By Nat Eliasson
Compiled by: Translation Guild Usopp
Token Economics 101 provides a high-level summary of how to value a project’s token. In this post, I’ll dive deeper into the supply side: how does the number of tokens, and the various ways that number can change, naturally or artificially, affect the perceived health of a project?
At first glance, this may seem like a trivial factor. However, understanding the supply of a token and how it changes over time is one of the factors within your power that will most likely allow you to get a good return on your investment in a project. And unless you know where and how to look, it’s easy to get a false sense of a project’s supply.
Even simple metrics like market cap can mislead or manipulate you unexpectedly. So let’s walk through everything you need to know when evaluating a token supply so you can be more informed before your next investment.
What do we need to pay attention to regarding supply?
What matters most is not the total supply of tokens, but how much the current supply of tokens is, how much the future supply of tokens will be, and how quickly it will be reached.
Let's start with classic Bitcoin. Currently, the circulating supply of Bitcoin is 18,973,506, and there will only ever be 21,000,000.
Bitcoin's circulating supply, total supply, and maximum supply
The last 9.6% of Bitcoin supply will not be fully released until 2140, so it will take quite some time to reach. And we can always see what the current inflation rate of Bitcoin is, and the whole process will not be affected by any accidents. It is fixed and unchanging.
Bitcoin Annualized Inflation Rate and Supply
Bitcoin is simple because there are no investors unlocking their assets, no team vaults, no threshold conditions, no vesting periods, and no other possible variables.
However, most cryptocurrencies are not as simple as Bitcoin. So, for Bitcoin, we only need to observe the circulating supply, maximum supply, and inflation table to know its current market, but it is more difficult to know the market of most other tokens.
We need to clarify the following issues:
What is the current supply? What is the future supply? How long will it take to reach the future supply? How is the future supply reached?
Let’s look at the various factors that may influence these issues and then analyze some case studies.
Market Cap & Fully Diluted Market Cap
Market capitalization and fully diluted market capitalization (FDV) are two simple, initial metrics for assessing the value of a cryptocurrency or token.
Market capitalization is equal to the circulating supply multiplied by the price of the token. If all tokens are in circulation, then the fully diluted market capitalization (FDV) is equal to the current price multiplied by the maximum supply.
So, assuming a token price of $10, a circulating supply of 10,000,000, and a max supply of 100,000,000, then the market cap would be $100,000,000 and the fully diluted market cap (FDV) would be $1,000,000,000.
These two indicators are useful when used in conjunction with the other characteristics we will mention. Because they can give you an idea of how the market values the project today, and how the project needs to develop in the future to reach a price that satisfies buyers' expectations.
If you see a big difference between market cap and fully diluted market cap (FDV), it means there are a lot of tokens locked up and waiting to enter the market. If you think the current price is in line with expectations, then you should investigate how they entered the market (3 & 4).
If the market cap is 10% of the fully diluted market cap (FDV), and all tokens are released over the next year, the project would need to grow 10x, or 1000%, in 1 year to maintain the current price.
However, if the market cap is 25% of the fully diluted market cap (FDV), and all tokens are released in 4 years, then the project only needs to grow 4x in 4 years, or about 40% per year.
Therefore, the Market vs Fully Diluted Value (FDV) ratio is one of the first things you should check to get some clues about supply. And once you do that, you’ll be eager to dig deeper into what circulating supply and max supply really mean.
Circulating Supply & Max Supply
Circulating Supply and Max Supply can answer questions 1 (what is the current supply) & 2 (what will the future supply be). Also, they can help us understand market capitalization and fully diluted market capitalization (FDV).
Max supply is a fairly easy number to get. What is the maximum potential supply of this coin? For Bitcoin, it is 21,000,000. Ethereum has no max supply. For Crypto Raiders, we set it to 100,000,000. Yearn is 36,666.
Getting the circulating supply is a little trickier. How many of a given token are in circulation? For Bitcoin, it’s simple, just subtract the amount that hasn’t been released from the max supply and you’ll get your number. Other L1s like Ethereum and Solana provide self-reporting or are monitored via an API.
Getting this data can quickly get complicated when researching project tokens. Here’s a simple example. For Crypto Raiders, we’ve released about 16,000,000 of our total supply of 100,000,000. However, if you check Coingecko, it says our circulating supply is only 6,723,611. Where’s the rest?
Coingecko and other APIs try to subtract "inactive" tokens from the circulating supply, even if they were previously released to the market. In our case, people had 9.5 million tokens locked up in our staking contract for 3-12 months. So Coingecko subtracted them from the supply:
Crypto Raiders project interface in Coingecko
I think this is a bit ridiculous. People chose to lock up 9.5 million tokens, not that we didn't release them. But from a technical point of view, they are not circulating tokens.
This shows how important it is to look deeper into the circulating supply. At first glance, it looks like only 6% of our tokens have been released, meaning the project would need to grow by about 20x to maintain its current price. But in reality, 16% of the tokens are unlocked, so it would need to grow by about 6.25x.
Curve is another great example.
Curve project interface in Coingecko
Their fully diluted market cap (FDV) is about 9x their market cap. And, it looks like only 11% of their tokens are in circulation. However, they give you a clue here: total supply. When we dig deeper into the circulating supply, we can see that a large amount of tokens are locked up in various contracts:
Curve project contract lock details interface in Coingecko
What’s striking is that the “founders” appear to own 572m tokens, and only 440m CRV is locked up in voting (as reported in the Curve Wars article). That’s a lot of tokens owned by the founders!
But when we look deeper into the contract, it shows that there are multiple people involved, so it doesn't just have one founder. And if you look at the actual contract, you'll see that the vesting period is 4 years. So it takes a while for these tokens to unlock.
