Original author:NAT ELIASON

Compilation of the original text: The Way of DeFi

Original author:

Compilation of the original text: The Way of DeFi

In this post, the author will delve into the issue of token supply: How does the number of tokens, and the various ways in which they can change, affect the health of a project?

At first glance, this may seem like a trivial factor. However, understanding the supply of tokens and how that supply will change over time is an important factor in helping us achieve a good return on investment in our projects. Unless we know where to look and how to look for data, it is easy to get the wrong impression about a project's token supply.

Even a seemingly simple metric like market capitalization can be manipulated and mislead investors in ways investors don't expect. Therefore, we need to learn how to assess token supply to get more information before investing.

What aspects of token supply do we need to focus on?

What is important about the token supply is not necessarily the total number of tokens, but the current stage of the token supply, the future stage, and the speed of change from the current stage to the future stage.

Let's start with Bitcoin. The current circulating supply of Bitcoin is 18,973,506, and the total amount will always be only 21,000,000.

The last 9.6% of the Bitcoin supply will not be fully released until around 2140, which will take quite a while. And we can see at any time what Bitcoin's current inflation rate is, and there won't be any unexpected changes along the way. It is fixed.

Bitcoin’s token supply is also easy to calculate, as there are no investor unlocks, no team vaults, and no token lock-up vesting.

However, the token supply of most cryptocurrencies is not so simple. So, while for Bitcoin we only need to look at the circulating supply, max supply and inflation charts to know what is going on, most coins face more complex situations.

The main things we're trying to figure out are:

1. Current Availability

2. Future availability

3. When will the future state of supply be reached

4. How to reach the future state of supply

Let's look at the various factors that can affect these issues, and then analyze some examples.

Market Capitalization and Fully Diluted Value

Market Cap and Fully Diluted Value (FDV) are our two simple starting metrics for valuing tokens.

Market cap is the circulating supply of a token multiplied by the token price. FDV is the current price multiplied by the maximum supply.

So if a token has a price of $10, a circulating supply of 10 million, and a max supply of 100 million, then the market cap would be $100 million and the FDV would be $1 billion.

These two metrics are helpful when combined with the other variables we'll cover, as they can give us an idea of ​​how the current market is valuing a project, and how the project needs to evolve in the future to justify its current price.

If we see a large difference between market cap and FDV, which means that there are many tokens locked up for listing, then we should investigate how these locked tokens will enter the market (3 and 4).

If the market cap is 10% of FDV, and tokens are issued next year, then the project needs to grow 10 times, or 1000%, within a year to maintain the current price.

However, if the market cap is 25% of FDV, and the token is issued in 4 years, then the growth rate in 4 years is only 4 times, or about 40% year-on-year.

So the market cap to FDV ratio is one of the first metrics we'll check before we want to dig into what circulating supply and max supply really mean.

Circulating Supply and Maximum Supply

Circulating supply and max supply help answer questions 1 and 2 of what is the supply now, and what will be the future supply, helping us understand market cap and FDV.

Maximum supply is fairly straightforward. For Bitcoin, it's 21 million. Ethereum has no upper limit. For Yearn, it is 36,666.

Circulating supply gets complicated. How many given tokens are in circulation? For Bitcoin, this is easy, just subtract the amount that has not yet been released from the maximum supply, and you have the answer. Other L1s like Ethereum and Solana either report on their own or have APIs available to monitor.

In contrast, project tokens are more complicated. for example. For Crypto Raiders, we have released approximately 16 million of the total supply of 100 million. But if we open Coingecko to check, it shows that the circulating supply is only 6,723,611. Where are the rest?

Coingecko and other APIs will attempt to subtract "inactive" tokens from the circulating supply, even if those tokens have previously been released to the market. In our case, the investor locked 9.5 million tokens in our staking contract for a period of 3-12 months, so Coingecko subtracted these tokens from the supply:

This might seem unreasonable. Investors just choose to pledge and lock 9.5 million tokens, and this part of tokens has already been released to the market.

