In-depth study of token supply
Original Title: "Tokenomics 101: The Basics of Evaluating Cryptocurrencies"
Author: Nat Eliason
Compiled by: Maynor, WhoKnows DAO
01 Introduction
Tokenomics 101 provides a high-level overview of how to evaluate a project's token. In this article, I will delve into the supply side of tokens: what is the quantity of tokens, how does the change in quantity (or manipulation) affect the health of the project?
At first glance, this may seem like a trivial factor. However, understanding a token's supply and how that supply will change over time is one of the biggest factors in achieving good returns when investing in a project. Unless you know where and how to find this information, it is easy to have a misleading impression of a project's token supply.
Even seemingly simple metrics like market capitalization can be misleading or manipulated in unexpected ways. So let's go through everything you need to know when evaluating token supply, so that you will have more information before your next investment.
02 Key Questions to Focus on in Token Supply
The focus of supply is not necessarily on the total number of tokens. It refers to what the current supply is, what it will be in the future, and how quickly it will reach that scale.
Let's start with the classic example of Bitcoin. The current circulating supply of Bitcoin is 18,973,506, and there will only ever be 21,000,000.
The last 9.6% of Bitcoin's supply will not be fully released until around the year 2140, which will take quite a long time to reach. We can see at any time what Bitcoin's current inflation rate is, and this process will not have any surprises. It is fixed.
Bitcoin is also straightforward because there are no investor unlocks, no team reserves, no grants with a minimum vesting period, or any other potential complications.
However, most cryptocurrencies are not this simple. While for Bitcoin, we only need to understand the circulating supply, maximum supply, and inflation chart to know where we stand, this approach becomes a bit more complicated for most tokens.
The key questions we are trying to figure out are:
- Current supply;
- Future supply;
- When will it reach future supply;
- How will it reach future supply;
Let's review the various factors that may affect these questions and do some case studies.
03 Market Cap & Fully Diluted Valuation (FDV)
Market cap and fully diluted valuation (FDV) are two simple initial metrics for evaluating the value of a cryptocurrency or token.
Market cap is the circulating supply of the token multiplied by the token price. If all tokens are in circulation, then FDV will be the current price multiplied by the maximum supply.
So, if a token is priced at $10, with a circulating supply of 10,000,000 and a maximum supply of 100,000,000, then the market cap will be $100,000,000, and FDV will be $1,000,000,000.
These two metrics can be very helpful when analyzing a project in conjunction with other variable factors, as they provide insight into how the market currently values a project and how much that project needs to grow in the future to justify its current price.
If you see a large discrepancy between market cap and FDV, it means that many tokens are locked and waiting to enter the market, and you should investigate how they will enter the market (see 3 and 4) to assess whether the current price is reasonable.
If the market cap is 10% of FDV, and the tokens are all issued next year, then the project needs to grow 10 times or 1000% within a year to maintain its current price.
However, if the market cap is 25% of FDV, and the tokens are released over 4 years, then only a 4 times growth or about 40% year-over-year growth is needed over those 4 years.
Thus, the ratio of market cap to FDV is one of the first things to check to provide clues about supply. Once you do this, you will want to dive deeper into the true meanings of circulating supply and maximum supply.
04 Circulating Supply & Maximum Supply
Circulating supply and maximum supply help answer questions 1 and 2: how much is the current supply, and how much will there be in the future? They help us understand market cap and fully diluted valuation.
Maximum supply is quite simple. What is the maximum potential supply of this token? For Bitcoin, it is 21,000,000. Ethereum does not have one. For Crypto Raiders, we set it at 100,000,000. For Yearn, it is 36,666.
Circulating supply makes things trickier. How much of a token is in circulation? For Bitcoin, this is simple; just subtract the amount that has not yet been released from the maximum supply to get your number. Other L1s, like Ethereum and Solana, either self-report or have APIs that can monitor this.
But for project tokens, it becomes complicated. Here’s a simple example. For Crypto Raiders, we have released about 16,000,000 of the total supply of 100,000,000. But if you look on Coingecko, it shows that the circulating supply is only 6,723,611. Where did the rest go?
Coingecko and other APIs will try to subtract "inactive" tokens from the circulating supply, even if those tokens have previously been released to the market. In our case, people have locked 9.5 million tokens in staking contracts for 3-12 months, so Coingecko subtracts these tokens from the supply.
To me, this seems a bit silly. People choose to lock 9.5 million tokens, not because we haven’t released those tokens. But technically, this removes them from circulation.
This illustrates how important it is to dig deep into a token's circulating supply. At first glance, it seems that only 6% of the tokens have been released, which means the project must grow nearly 20 times to maintain its current price. But in reality, 16% of the tokens have been unlocked, so the growth needed is 6.25 times. Another good example is Curve.
Their FDV is about 9 times their market cap, and it appears that only 11% of the tokens are in circulation. But they give a clue here: total supply. When we dig into the circulating supply, we can see that a large number of other tokens are locked in various contracts.
One noteworthy thing is that the "founders" seem to have 5.72 million tokens, while only 4.4 million CRV are locked for voting (as discussed in the Curve Wars article). The "founders" have a lot of token holdings!