The reason it's worth knowing these details is that it helps you gauge how much tokens are actually being put into the market. For me, I think that CRV locked in voting should be counted as part of the market cap, which puts the market cap closer to 2120 million than 974 million. This puts it pretty close to the fully diluted market cap (FDV) and suggests that it doesn't need to grow in order to meet the market's preferred price.
However, circulating supply vs max supply is only part of the picture when it comes to understanding supply. If the supply of a token increases 4x in 4 months or 4 years, you will feel very different. This is why we also need to look at the emission schedule.
Release Schedule
Remember the main question we want to clarify:
What is the current supply? What is the future supply? How long will it take to reach the future supply? How is the future supply released?
Circulating supply vs max supply answers questions 1 & 2. Emission schedule answers questions 3 & 4: how and when supply is reached.
Usually when we need to dig into a project’s documentation, we look at the release schedule. This is not available on Coingecko, so you’ll have to do some research to figure it out.
In my recent JonesDAO article, I put together a chart showing their token emission over time:
Jones release schedule
The first thing that should be noted is that they have an initial release period that is slowly increasing, and then there will be an accelerated release period from April 30, 2022 to October 30, 2022. That is the unlocking period for private investors, which is linear over 6 months.
During that 6 month period, approximately 3% of the JONES supply will be released each month. However, from now until April 30th, only 1.36% of the JONES supply will be released each month.
So, during this 6 month period, inflation will more than double, and the new tokens coming into the market will go entirely to those who entered at a deeply discounted price, giving them a greater financial incentive to sell their tokens even if the price did not move during this period.
This is not to say that investors are malicious or that they are doing this intentionally, just that they are free to do so. Before buying this token, you should expect this change to affect future supply.
You may see another way of releasing tokens based on platform performance. Convex is a good example where most of their CVX token releases are based on the amount of CRV tokens their pools earn:
Amount of CVX minted per unit of CRV profit - The proportion of CVX minted decreases over time
This gives you an idea of how CVX’s inflation rate has been decreasing, as the minting rate of CVX changes: the amount of CRV minted keeps decreasing until 100m CVX are in circulation.
How initial fluidity affects release rate
Another thing to watch out for on the release schedule is the impact of percentage changes. Even with a 4 year gradual release schedule, if the tokens start unlocking at a very small percentage, this can hurt early buyers.
For example, let's look at a new project that just launched a token: JPEG'd. They sold 30% of their tokens in a public auction and used part of the funds raised to increase liquidity of the token.
Their overall distribution is clear at a glance:
JPEG supply allocation scheme
35% of the tokens are allocated to the team and advisors with a vesting period of 2 years, with an initial critical period of 6 months. So, 30% of the tokens are unlocked first. After 6 months, 35% of the tokens are released to the market over a period of 18 months. So during this period, about 2% of the supply per month continues to enter the market, and then inflation stops.
2% entering the market is a relatively small increase when 30%+ is already in circulation. Token supply will double in 15 months, but that’s plenty of time for the project’s valuation to catch up to the token price.
In contrast, if only 10% of tokens were initially released, the token supply would double in 5 months instead of 15 months! Early buyers would be more impacted by the unlocking, and the token price would have a hard time keeping up with the new inflation.
Okay, we've covered most of the important considerations. There are only a few final factors left to consider.
Initial Distribution & Mining
Most protocols will release a considerable portion of tokens to liquidity pool (LP) rewards. If you provide liquidity to the protocol, you can stake the liquidity and earn a stable amount of tokens.
On the surface this seems very community oriented as anyone can buy a token, create liquidity, and stake it to earn more tokens, but depending on how the process works, the initial team or insiders may be able to exploit this and significantly increase their share of tokens.
A recent example is LooksRare. As Cobie explains in his article on the subject, half of the mining rewards went to early investors who locked in their stake. So while retail investors may feel like they are earning most of the platform’s fees, in reality those fees are going to early investors.
Another way this case manifests is that a large portion of the team or investors' tokens are suddenly unlocked because they can use them for liquidity mining. What you envision is that the team and investors have a lock-up period of at least 3 to 6 months, and then they can slowly get their tokens back in linear time.
Unlock
Finally, it is important to note the timing of unlocking a large number of tokens. Some protocols like Convex have a lock-up mechanism, and if users want to get token rewards through lock-up, they must participate in this protocol.
When Convex first released this feature, a large number of CVX holders locked up their tokens in the first week. This means that after 17 weeks, all of these tokens will be unlocked. The mechanism was introduced in early September, and these tokens started unlocking in early January. Notice anything?
Convex Finance (CVX) Price Chart
There are other market movements going on at the same time, but it’s hard to ignore the impact of locking and unlocking tokens. So if you buy a locked token like veCRV, or any other token with a lock mechanism, it’s best to be aware of the times when a large amount of circulating supply will unlock.
Review
As you dig deeper into a project’s token, having a full understanding of supply and how it changes over time will give you a better idea of whether now is a good time to invest.
You can get a ton of information from public dashboards like Coingecko, but digging into the details in a project’s documentation can help you uncover subtle details like how the release schedule changes over time, where tokens are going, and what tokens might be unlocked in the future.
However, supply is obviously only one piece of the token economics puzzle, so in future installments in this series we’ll also dig deeper into demand, game theory, return on investment (ROI), and other fine token economics stuff worth knowing before investing or launching your own project.
P.S. If you want to design token economics for your project, please reach out on Twitter. Especially if it's a game.
By Nat Eliasson
Translation: Usopp
Proofread by: jomosis1997
Typesetting: Bo
Reviewer: Suannai