Course 3.2: Project Evaluation & Due Diligence

Glossary Terms to know

• ‍Tokenomics: Refers to the economic model governing a cryptocurrency project, encompassing factors such as token distribution, utility, and value proposition.
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• ‍White Paper: A detailed document outlining the concept, technology, and goals of a cryptocurrency project, often provided by its developer team before launch.
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• ‍Vesting Schedule: A timeline outlining when tokens become available to their holders, often used to incentivize long-term commitment.
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• ‍Token Burn: The permanent removal of cryptocurrency tokens from circulation, typically used to reduce supply and increase the value of remaining tokens.
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• ‍Use Case: The intended purpose or function of a cryptocurrency token within its project's ecosystem, which is outlined in its white paper.

Introduction

Rooted in blockchain technology, many crypto projects spearhead the foray into Web3 and have huge potential to bring in high returns on investment. It’s here that project evaluation becomes crucial; a process through which investors strategically assess the risks and rewards of a project. 

Without thorough research into a project, it becomes much more likely that you risk losing your entire investment. In this guide, we’ll explore the key aspects of 

crypto project evaluation, including

• tokenomics, 
• use cases,
• Team evaluation
• And more.

We’ll also help you identify common red flags that point toward scammy or fraudulent projects. Armed with this knowledge, you can confidently discover and evaluate new projects to add to your portfolio.

Evaluating Tokenomics

Tokenomics is a popular term in the crypto space. It describes the economic model that shapes the behaviors and actions in a cryptocurrency project, as well as the elements that make the project valuable. Tokenomics is shaped by two main things: the project’s distribution systems, and its utility. Most tokens are utility tokens. They’re created with a specific purpose in mind, such as the Binance Coin, which Binance users can use to pay transaction fees. 

What is a white paper?

These factors have a huge impact on the project’s appeal to investors. The developers/founders of a project are responsible for outlining its tokenomics. Usually, these factors are explained in a white paper before the project launches. This in-depth document discusses:

• the project's potential uses
• benefits, 
• how its underlying technology works, 
• and its long-term plan. 

What are token distribution models?

Token distribution models are another key concept in tokenomics, which describes how tokens are allocated once launched. One method is to pre-sale (or private sale), where a significant portion of the supply is sold to investors or venture capital firms discreetly. This offers financial stability to the project but can affect its decentralized nature. 

Conversely, projects can use the public sale model, where tokens are immediately made available to general investors. This enhances the distribution range and can gather a large, diverse user base. Common crypto consensus mechanisms like proof-of-work and proof-of-stake are also useful distribution models, which are familiar to most crypto users.

Projects can go through several rounds of strategic distribution, sometimes at different prices, to help the token grow. Another method is to use vesting schedules, where tokens are only made available for specific periods. This is to benefit its general circulation and ensure long-term commitment. Afterwards, the project may go into a lock-up period, when no tokens are available for purchase.

What are token burns?

Token burns - when a certain amount of tokens are permanently deleted - can also help improve demand. This reduces supply, causing investors to up their prices in response. All these variables influence investor confidence and can prolong or heighten a token’s value as it’s distributed and circulates in the market. 

What good tokenomics looks like

Bitcoin is an example of good tokenomics. To validate new Bitcoin, users have to undergo an extensive mining process, heightening its value. To keep supply and demand balanced, new Bitcoin undergoes a halving in value around every four years, so as time goes on, supply dwindles. Unclear or undisclosed vesting schedules, infinite supply, minuscule public allocation, and vague utility are tokenomics red flags.

Dive into Price History

Looking at a coin's price history can tell you a lot about its ups and downs, overall trends, and where it might be headed. This can help you estimate future price increases. Remember, the crypto market is known for its wild swings, but some coins are especially jumpy. This volatility could be a sign of a "pump-and-dump" scheme, which is a big red flag!

The Team at the Wheel: Why Team Evaluation Matters

The team behind a cryptocurrency is like the engine driving a car. When evaluating a crypto investment, don't underestimate the importance of researching the team. A strong team with experience, a clear vision, and a proven track record inspires confidence in the project's ability to succeed. Look for developers with blockchain expertise, financial wizards, and leaders who can navigate the ever-changing crypto landscape. A skilled team is a strong indicator that the project has the potential to deliver on its promises and become a worthwhile investment.

Project Use Case and Adoption Potential

A project’s use case is the main focus of its white paper. The founding team should provide clear, well-defined, and practical examples of the token’s uses - from providing the ability to purchase rare digital items, or for simple daily transactions. A token’s use case is also what distinguishes it from other cryptocurrencies, giving it a unique value. 

Use case example

It’s crucial to differentiate between innovative and oversaturated use cases. One example of an innovative token that provides value to its user base is Synthetix (SNX). SNX enables issuance for synthetic assets, like synthetic gold or synthetic USD. It’s pegged to the value of actual USD and is backed by SNX collateral. Other good use cases include giving users access to rare digital items, intellectual property rights, or services.

If a token provides access to the same assets, services or experiences that another token does, its use case is weak. The use case of a project also determines its target market and potential for real-world adoption. If the use case of a token is highly specialized, such as for use within an exclusive game, its adoption potential is quite low. If its use case is advantageous to a wide demographic, like a token that facilitates ownership of real estate worldwide, it has a high potential for user adoption. 

Potential investors  should analyze:

• the project’s team
• read the white paper, 
• Read the roadmap, 
• and any other documents provided that explain its use case and target market.

Expert advice and gauging the crypto community’s opinions of new projects are also fantastic factors to consider.

Identifying Red Flags and Avoiding Scams

Before investing in a project, assess it for any red flags from its official team and any involved promoters or investors. Look out for:

• ‍Unrealistic promises: If the project team guarantees high returns on your investment within a short period, for example, it’s a big red flag.
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• ‍Excessive marketing hype: While some marketing is expected of any project, it becomes concerning when a massive campaign is launched to promote the token as far as possible. This is even more worrying if the token has yet to launch and real functionality is proven. 
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• ‍Unclear or vague information: Even before launching, a project should provide extensive documentation that explains the technology behind the crypto, its use case, and the tokenomics model. If the project isn’t transparent about these variables, it’s highly suspect. 
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• ‍An anonymous team: Anonymity is usually respected in the crypto community, as its members value the enhanced autonomy of an anonymous profile. However, the team behind a project should prove that they’re experts in the industry and can develop a valuable, functional token.

Project evaluation and Due diligence: Conclusion

Navigating the vast landscape of cryptocurrency projects requires a keen understanding of project evaluation and how to perform due diligence. We've explored the critical aspects of tokenomics, use cases, smart contracts, and red flags to watch out for. However, this is just the beginning! We highly encourage you to continue your research by engaging with crypto experts and community members to heighten your understanding of project analysis before investing. 

By staying informed and vigilant, you can make more informed investment decisions in the dynamic world of cryptocurrency. Ready to share your thoughts and learn from others? Join the discussion in the comments here.