This example also tells us how important it is to have a deep understanding of the circulating supply of tokens. At the beginning, we may feel that only 6% more tokens are released to the market, which means that this project needs to grow nearly 20 times to maintain the current token price. But in fact, 16% of the tokens are already unlocked, so maintaining the current price may only require the project to grow by about 6 times.

Curve is also a very good example.

Curve's FDV is about 9 times the market cap, and it looks like only 11% of the tokens are in circulation. But when we dig deeper into the circulating supply, we find that a large number of tokens are locked in various contracts.

Among them, the contract address of the founder "Founder" has 572 million tokens, and 440 million CRVs are locked by voting. The total amount of tokens owned by the founding team is a bit surprising. However, the contract information shows that these locked tokens have a lock-up period of more than 4 years.

The author believes that the CRV locked by voting should be included in the market value, so the market value should be 2.12 billion US dollars instead of 974 million US dollars. This also makes CRV's market value closer to FDV.

However, the comparison of circulating market capitalization and maximum market capitalization is only part of the analysis, we also need to understand the timetable of token release.

Token release schedule

Our analysis has always revolved around these four questions:

1. Current Availability

2. Future availability

3. When will the future state of supply be reached

4. How to reach the future state of supply

Circulating supply and max supply give us answers 1 and 2, token release schedule answers 3 and 4.

To check the token release schedule, we usually need to check the project's documentation. The picture below is the JonesDAO token release chart made by the author.

It can be seen from the figure that the release of JonesDAO tokens was relatively gentle at the beginning, but from April 30, 2022 to 10:30, the release accelerated. This period is the time when tokens are unlocked by private investors. About 3% of tokens are released every month, and before April 30, only 1.36% of tokens enter the circulation market every month.

Private investors have a great cost advantage and have a great incentive to dump tokens. That's not to say these investors are malicious, or that they necessarily do. But we must consider these situations in advance before buying tokens.

The other is the release based on platform performance. Convex is a typical representative, and the release of CVX tokens is based on how many CRV tokens the token pool earns.

The inflation rate of CVX has been decreasing, because the minting ratio of CVX and CRV will continue to decrease until the circulation of CVX reaches 100 million.

How Initial Liquidity Affects Token Release Rate

We also need to consider the change in the proportion of each part of the token distribution. Even though the project has a 4-year release schedule, it could hurt early investors if too few tokens are initially locked.

As an example, JPEG'd just issued a token. The project party sold 30% of the token supply in a public auction, and then added some of the raised funds to the token liquidity pool.

35% of the tokens are allocated to the team and consultants, with a 2-year lock-up attribution, and cannot be sold within 6 months (the sale will lose this part of the ownership). 30% of the tokens are in circulation from the very beginning, and 35% of the tokens will be released from the 6th month for a period of 18 months. During this time, the monthly inflation rate was about 2%.

A 2% inflation rate is relatively small compared to a 30% circulation. The supply of tokens has doubled in 15 months, however, the project side also has ample time to increase the value of the project to maintain the token price.

If the initial release of tokens is 10%, then the circulation of tokens will double within 5 months, which will have a huge impact on the price.

Initial Token Distribution and Yield Farming

Most protocols distribute a large portion of tokens as LP rewards.

On the surface, this method is very community-based. Anyone can buy tokens, create liquidity, and participate in staking to earn more tokens. However, this method may also help the founding team or insiders greatly Boost their token share.

A prime example is LooksRare. Cobie’s previous article also revealed that half of the project’s mining rewards flowed into the pockets of early investors, although their tokens were still locked.

Another situation is that the tokens of the team or investors are unlocked and added to the liquidity pool. What we hope to see is that the team and investment institutions will lock it for at least 3-6 months, and then release it linearly.

unlock

Token unlocking is also very important. Some protocols, such as Convex, have special unlocking mechanisms that users need to consider if they want to earn rewards for their tokens.