What is a crypto token?
– A crypto token is a digital unit of value created on top of an existing blockchain. It can represent access rights, a claim on future revenue, a voting share, loyalty points, or even another cryptocurrency. Tokens rely on the host blockchain’s infrastructure and rules rather than being that blockchain’s native asset.
Key definitions (jargon explained)
– Blockchain: a distributed, tamper-resistant ledger that records transactions in ordered blocks.
– Cryptocurrency: the native digital money of a blockchain (for example, Bitcoin on the Bitcoin blockchain). Cryptocurrencies are primarily payment and store-of-value units native to their chains.
– Smart contract: program code deployed on a blockchain that executes automatically when predefined conditions are met.
– Cryptography: mathematical techniques (public/private key pairs, hashing, elliptic curve methods) that secure accounts and transactions.
– ICO (initial coin offering): an early-stage public sale used by projects to distribute tokens and raise funds.
– IEO (initial exchange offering): a token sale run through a cryptocurrency exchange, where the exchange often claims to vet the project.
How tokens differ from coins (short)
– Coin: native money of a blockchain (e.g., BTC on Bitcoin, ETH on Ethereum).
– Token: issued on top of an existing blockchain (e.g., an ERC-20 token on Ethereum). Tokens typically depend on the blockchain’s smart-contract system and templates for creation and transfer.
Brief history and why tokens matter
– Early experiments with token-style projects began before the ICO boom. One early example was Mastercoin (announced in 2012), which proposed layered features on top of Bitcoin.
– Between 2012 and 2016 token projects grew gradually; in 2017 sales of tokens surged as the model attracted both genuine projects and opportunistic actors.
– After a rapid rise and subsequent setbacks in 2018, exchanges began hosting token sales (IEOs) to provide perceived vetting. Regulators warned that exchanges might need to register if they acted like brokers or trading platforms.
– Today, tokens are still widely used to fund, govern, and operate blockchain-based services. However, the fundraising process has attracted scams and regulatory scrutiny, so careful evaluation is required.
What tokens are used for (typical purposes)
– Utility: grants access to a service (for example, software usage time or storage).
– Rights or stake: represents ownership interest, future revenue share, or voting power in a project.
– Asset representation: stands in for another asset (for example, a token that equals a specified number of bitcoins).
– Incentives/staking: used to reward participants who support network functions (security, storage, validation).
Worked numeric examples
1) ICO purchase and later market price
– Scenario: An ICO sells Token A at $0.10 per token. Total supply = 1,000,000 tokens.
– An investor buys 10,000 tokens → cost = 10,000 × $0.10 = $1,000.
– Later the token trades on an exchange at $0.50 per token → value = 10,000 × $0.50 = $5,000.
– Result: unrealized gain = $5,000 − $1,000 = $4,000 (400% increase). Note: past performance is not predictive; this example illustrates mechanics, not a recommendation.
2) Token representing another cryptocurrency
– Scenario: Token B is designed to represent 15 bitcoins. If market BTC price = $40,000, the implied value of Token B = 15 × $40,000 = $600,000. Whether Token B can be redeemed for actual BTC depends on the issuer’s promises and custody arrangements.
Checklist — how to evaluate a crypto token (step-by-step)
1. Read the whitepaper: confirm the token’s stated purpose, token supply, distribution plan, and how funds will be used. Treat this as a project pitch; look for concrete technical or customer evidence.
2. Identify the token standard and host blockchain: check whether
whether it is a token built on an existing blockchain (for example, ERC‑20 on Ethereum, BEP‑20 on Binance Smart Chain) or a native chain coin. Check compatibility (wallet support, DEX listing), typical gas costs for transfers, and whether the standard carries known risks (e.g., upgradeable/ownable contracts that allow privileged changes).
3. Confirm supply metrics and math
– Circulating supply: tokens currently available to the public.
– Max supply (or total supply): maximum number of tokens that can ever exist.
– Inflation schedule: rate and mechanism for new issuance (fixed schedule, block reward, minting via governance).
– Key formulae:
– Market capitalization = Price × Circulating supply.
– Fully diluted valuation (FDV) = Price × Max supply.
– Annual inflation rate ≈ (New tokens issued in 12 months) / (Circulating supply at start).
– Check for token locks, vesting schedules, and cliff periods for team and investor allocations.
4. Ownership concentration and vesting
– Find largest holders (often visible on block explorers like Etherscan): calculate ownership share = (tokens held by address) / (total supply).
