The crypto markets are notoriously volatile and unpredictable. In the 2020–2021 bull run, many lesser-known altcoins rocketed to dizzying new highs before crashing violently. Now in 2023, a new wave of investors is hoping to capitalize on the next cycle.
But simply looking at a crypto’s all-time high (ATH) price can set unrealistic expectations. Projects often have very different token supplies and valuations between market cycles. Ignoring important metrics like market capitalization and circulating supply when investing can lead to costly errors. Let’s explore some of the most common crypto investing mistakes — and how savvy investors can avoid them.
Using All-Time High Price as the Benchmark
Many new crypto investors examine a project’s ATH price during the last bull market, and make that their long-term target. The logic is alluringly simple: if a coin hit a peak of $X, it should be able to reach that level again.
For example, a new investor might look at Chia (XCH), which hit an ATH of $1,645 in mid-2021 before crashing. They then assume that since XCH trades around $30 today, it could conceivably return to its high of $1,645 for a 55x gain in the next bull run.
Unfortunately, this thinking ignores critical factors like market capitalization and circulating supply. It focuses solely on the nominal “price per coin” metric while ignoring the project’s overall valuation.
In May 2021 when XCH hit its $1,645 high, its market cap peaked at around $583 million with just over 350,000 coins in circulation. Today in September 2023, XCH’s market cap stands at $234 million — but its circulating supply has risen sharply to over 8.4 million coins. So despite trading at just 2% of its previous ATH price, XCH’s current market cap is already 43% of its all-time high market cap.
For XCH to return to a $530 million market cap again, its price would only rise to around $64 — not $1,645. The previous #ATH is simply no longer an accurate reference point. This vast supply inflation means ATH price should not guide investment strategy or targets. Let’s explore why.
Understanding Supply Inflation and Dilution
When a project issues new coins, it dilutes the ownership stake of existing holders. The same valuation is now divided across a larger token supply.
Many altcoins experience extreme supply expansion between market cycles. Coins are issued or unlocked to founders, employees, investors and the community treasury. This is natural early in a project’s lifecycle — but it seriously impacts valuation targets.
For example, Cardano launched with a total supply of 25.9 billion $ADA. Today, it has over 35 billion coins in circulation — a 40% increase. $MATIC has gone from a 3.2 billion initial supply to over 9.3 billion now, almost tripling.
Such vast inflation makes past price levels irrelevant. When supply doubles, a coin’s price needs to rise exponentially more to reach the same market cap again. A CHIA hitting $1,600 with 8.3 million coins would require a $13.28 billion market cap.
Savvy crypto investors understand this dynamic profoundly impacts return targets and expectations. Coins with lower inflation rates have an inherent edge.
Evaluating Supply Schedules
When analyzing a crypto for investment, investors should closely examine its monetary policy and token distribution schedule.
Coins like Bitcoin and Litecoin are disinflationary — the total supply is capped, and new issuance decreases over time. This guarantees diminishing inflation, enhancing scarcity.
Ethereum currently issues new $ETH through mining rewards, but shifted to a largely disinflationary model. Burning fees also help offset issuance. Other projects have more complex distribution schemes that unlock supply over time. Ripple slowly releases XRP from escrow accounts, while Cardano’s staking rewards issue new $ADA each epoch.
NFT projects and metaverse tokens also frequently have reward programs that expand the pool — for example Sand in the Sandbox or Atari Token for Atari’s VCS console.
Investors should model a coin’s projected inflation rate over their desired holding period and factor that into valuation estimates. Protocols with lower minting rates all else being equal have better odds of maintaining value.
Lockups and Vesting
Another key factor is founder and investor lockups that restrict when tokens can be sold.
Most projects allocate large portions of supply to teams and backers. For example, 25% of Near Protocol’s 1 billion $NEAR tokens were set aside for community funds and seed investors.
These allocations are typically locked or vested over months or years to reduce dumping risk. Near’s investor tokens vest over 3 years after launch, while employee grants have 4-year vesting.
Lockups delay when team members and investors can liquidate holdings. This helps stabilize price — a project is less likely to crash if founders can’t immediately cash out.
Supply Schedule vs. Demand Growth
In a perfect world, a crypto’s monetary policy would expand supply steadily in line with user and investor demand. But the real world is far messier. Supply explosions without matching demand growth severely hamper value. Investors should prioritize projects where minting rates seem reasonably aligned with ecosystem traction and utility.
A project may mint millions of tokens but see only lackluster developer activity and user adoption. Such a situation risks overvaluing the coin relative to fundamental utilization. Technical merits only translate to value with actual usage.
Analyzing circulation metrics can provide useful insight. On-chain activity like transactions, active wallets and TVL (Total Value Locked) should ideally trend upward as the coin base expands. If network utilization stalls, placing large bets becomes risky.
Avoiding All-Time High Obsession
Like we explored initially, basing targets on old all-time highs is often delusional in crypto. Investors prone to this thinking experience overconfidence about price return potential. More realistic guidance estimates value based on fundamental utility slated to emerge in the next cycle or parallels to relevant competitors.
For example, it may make sense benchmarking a scaling solution’s expected valuation against a rival like Polygon or Arbitrum. Or for a new DEX project, comparing prospects against Uniswap. This accounts for the protocol’s competitive positioning.
There are no guarantees of repeating previous market cycles. Each bull run sees new innovations and leaders arise while former stalwarts fade away. Investing based on ecosystem role and traction is prudent rather than chasing ghosts of old glory days.
Honestly Appraising Dilution Risk
Dilution definitely matters for crypto valuation prospects. But some projects handle inflation responsibly in ways that enhance value.
For example, OlympusDAO introduced protocol-owned liquidity (POL) and algorithmic rebasing of supply to maintain holder ratios. Its bonds and staking ecosystem benefit greatly from expanding supply, as more utility flows into the protocol.
Such inflationary designs can work sustainably if networked effects arise from new issuance. But most projects don’t apply this nearly as effectively. Investors must analyze if dilution makes sense or is likely harmful.
Soberly balancing risks and opportunities is critical. Being realistic about expected returns given issuance trends can stem foolish #FOMO speculation and disappointments.