Cryptogram - 03JUN2022

How to identify a good crypto asset

03 June 2022

In this issue

Hello, Since we wrote to you last Friday, the crypto world was witness to yet another spectacular LUNA crash in the market. A LUNA crash, again. No surprises.

Recently, Terra 2.0 released new LUNA tokens whose value reached an all-time high of about USD 19.5 on Saturday, and then crashed to USD 4.4 on the same day, and as we write this it is hovering around USD 7. There has been a huge loss in confidence in the Terra project but some investors thought it was wise to invest in it again. Now, we are not going to dissect the Terra project. But this is a good opportunity to ask - how can an average crypto investor decide whether to invest in a cryptocurrency?How can you evaluate a cryptocurrency before investing in it?We have LOTS to tell you, so, sit down, this is going to be a long one. 

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THE BIG STORY

Identifying a good crypto asset: DYOR!

Let’s begin by understanding what a “good” crypto asset means. Any crypto asset which can generate meaningful returns within a reasonable amount of time can be considered good.While terms like “meaningful” and “reasonable” can mean different things to people, picking the right asset will be the first and foremost battle one has to win to even start thinking about making the first investment, let alone making a solid profit.Evaluating a crypto project involves a creative blend of deep research and probabilistic thinking. The crypto world often throws a particular phrase at people who request others for financial advice because people are, you know, generally lazy. It’s called DYOR - Do Your Own Research.For an average investor, doing that research can be difficult because it involves rigorous thinking for an extended period of time, and thinking is hard. But we gotta do what we got to do, right?

The first step of the process is to look at the Whitepaper. If blueprint is to architecture, then whitepaper is to a crypto project. Whitepaper is a document (mostly non-technical, relax!) released by the developers that explains the purpose of the project and the technology they are using to achieve it. Any investor who wants to make an investment should read the whitepaper to have a deep understanding of what the project aspires to be. Whitepapers are available for every crypto project.Next, look at the founding team.A project could have great potential and a thriving community, but if the people working for the project don't stick around through the tough phases, things will go for a toss. Take the Fantom ecosystem as an example. When their star developer and steward had to withdraw from the project, the price of FTM tanked like a deck of cards. A hard, objective look at how passionate and transparent the project founders are communicating with the community members is a good proxy for the future success of a crypto project. If you are happy with the founders, then ask yourself, ‘Do I feel the vibe?’

Ever been to a place where you had to party with complete strangers and yet felt like you’ve known them for years? That’s the vibe you are looking for from a crypto project’s community. If a project doesn’t have an active community on Telegram or Discord, run away and do not turn back. Web 3.0 is all about community. The best way to check the mindset of the already invested members of a project is to join their group. Spending a few hours asking questions or even just passively observing among the community members can unravel things about the project, and whether they are part of the “when moon?” tribe (a phrase that indicates the project is a possible ponzi scheme).One of the hallmarks of a crypto asset is decentralization. While some consider it to be not an effective contributor to the price performance of an asset (Solana is relatively more centralized yet it has delivered good returns to investors), the degree to which the underlying blockchain is decentralized matters in certain cases. Generally, the more decentralized a network is, the less control a centralized entity (which is heavily invested in that project) can exercise. Usually, that’s a good thing because it prevents manipulation of the network by such entities. There’s another aspect of decentralization from the context of its native tokens. If most of the tokens are concentrated only in a few whale wallets, then it's a telltale sign that those tokens can be dumped in the market (creating a flash crash) in a coordinated fashion. Bitcoin is the most decentralized crypto asset followed by Ethereum - they both are the leaders of the space currently.With that, we’ve covered some of the basics. Now, we get to the slightly tougher part: tokenomics. Understanding tokenomics may be hard for a person without basic knowledge of economics. But if you take your time with it, you will get it. TOKENOMICSAs the name suggests, it is the economics of a crypto token. Tokenomics defines the supply and demand characteristics of a crypto token. It covers all aspects involving a token’s creation, management, and removal. While evaluating a crypto token, you need to look at three aspects of its tokenomics - supply metrics, utility metrics, and inflation. Supply metricsA general thumb rule, scarcity adds value. If something has limited supply and high demand, then its value will increase, and thus it will provide good returns.There are three metrics that will help you understand the supply of a token and thus create a simple yet powerful framework for understanding tokenomics.