– High concentration (large holders or “whales”) raises risk of price manipulation or sudden sell pressure.
– Confirm time‑based vesting (tokens unlocked gradually) for founders and early investors; immediate unlocks are a red flag.
5. Utility vs. security vs. governance token
– Utility token: gives access to a product or service.
– Security token: represents an investment contract and may be regulated (tied to profits, dividends, or shares).
– Governance token: gives voting rights on protocol changes.
– Determine whether the token’s design or marketing could meet your jurisdiction’s legal test for a security (seek legal counsel for confirmation).
6. Smart contract security and audits
– Check for third‑party audits (CertiK, OpenZeppelin, Trail of Bits). Confirm audit scope (full protocol vs. limited).
– Look for bug bounties, formal verification, and whether audit reports are recent and public.
– Beware of unaudited contracts, unverified source code, or open “owner” keys in the contract.
7. Liquidity, markets, and price history
– Check trading volume (daily average), number of centralized exchange (CEX) and decentralized exchange (DEX) listings, and liquidity pools.
– Low volume and shallow liquidity mean large orders will move the market and spreads will be wide.
– Examine historical price charts for volatility patterns and responses to news or token unlocks.
8. Redemption, custody, and peg mechanics
– If the token claims to represent another asset (e.g., wrapped BTC), verify redemption mechanisms and custodian transparency.
– Confirm where underlying assets are held, who controls them, and whether proof-of-reserves are provided and audited.
9. Governance model and upgrade risks
– Check how governance works (on‑chain voting, off‑chain signaling) and quorum/thresholds required to enact changes.
– Identify whether upgrades require multi‑sig consent, timelocks, or unilateral admin keys. Admin keys that can mint or drain funds are a risk.
10. Team, community, and business case
– Verify team identities, track records, and public contributions. Anonymous teams increase risk.
– Look for a functioning product or real users; a vibrant developer and user community is a positive sign.
– Assess token demand drivers: fee burn, staking rewards, utility consumption, or required holding for services.
11. Legal and regulatory considerations
– Check public statements and legal opinions about regulatory compliance.
– Monitor enforcement actions in relevant jurisdictions. Tokens can be delisted or restricted by exchanges after regulatory scrutiny.
Quick step-by-step due diligence checklist (practical)
1. Read the whitepaper and official docs; extract supply, inflation, and use cases.
2. Verify token contract on a block explorer; confirm standard and that source code is verified.
3. Compute market cap and FDV; compare with peers.
4. Check top holders and vesting schedules; calculate concentration % for top 10 addresses.
5. Review audit reports and bug bounty programs.
6. Inspect liquidity: daily volume, DEX pool depth (token vs base), and orderbook spreads on CEXs.
7. Confirm custody/peg claims with proof-of-reserves or custodian agreements.
8. Evaluate governance: who can change code, and what protections exist?
9. Search news and regulatory databases for enforcement actions or controversies.
10. Document open questions and decide which you can answer with public data before risking funds.
Worked numeric examples
A. Market cap and FDV
– Given: Price = $2.50, Circulating supply = 100 million tokens, Max supply = 500 million tokens.
– Market cap = 2.50 × 100,000,000 = $250,000,000.
– Fully diluted valuation (FDV) = 2.50 × 500,000,000 = $1,250,000,000.
Interpretation: FDV shows potential dilution if all tokens are minted or released; a large gap indicates future supply growth that could dilute price.
B. Ownership concentration
– Top 3 addresses hold 30m, 20m, and 10m tokens respectively. Total supply = 100m.
– Top 3 ownership = (30 + 20 + 10) / 100 = 60%.
Interpretation: 60% in three addresses suggests high centralization risk.
C. Inflation impact (simple)
– Current circulating supply = 100m. Annual issuance = 10m new tokens.
– Annual inflation rate = 10m / 100m = 10%.
– If demand stays flat, a 10% supply increase could push price down roughly 9.1% in isolation (approximation using 1/(1+inflation) ≈ price multiplier), but market dynamics typically differ.
D. Staking yield conversion (APY approximation)
– Suppose protocol mints 5m tokens annually for stakers. Circulating supply = 100m. Staking pool = 50m tokens staked.
– Reward rate per staked token = 5m / 50m = 0.10 tokens per year = 10% nominal.
– If token
price falls or holders compound rewards, the effective annual yield (APY) changes. Two useful conversions:
1) Compound APY from a nominal reward rate (r) with n compounding periods per year:
APY = (1 + r/n)^n − 1.