However, when we delve into that contract, it seems to be given to multiple people, so it is not just one founder. If you read the actual contract, you can see that the minimum vesting period is over 4 years, so these tokens will take some time to unlock.
The reason to break this down is that it can help you gauge the actual number of tokens the market is exposed to. I believe that the voting-locked CRV should be counted in the market cap, which should be 2.12 billion instead of 974 million. This brings the market cap quite close to FDV, indicating that the project does not need to grow as much as it seems to justify its token price.
But circulating versus maximum supply is only part of the story. Whether the token supply grows 4 times in 4 months or 4 years will feel different. That’s why we also need to look at the token issuance schedule.
05 Token Issuance Schedule
Circulating versus maximum supply tells us 1 and 2. The issuance schedule tells us 3 and 4: how & when it will reach.
The issuance schedule is when you need to dive into the project documentation. This will not appear on Coingecko, and you will need to do some digging to figure it out.
In a recent article about JonesDAO, I put together a chart showing their issuance.
First, note their slow initial issuance slope, followed by an acceleration in issuance from April 30, 2022, to October 30, 2022. This is the period when private investor tokens are unlocked, and they unlock at a linear rate over 6 months.
During these 6 months, about 3% of the JONES supply will be released each month. However, from now (referring to the time of writing on March 6) until April 30, only 1.36% of the JONES supply will be released each month.
So during these 6 months, the inflation rate will more than double. And the new tokens entering the market will entirely belong to those who entered at a significant discount, even if the token price does not change from now until then, they have more economic incentive to sell.
This is not to say that investors are malicious or that they will do this, just that they might. You should be aware of these changes in future token supply before you start buying tokens.
Another type of issuance you might see is performance-based releases. Convex is a good example, where most of the CVX tokens are issued based on how much CRV tokens are earned from using liquidity pools.
This will let you know that the inflation rate of CVX has been decreasing, as the CVX:CRV mint ratio will decrease until it reaches a circulating supply of 100 million CVX.
06 How Initial Liquidity Affects Issuance Rate
A subtopic to consider in the issuance schedule is what the percentage changes look like. Even with a gradual 4-year issuance schedule, if it starts from a very small percentage of token unlocks, it can be detrimental to early buyers.
For example, let’s look at a new project that just launched a token, JPEG'd. They sold 30% of the token supply in a public auction and then used part of the raised funds to add liquidity for the token.
As shown in the figure below, their overall distribution is very simple and straightforward.
35% of the tokens will vest over 2 years for the team and advisors, with an initial 6-month minimum vesting period. Thus, 30% of the tokens will start unlocking, and 35% of the tokens will enter the market starting from the 6th month, over a period of 18 months. During this time, about 2% of the supply will continuously enter the market each month, after which inflation stops.
When more than 30% of the supply is already circulating in the market, the 2% supply entering the market is a relatively small increase. The token supply will double in 15 months, but that is enough for the project’s valuation to catch up with the token price.
In contrast, if only 10% of the tokens were initially issued, then the token supply would double in 5 months instead of 15 months! Early buyers would be more affected by the unlocking of more tokens, and the token price would struggle to keep up with the new inflation.
Alright, we have covered most of the important considerations, with just a few final factors to consider.
07 Initial Token Distribution & Farming
Most protocols allocate a significant portion of the token issuance to LPs as rewards. If you provide liquidity for the protocol, you can stake these liquidity tokens to earn stable tokens.
On the surface, this seems community-oriented, as anyone can buy tokens, create liquidity, and stake to earn more tokens. However, depending on how it is structured, this can be a subtle way for the initial team or insiders to significantly increase their token holdings.
A recent larger case is LooksRare. As Cobie explained in a related post, half of the operational rewards are given to early investors whose tokens are still locked. While retail investors may have the impression that they are earning most of the platform fees, they are actually flowing to early investors.
Another scenario may occur when a large number of tokens for the team or investors are immediately unlocked, as they can use these tokens for liquidity farming. You want to see that the team and investors have at least a 3 to 6-month lock-up period, followed by linear vesting.
08 Token Unlocks
Finally, it is important to note when a large number of tokens may unlock. Protocols like Convex have locking mechanisms, where users must choose to participate to earn rewards for their tokens.
When Convex first launched this feature, a large number of CVX holders locked their tokens in the first week. This means that after 17 weeks, all of these tokens will be unlocked. This mechanism was introduced in early September, and these tokens began unlocking in early January. Notice anything?
While there were other market changes at that time, it is hard to ignore the potential impact of this locking and unlocking. If the tokens you purchase have a veCRV-style lock or any other locking mechanism, it is best to be aware of when a large number of circulating supply tokens may be unlocked.
09 Conclusion
When you dig deep into a project's token, fully understanding the token supply and how it changes over time will give you a better sense of whether now is a good time to invest.
You can gather quite a bit of information from public dashboards like Coingecko, but digging into the details in the project’s whitepaper or documentation can help uncover more subtle details, such as how the issuance schedule changes over time, who the tokens will go to, and what forms of unlocks may occur in the future.
However, supply is clearly just part of the puzzle. Therefore, in subsequent articles in this series, we will also delve into demand, game theory, ROI, and other aspects of tokenomics that are worth understanding before investing in or launching your own project.
