Five Steps to Analyzing a Cryptocurrency White Paper
Investing in cryptocurrency can be a lucrative opportunity, but with so many coins out there, it can be challenging to choose the right one. One of the easiest ways to separate a good project from a bad one is by researching its white paper. In this article, we’ll take you through the most important steps on how to read and analyze a white paper to help you make better financial decisions.
What is a White Paper?
A white paper is a summary of a crypto project that explains the reasoning behind it, along with important details such as the roadmap, funding, and the team behind it. Unfortunately, many people don’t bother to read white papers because they think they’re too complex or out of negligence.
The Importance of Reading and Analyzing White Papers
Reading and analyzing a white paper is essential because it provides crucial information that can help you make better financial decisions. By understanding a project’s reasoning, utility, blockchain architecture, token distribution, and team behind it, you can separate good projects from bad ones and avoid losing your investment.
The Steps to Analyzing a White Paper
Step 1: Reasoning Behind the Project
The first section of a white paper should clearly state the reason why the project was started. Usually, a white paper introduces a problem that the project wants to solve and describes how it’s going to be the solution. For example, Bitcoin introduces the problem of centralization in online payments and presents the solution of a peer-to-peer payment system that does not need to go through a middleman.
Step 2: Utility and Use Case
The second section of a white paper discusses the solution in detail. This solution can be anything like a new blockchain that improves on weaknesses of older chains, a D5 protocol that does something better than its numerous predecessors, a new blockchain with faster transactions and lesser fees, and many more. This is where the white paper explains how the new project differs from its competitors. Take note that if a white paper dedicates this entire section to describing how they are better than their competitors and not how they plan to solve the problem, then it’s probably not the right project for you.
Step 3: Blockchain Architecture
The third section of a white paper outlines the blockchain architecture behind the project. This is one of the most important sections where you can tell whether a project is worth investing in or not. It outlines the consensus mechanism, why the project should be on the blockchain and not anywhere else, and why the team chose a particular chain. The consensus mechanism is simply the algorithm that ensures that a blockchain works properly, and the two most prevalent types used in the blockchain space are proof of work and proof of stake consensus algorithms.
Step 4: Token Distribution and Utility
The fourth section of a white paper is token distribution and utility. Token distribution is an integral part of tokenomics and is key to a project’s future success. Every project has initial token distributions where they decide how many tokens will be distributed and how they will be distributed. Take note that if a small group of people would control a large portion of the token, it will go against the key principle of blockchain, which is decentralization. Another thing to look out for in this section is whether there are mechanics that cap its growth or even burn issued tokens. For example, there will only ever be 21 million Bitcoins, while Ethereum has an unlimited supply, but excess coins can be removed from circulation by burning.
Step 5: Team Behind the Project
The fifth and final section of a white paper should provide information about the team behind the project. You should scan the credentials of the team and verify whether they have worked on any successful projects in the past. Of course, Bitcoin is an exception to this rule, but if there is very little or no information about the team, this is probably a huge red flag.
Red Flags to Watch Out For
While reading and analyzing a white paper, it’s important to watch out for red flags that indicate a poor project. Here are some of the most common red flags:
Difficulty in Accessing the White Paper
If a team does not have a link to its white paper or a link to any other relevant documentation on their website, they probably don’t want you to see it.
Vague Promises
A poor white paper will often use vague statements to conceal their incompetence. Since they can’t really explain what they do, you might see statements like “revolutionize payment,” “the next Bitcoin,” or “Ethereum killer.”
Lack of References
The reference section gives you a clue of where the authors got their information from. If the authors did not cite specific journals or other reputable sources, then it’s probably a sales letter disguised as a white paper.
Conclusion
A good white paper should contain enough information that addresses most of the questions that you might have. If the tone has become more salesy and less academic, then the only goal is to attract investors and not really solve any problem. By following these steps and tips, you can find the right cryptocurrency to invest in and avoid losing your investment.