BTC whales and miners sold into institutional buyers in Q4 2020, on-chain data infers
Fully diluted values may mislead DeFi investors and traders
A closer look at three prominent DeFi projects reveals the limitations of inflationary supply on price.
Fully diluted market value is what a digital asset's market cap would be if all the coins or tokens in its total supply were issued.
For example, Uniswap will ultimately issue a total of 1 billion UNI tokens over the next four years. If we hypothetically price UNI at an even $3.00 per token, the FDV would be $3 billion. As of Oct. 15, the decentralized exchange's governance token has a circulating supply of 185,059,564 and is actually trading at $3.36 per token, giving UNI a market capitalization of $623 million — which is still a far cry from its current fully diluted value of $3.364 billion.
Well-known decentralized finance projects currently vary tremendously in terms of their market-cap-to-FDV ratio. For example, yearn.finance allocated its total supply of YFI tokens within a week, which means that its market-cap-to-FDV ratio is equal to 100%. Curve, on the other hand, distributes 2 million CRV tokens each day via liquidity mining, which will gradually inflate its supply to a maximum of 3.03 billion CRV — resulting in an extremely low market-cap-to-FDV ratio of 2.64%.
In comparison, SushiSwap hard-capped its supply at 250 million tokens on Sept. 20 — bringing its FDV down to $99 million, based on the Oct. 15 price of $0.76 per SUSHI. This makes SushiSwap's market-cap-to-FDV ratio approximately 76.93%, after the reduction in supply. Its main competitor, Uniswap, has a ratio of approximately 18.51%.
How important is a cryptocurrency's fully diluted value?
The question worth examining here is whether or not FDV is a critical metric in the cryptocurrency market. Are market participants rational to look at theoretical valuations placed years into the future?
In order to answer this question, we compare the numbers behind Uniswap, SushiSwap and Curve — three decentralized exchanges with proven cash flows.
First, CRV has the lowest market-cap-to-FDV ratio and, in terms of price, is the worst performer. As of Oct. 15, its price of $0.54 has fallen 99% from its peak of $54, and the price hasn't risen much from the bottom of $0.46.
Among the three decentralized exchanges, Curve has the best market-cap-to-annual-fees ratio, at 6.26 — but it also has the highest FDV-to-annual-fees ratio, at 237. Given that its total value locked in is about 53% that of Uniswap's and its seven-day average fees are 19% of Uniswap's, we might infer that market participants are concerned about its massive ongoing token distribution. Also, we can see the steep curve of the increase in the CRV supply. As a result, the potential daily sell pressure is pushing its token price to only 16% that of UNI's.
The drawbacks of looking at fully diluted values
In the cryptocurrency space, many people are afraid of the increasing supply of coins or tokens. Perhaps more accurately, they fear aggressive inflation schedules. Couple this with the small chance of a significant change in a project's fundamentals taking place in a short period of time, the market's way of coping with the ongoing issuance of new tokens is to continually lower the price.
Curve is a good case of this, as it has created a strange phenomenon in which the crypto community views Curve as one of the most stable liquidity-farming platforms, but everyone avoids purchasing CRV tokens on the secondary market. With prices falling sharply and an aggressive inflation rate, Curve's market capitalization hasn't changed much since mid-September — and it has even declined.
The fully diluted value denomination may be a good metric for long-term investors, as it allows them to better judge whether a project's value is extremely out of line. For instance, the FDV of CRV climbed to $160 billion, as of Oct. 15 — roughly 65% that of BTC’s — on the day of its launch. This makes it easy for investors to perceive that the price of CRV is overvalued. Also, it allows investors to avoid the valuation trap caused by a low quantity of initial tokens.
One drawback of the fully diluted value metric is that it can inflate the total value of a project. For example, let's say a project currently has 1 million tokens outstanding. Later today, it's going to announce another 10 million tokens issued over the next three years. Does this mean that the "market capitalization" of the project will be 11x higher than it was yesterday? Since project governors can initiate proposals to change the supply curve at any time, the current FDV could become irrelevant.
The discussion of valuation methods is ultimately about whether or not a coin or token is worth buying. Does reducing the FDV by lowering inflation lead to an increase in the token price? Here, SushiSwap gives us a good example.
The left circle in the below chart coincides with Uniswap's launch of its UNI token, which caused competitor SushiSwap's TVL to decline rapidly. The circle on the right coincides with SushiSwap's decision to hard-cap its supply at 250 million tokens, which led farmers to opt-out, as they didn't see enough incentives to continue farming SUSHI. This implies that, when rewards are meaningfully reduced, yield farmers simply flock to the next project.
In yield farming, sustainability is key, since the periods of time for farming are not short. For instance, Uniswap's rewards are spread over four years. Reducing the total supply of tokens may boost the price, but it won't change the value of the project. At the same time, it won't make the asset suddenly more scarce.
When comparing these three decentralized exchanges, SushiSwap has some of the best financials, across the board — the lowest FDV-to-annual-fees metric, at 18.30, and the highest market-cap-to-FDV percentage, at 76.93%, once it suddenly lowered the token supply. However, market participants regretted this approach, and this was reflected in its price. What's worse is that its price rebounded only 10.26% from all-time low.
In another example, Cream Finance (CREAM) burned 67.5% of its token supply on Sept. 20. The token price was supposed to triple — if the FDV was maintained — but it increased by less than 50%. Again, for a yield-farming project that will take years to finally end, scarcity at the beginning is not a major factor. Therefore, the reduction in liquidity-mining output doesn't dramatically affect prices.
Cheap FDVs don't inherently provide token price support
In summary, the case of CRV shows us how an aggressive inflation rate can disincentivize investors from purchasing and holding newly minted tokens. The case of SUSHI, on the other hand, shows us that a huge reduction in supply, while making FDV look cheaper, has had little effect on its price.
Yield-farming rewards and inflationary supplies have a huge role to play in acquiring users. However, even more critical is the ability to attract users to a project and to allow the fundamental value to grow faster than the token supply is diluted.
Disclaimer: This material should not be taken as the basis for making investment decisions, nor be construed as a recommendation to engage in investment transactions. Trading digital assets involve significant risk and can result in the loss of your invested capital. You should ensure that you fully understand the risk involved and take into consideration your level of experience, investment objectives and seek independent financial advice if necessary.
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