TL;DR

Tokens with elastic supply have a changing circulating supply. The idea: instead of price volatility, what changes is the supply of tokens through an event called a rebase or adjustment.

Imagine if the Bitcoin protocol could adjust how many bitcoins were in a user's wallet to reach a desired price. You have 1 BTC today. You wake up tomorrow, in your wallet there are 2 BTC, but each is worth half of yesterday's price. That's how the rebase mechanism works.

Introduction

Decentralized Finance (DeFi) has seen an explosion of new types of financial products on the blockchain. We've discussed yield farming, Bitcoin tokenized on Ethereum, Uniswap, and flash loans. One other segment in the crypto space that is interesting to watch is tokens with elastic supply, or rebase tokens.

The unique mechanism behind this token allows for a lot of experimentation. Let's see how it works.

What is a token with elastic supply?

Tokens with elastic supply (or rebase tokens) function in such a way that the circulating supply increases or decreases due to changes in the price of the token. This increase or decrease in supply works by a mechanism called rebasing. When a rebase occurs, the supply of tokens is increased or decreased algorithmically, based on the current price of each token.

In some ways, tokens with elastic supply can be compared to stablecoins. The token aims to reach the target price, carried out by a rebase mechanism. However, the main difference is that rebase tokens achieve this with a changing (elastic) supply.

But, wait a minute, aren't there many crypto assets that operate with an ever-changing supply? Yes, quite a lot. Currently, 6.25 new BTC are minted in each block. After the 2024 halving, the number will decrease to 3,125 per block. This is a predictable amount, so we can estimate how much BTC there will be next year or after the next halving.

Tokens with elastic supply are somewhat different. As mentioned, the rebasing mechanism adjusts the supply of circulating tokens periodically. Suppose we have a token with an elastic supply that aims to reach a value of 1 USD. If the price is above 1 USD, the rebase increases the current supply, reducing the value of each token. Conversely, if the price is below 1 USD, a rebase will decrease the supply, making each token worth more.

What does this mean from a practical point of view? The number of tokens in the user's wallet changes if a rebase occurs. Let's say you own Rebase USD (rUSD), a hypothetical token that targets a price of 1 USD. You have 100 rUSD safely stored in your hardware wallet. Suppose the price is under 1 USD. After the rebase occurs, you will only have 96 rUSD in your wallet, but at the same time, each token will be worth proportionally more than its value before the rebase.

The idea is that your holdings will not change proportionally to the total supply. If you had 1% of the supply before the rebase, you will still have 1% after, even if the number of coins in your wallet has changed. In essence, you keep your share of the network, no matter what the price.

Example of rebase token

Ampleforth

Ampleforth was one of the first coins to work with elastic supply. Ampleforth aims to be a uncollateralized synthetic commodity, where 1 AMPL targets a price of 1 USD. Rebase occurs every 24 hours.

The project had relatively little traction before the introduction of a liquidity mining campaign or liquidity mining called Geyser. What's interesting about this scheme is its duration. The project distributes tokens to participants over a 10-year period. Geyser is a prime example of how liquidity incentives can create significant traction in DeFi projects.

Although technically a stablecoin, the AMPL price chart shows you how a token with an elastic supply can have high volatility.

AMPL price targets $1, however, volatility is possible.

Remember that this price graph only shows the price of AMPL tokens, does not take into account changes in supply. Even so, Ampleforth is highly volatile, making it a risky coin to play.

It may make more sense to map tokens with elastic supply in terms of market capitalization. Since price per unit doesn't matter as much, market capitalization can be a more accurate barometer for gauging a network's growth and attractiveness.

AMPL market capitalization on a logarithmic scale. Source: coinmarketcap.com.

Yam Finance

Yam Finance is another elastic supply token project that has gained public attention. The overall design of the Yam protocol is a kind of mix between Ampleforth's elastic supply, Synthetix's staking system, and yearn.finance's fair launch. YAM also aims to reach a price target of 1 USD.

YAM is a completely community-owned experiment, because all tokens are distributed through liquidity mining. There is no premium, no allocation for founders – the opportunity to earn these tokens is even available to everyone through the yield farming scheme.

As a completely new and unknown project, Yam was able to reach the value of 600 million dollars locked in its staking pool in less than two days. What attracts this much liquidity is perhaps how YAM farming specifically targets holders of some of the most popular DeFi coins, such as COMP, LEND, LINK, MKR, SNX, ETH, YFI, and the LP token Uniswap ETH-AMPL.

However, due to a bug in the rebasing mechanism, the printed supply was more than planned. The project was eventually relaunched and moved to a new token contract thanks to a community-funded audit. Currently, Yam's future is completely in the hands of its holders.

Token risk with elastic supply

Elastic supply tokens are a very risky and very dangerous investment. You should invest in this project only if you really understand what you are doing. Remember, looking at the price chart won't be very helpful, because the number of tokens you own will change after the rebase occurs.

Of course, this can strengthen your profit levels, but it can also increase losses. If a rebase occurs when the token price is down, you will not only lose money from the token price drop, but will also have fewer and fewer tokens after each rebase!

Since it is quite difficult to understand, investing in rebase tokens will likely result in losses for most traders. You should only invest in tokens with elastic supply if you can fully understand the mechanisms behind them. Otherwise, you will not be able to control your investments, and will not be able to make the right decisions.

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Conclusion

Tokens with elastic supply are one of the interesting innovations in DeFi. As we have seen, these types of assets are coins and tokens that can algorithmically adjust their supply to reach a target price.

Are elastic supply tokens just an interesting experiment, or will this type of asset gain significant traction? It's hard to answer, but there are definitely new DeFi protocol designs being developed that try to take this idea even further.

Do you still have questions about elastic supply tokens and other DeFi projects? Check out our question and answer platform, Ask Academy, where the community will answer your questions.