Example: nominal r = 10% (0.10). If rewards are auto-restaked daily (n = 365),
APY = (1 + 0.10/365)^365 − 1 ≈ 0.10517 = 10.517%.
2) Adjust nominal yield for token inflation to get a rough real yield (price-adjusted), assuming price moves only from supply inflation:
Real yield ≈ (1 + nominal_yield) / (1 + inflation_rate) − 1.
Example: nominal staking yield = 10%, token inflation = 10%:
Real yield ≈ 1.10/1.10 − 1 = 0% (i.e., inflation cancels nominal gains, ceteris paribus).
Note assumptions: compounding example assumes rewards are restaked at the same token price; real-yield formula assumes price change driven solely by supply inflation and demand unchanged — a strong assumption often violated in markets.
E. Market capitalization and fully diluted valuation (FDV)
– Market capitalization (market cap) = price × circulating supply. This measures current market value of tokens in circulation.
– Fully diluted valuation (FDV) =
Fully diluted valuation (FDV) = price × total (or maximum) supply. FDV estimates the market value if every token that can ever exist were outstanding at the current price. It’s a forward-looking metric that treats unissued tokens as if they already trade at today’s market price.
Worked example
– Token price = $5
– Circulating supply = 2,000,000 tokens → Market cap = 5 × 2,000,000 = $10,000,000
– Total (max) supply = 10,000,000 tokens → FDV = 5 × 10,000,000 = $50,000,000
Interpretation: FDV is five times the current market cap in this example because only 20% of tokens are circulating.
Key limitations and caveats
– FDV assumes the token price would remain unchanged if all remaining tokens were issued. In reality, issuing large new supply usually exerts downward pressure on price.
– Market cap and FDV are not the same as liquidation or enterprise value. They ignore liquidity (how easy it is to buy/sell large blocks), protocol-owned assets, off-chain liabilities, or revenues.
– Circulating supply definitions vary. Some services exclude tokens that are locked, burned, or held by the protocol; others use different rules. Always check the data source’s methodology.
– Large, concentrated holdings (team, treasury, investors) can cause abrupt dilution or sell pressure when unlocks/vesting periods end.
– FDV can be misleading for tokens with no hard cap (inflationary issuance) or tokens that can be minted/burned dynamically.
Simple dilution math (how a new issuance affects ownership)
– You own 100,000 tokens.
– Current total supply = 1,000,000 tokens → your share = 100,000 / 1,000,000 = 10%.
– New issuance increases total supply to 1,500,000 → new share = 100,000 / 1,500,000 ≈ 6.67%.
Percent point decline = 10% − 6.67% = 3.33 percentage points; relative decline = 33.3%.
Checklist to evaluate market-cap and FDV claims (practical steps)
1. Verify numbers
– Find current price on exchanges or data aggregators (CoinGecko, CoinMarketCap).
– Find circulating and total/max supply on the token contract, whitepaper, or block explorer (e.g., Etherscan).
2. Confirm definitions
– Read the data provider’s methodology for “circulating supply.”
– Check whether locked/vested tokens are excluded or included.
3. Inspect the token distribution schedule
– Identify allocations to team, advisors, investors, and treasury.
– Note cliffs and vesting durations and dates of upcoming unlocks.
4. Calculate FDV and market cap yourself
– Market cap = price × circulating supply.
– FDV = price × total (or max) supply.
5. Model potential dilution
– Use the dilution math above to see how your ownership and theoretical market cap change if locked tokens are released.
6. Assess liquidity and free float
– Check order-book depth on major exchanges; low depth means large trades can move price significantly.
7. Read governance/tokens rules
– Some protocols can mint/burn at governance vote; others have fixed caps enforced by code.
8. Consider token sinks and demand drivers
– Review whether the protocol burns tokens, requires token staking for utility, or has strong demand drivers that could offset dilution.
Practical example: checking a new project before sizing a position
Step 1 — Collect numbers
– Token price = $2 (from exchange)
– Circulating supply = 1,000,000 (from block explorer)
– Total supply = 10,000,000 (from whitepaper)
Step 2 — Compute
– Market cap = 2 × 1,000,000 = $2,000,000
– FDV = 2 × 10,000,000 = $20,000,000
Step 3 — Inspect vesting
– Team: 2,000,000 tokens, cliff 1 year, linear vesting 3 years thereafter
– Investors