Does token supply affect price? If so, by how much?
Here’s result from 1k largest tokens over past 3 yrs.
The data may surprise you 👇
As you may suspect, simple answer to 1st question is yes.
Supply grows—> price drops, other things equal.
Simple answer to 2nd question is: about half of the supply growth rate.
Data from top 718 tokens by mkt cap (skipping those w/o at least 2 yrs of data) over 2020-22 shows:
10% increase in a token’s total supply is related to average price decrease of 5.1%.
(p.s. Initial token price & overall crypto mkt condition are controlled for in estimation.)
In other words token supply increase, on the margin, can grow a token’s mkt cap (b/c mkt cap = total supply x price, and only half of increase in supply is cancelled out by price drop).
Think abt this for a sec b/c theoretically it *shouldn’t* happen.
If mkt cap represents entire project’s valuation, that total mkt cap shouldn’t change whether it’s divided among 1000 or 1 million tokens. Number of tokens doesn’t matter for project value as a whole. Or does it?
In stock mkt there’s a related well-known phenomenon— the “stock split premium”. When a company splits stocks its mkt cap often goes up, even though theoretically it should have no impact.
How come?
One reason, which applies to both tokens & stocks, is when price is lowered it reduces buyers’ entry barrier—> demand increases—> holder base grows—> liquidity goes up—> higher price.
But apparently this effect is stronger in crypto than in stocks. Why?
B/c projects often use at least some of new token emission for airdrops & rewards to incentivize/attract new users, i.e. directly increasing holder base w/o even going through 2ndary mkt.
This has curious implication for a project’s token strategy.
For example, when project emits 10% more tokens, it can give half of it to existing holders—e.g. as staking yields—so they aren’t worse off than before (expected price drop is 5% but they get 5% more tokens), & give other half to potential new users to incentivize adoption.
It can be a feasible way to grow adoption & mkt cap w/o damaging relationship w/ existing holders.
Mind you, this likely only works for healthy projects w/ stable holder base & a real product people want to use. Plus you obv don’t want overdo it. (At least you’d need a predictable emission path & clear communication, or you damage trust.)
There’re lots of other nuances abt this relationship btw token supply & price. Here are some:
– Does it matter whether it’s a bull or bear mkt?
Yes.
Supply expansion has less impact on price in bull mkt. Reason is intuitive— demand is higher in bull mkt to help counter supply impact.
10% supply increase leads to almost 7% price drop on average in bear mkt, v.s. 3% price drop in bull mkt.
Project teams are apparently aware of this— overall token supply growth has been lowered cross the board this yr.
Average annual token supply growth dropped 7 percentage points from last yr.
Still, average supply growth is 30% in 2022 (median is 10%). Whether that’s big or small depends on your perspective.
For reference, US money supply growth at the height of Covid crisis in 2020 was 25% & right now it’s less than 2%. Again I’m not passing value judgement here. But even w/o considering anything else, is it any wonder that crypto prices in dollar terms dropped sharply?
– Does the size of the token matter?
Yes.
Negative relationship btw supply growth & price growth seems to only hold for more established tokens w/ larger mkt cap.
For micro-cap tokens (mkt cap < $1.5 million) increasing supply may actually lead to higher price growth.
Why?
B/c as mentioned at beginning, increasing supply & getting token into more hands help increase liquidity & 2ndary mkt trading demand, which in turn boost price.
For micro-cap tokens it looks like this effect may be dominating. But it’s less & less pronounced once you grow past a few million $ in mkt cap.
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– Does it matter whether we’re talking about positive or negative token supply growth?
Yes.
Effect of supply shrinkage on price is stronger than supply expansion. A lot stronger actually.
10% shrinkage in token supply—> 32% price increase
v.s.
10% expansion in token supply—> 4.9% price decrease
Why?
Not sure but an educated guess is crypto investors love supply reduction— narrative of token burns & buybacks creates additional demand on its own & reflexively reinforces effect on price.
– Does it matter whether a token has a max supply cap?
No.
Relationship btw supply growth & price growth doesn’t change whether the token has a finite supply cap in the future or not.
Ironically, tokens w/ hard supply cap have on average dropped more in bear mkt compared to those without. The difference is statistically significant.
Some possible reasons:
- Tokens w/ hard supply cap may disproportionally attract more speculative holders.
Originated w/ Bitcoin’s 21 million, finite supply has become a crypto meme. Many crypto investment gurus & influencers have it as an unnegotiable in their checklist of token buying recommendations. Speculators care more abt their checklist than what project actually does.
But speculators aren’t real users. Their holdings are more volatile than people who use the product regularly. When you attract a more speculative holder base, you attract higher price volatility.
- It may reflect a lack of thoughtfulness in project’s tokenomic design.
Fixed supply cap has so many limitations— I’ll talk abt those in another post— that makes it hardly an ideal choice for any project that aspires to be something other than a static digital gold.
But it’s simple & attractive to investors. Any project team, whether they’ve thought through how token supply should evolve or not, can at least do a fixed cap w/o having to explain themselves.
Result is tokens w/ fixed cap actually had higher supply growth on average than those without over past cycle— fixed cap is such a great cure-it-call on surface that can hide much sloppiness in supply management.
Again, more on this in future post.
To be clear, I’m NOT saying whether X level of supply growth is good or bad. That’s a complex question depending on many things— stage of project, its goal, biz model, product, etc. Yes supply affects price. But that’s only one piece of tokenomic puzzle.
TLDR:
- 10% token supply change negatively correlates w/ 5% price change on average
- Supply reduction has 5x stronger impact on price than supply expansion
- Supply has more impact on price in bear mkt
- effect is same whether token has max supply cap or not
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