Erik Weijers, 5 months ago

The effect of token supply on price

Did you ever wonder whether the inflation rate of a token or coin influences the price? A crypto researcher asked herself just this question and decided to research the inflation versus price effects of 700+ coins. The results are tantalizing. 

Surely, it can't be good if a crypto projects sprays around coins... or can it? After all, isn't part of the reason many people are in Bitcoin that they dislike the central banks of the world printing money out of thin air and devalue their savings?  

But most crypto projects are inflationary. Even scarcity coin number 1 Bitcoin keeps being issued at a current rate of 6.25 BTC per 10 minutes. And still, the market capitalization of the entire crypto industry keeps rising - with deep bear markets in between, obviously.  

Supply grows -> market cap grows 50% of that

One of the interesting findings of Tascha Che's research (she is a macroeconomist and tech entrepreneur) confirmed the finding that precisely when the number of coins is inflated, the market cap of a coin grows: 

  • Growth in token supply leads to half of that in price decline. For example, 10% growth in supply leads to 5% price drop.

The implication is that you can grow the total market cap of your project through inflation. This effect is larger for micro cap tokens. How can this be? After all, creating new tokens costs nothing, so how could it raise the total market capitalization of the project? Tascha suggests that it has to do with increasing adoption. 

In the above example, when project emits 10% more tokens, it can give half of it to existing holders, as staking yields. They won't complain. And the other half can be given to new holders to incentivize adoption. Che: "It can be a feasible way to grow adoption & mkt cap w/o damaging relationship w/ existing holders." 

Other interesting findings

  • The effect of shrinking number of coins on the price is greater than of growing number. (10% decrease in supply leads to 32% increase in price on average). This effect seems to only hold for more established tokens with a larger market cap.
  • Whether a project has a max number of coins (like bitcoin) does not matter for the above findings (!)
  • The supply expansion has less impact on price in bull markets, and will hurt the market cap in bear markets more (see image below). 

Increasing token supply has less effects in bull markets

What are the implications?

When looking into a token, take the so-called tokenomics into account and combine these with the above research. Tokenomics are about the supply and emission schedule: how many coins are released on the market at what time intervals? How are they distributed? And how long do early investors have to wait before they can sell their coins (vesting schedule)?  Also, some tokens have a 'burn rate', which determines that tokens are bought back from the market and/or taken out of circulation. This is a deflationary force.

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