  • Maximum supply: The most that can ever exist

  • Circulating supply: How many exist in the market now

  • Total supply: How many were created on blockchain

The above three metrics can aid in grasping a token’s supply characteristics and take action accordingly. For example, if a token’s supply is reduced by 25%, then one can assume that the demand for the token (if other fundamental aspects like utility, community etc. stay strong) will shoot up in the future. By simply digging a little with these numbers, one can perceive the overall market perception and expectations of how investors are going to behave at any point of time. Lesser the amount of tokens available for buying in the market, higher the demand - therefore, better your chances of good returns. InflationAnother factor that plays a major role in tokenomics is inflation. The “market cap” (MC) of a token is calculated by multiplying current price by circulating supply. The “fully diluted market cap” (FDMC) of a token is the current price multiplied by maximum supply.Inflation = MC divided by FDMC.If the ratio is close to 1, then maximum supply has almost entered the market. So, inflation is going to be very low, favoring the token’s potential to surge in price. On the other hand, if it's close to 0, then supply has not entered the market yet and there’s going to be high inflation (incoming dump), which doesn’t augur well with token’s price. Supply metrics can be used in conjunction with inflation (MC/FDMC) to determine the quality of the tokenomics. Below are two examples of tokenomics that are viewed from the above perspective. (Investors are advised to do their own research while doing so as network upgrades can quickly change the tokenomics.)

  1. Bitcoin - inflationary but the supply is fixed (21 million) which means there can never be a single Bitcoin mined beyond its 21 million. This is a good scenario to have. 

  2. Dogecoin - inflationary with no limitation on supply. 5 billion DOGE will be added to the network every year. This scenario likely leads to dilution of demand.

Utility metricsAn important metric which offers a great perspective into the success of a crypto project is “illiquid supply.” In simple terms, it tells us about how many tokens are being held by investors who are not willing to sell, which, in turn, creates demand in the future as more try to “HODL” (crypto slang for “holding a token”). Now, there’s a catch to this. What if the incentive mechanisms of a crypto project (like Safemoon) only favour to hodl the token? Then utility becomes redundant, rendering the blockchain useless in the long term. Utility can either be measured through the number of transactions (along with monetary terms) or through total value locked in applications built on top of the crypto project. The right approach to this conundrum is to combine both of them and observe if the corresponding metrics grow rapidly together in the future. And with that, we can wrap this up. You’ve learned a lot today! 

If you have kept up with us till here, congrats on the effort! You have a great future in crypto. Now you know why people refrain from doing their own research. It is a demanding exercise. But we assure you, it is fruitful for those of you who want to make it in the crypto world. A word of caution: even with all the above considered, one has to take a leap of faith based on instinct because there are no guarantees in this world that a token can succeed 100%. There are always outlier events that can quickly change the fate of a crypto project. Remember that Terra (LUNA), a $60-billion crypto ecosystem, backed by big VC’s (which is usually seen as a success contributor), lost 99% of its value in three days. So, don’t ever bite more than you can chew.

  THE TOP FIVE 

Stories from this week you cannot miss

1.  Binance has received regulatory approval from Italy’s financial regulator to operate as a cryptocurrency service provider in the country.2. Crusoe, a bitcoin mining company partly funded by the Oman Investment Authority, is deploying equipment in Muscat, Oman to capture flared gas to power its mining.3. MoneyGram has partnered with Stellar Development Foundation to leverage its blockchain to roll out a service that will allow users to seamlessly send and convert stablecoins into fiat currencies.4. South Korea will start investing in metaverse projects directly, committing more than $177 million dollars to kickstart national jobs and companies in this field.5. The Tron blockchain has become the third-largest network in terms of total value locked (TVL) in decentralized finance (defi) protocols.

  EXPLAIN, PLEASE 

Demystifying the world of cryptocurrency

This week, we explain PRIVATE KEY and PUBLIC KEY.

This one is pretty easy. As you know, one of the most basic elements of a blockchain is that there is no third party to verify or authenticate transactions - it is strictly between two parties. But how can the two parties ensure that a transaction is secure if there is no one policing the system?One of the ways is ‘Public-key cryptography.’ Many cryptocurrencies including Bitcoin use this system. Under this system, each person in the network will have a public key (can be shared with anyone) and a private key (not to be shared with anyone), which are paired to each other.If you want to receive a transaction, you share the public key with the sender and they send the transaction to that key. That transaction can be accessed only with the private key. The public and private keys enable you to send your cryptocurrencies to anyone within the blockchain. 

That’s it for this issue folks, have a great weekend!If you have any questions or feedback for us, write to us at [email protected]. You can check out the previous issues here.