces; knowing which venture capital fund is behind each project and how much they paid for those tokens is beyond what any retail trader really needs to know. Simply knowing the unlock dates is enough. To give you an idea of how much money VC’s can make off of these investments I have taken a spreadsheet I have access to and redacted the names of which token is which so that you can see what the ROI can be like for successful VC investments.

This information is available on the UnlocksCalendar substack, except you’ll also know which token this is for, which Venture Capital Fund is invested and what the unlock schedules look like. If you are mildly intelligent and captured with a certain level of compulsion, you could cross-reference the unlock dates in the screenshot above to figure out which tokens are which, but I will leave that to the turbo-autists reading this to do so if they choose. As you can see, most of the VC investments here are returning several multiples on the initial investment. Of course, you are seeing only the winners here, there are many more losers that you don’t see that eat into the profit from some of these winners. But this is essentially the business model of a Venture Capital Fund. You back a good project in exchange for a portion of the project tokens, you hope the project stays solvent long enough for whatever period you agree to not sell your tokens, and then you either manage a graceful exit for a profit, or you market dump your tokens with all of the grace of a hippo in full pursuit of a stray primate in the river. But at some point they have to sell, it’s their business model to sell. You, as the retail trader need to be the kind of monkey that only bathes in the river when the Hippo’s back is turned.

4. Conclusion

Hopefully after reading through this you understand a bit better some of the forces that are at play in new project launches that control the price of the token. After reading this you should be able to identify which tokens can function as a store of value against inflation, and which tokens are the most likely to hold value or grow over time, and which are likely to get diluted by increased future selling pressure.

You should have some basic level of familiarity with finding a project whitepaper, researching tokenomics, and finding out when Venture Capital, and team/developer tokens will unlock. If you can do that, then you can time any alternative investments you make outside of the main Layer 1 tokens and bitcoin/ethereum. Also, please take note that some Layer 1 tokens themselves are venture capital funded. Solana (which is constantly suffering from outages due to a failure to be properly decentralizes (As covered in Section 2 of Speculators vs. Users post)) is heavily VC backed. Other protocols like $NEAR are also VC backed as well. Knowing that and knowing when those VC tokens unlock can help you to better protect yourself. VC’s don’t always design bad products, but knowing that they have an incentive to make a project look good, or hype it up because their tokens are still vesting can better help you to sift through the BS and time your long and short term investments accordingly.

The business model of a VC does nothing to indicate that the projects they choose are any more sound than the projects a monkey would choose if it pulled them out of a hat. Ultimately the project only has to last for long enough for their interests to fully vest. Whenever a major project like Luna collapses, there is a considerable list of VC firms that lost money in the collapse (as well as some who made money). In the $LUNA Post-Mortem I did speculate that we would soon be hearing about which VC funds were completely devastated in the loss over the coming months, and that information is starting to come out now.

Entities like these are likely going to come further into vogue in the crypto space as time passes and the competent ones solidify their control over the space. It is even likely that in time the vesting schedule will be done away with for something that is less jarring to asset prices in the markets, but for now you need to be aware of token unlock schedules and vesting schedules so that you aren’t blindsided one day asking why a token you had went from $1 to $20 and then back to $3 (true story). You can instead know to just have sold at $20 because token supply was going to increase by 48% next week as developer token unlocks occurred. Or maybe, you decide to just stick to Bitcoin and ETH where no such structures exist and the inflation rate and available tokens to market is not subject to large shocks. But at least you can now make the choice consciously.

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