Written by: Tascha Lab
Compiled by: TechFlow
TLDR:
- The supply of tokens is negatively correlated with price changes. On average, a 10% increase in supply will cause the token price to drop by about 5%.
- A decrease in supply has a 5x stronger impact on price than an increase in supply
- Supply changes have a greater impact on prices in bear markets
- The effect is the same whether the token has a maximum supply cap or not
1. Does token supply affect price?
2. If so, how big is the impact?
The following data is from the top 1,000 coins by market cap over the past three years, and it may surprise you.
The answer to the first question is yes. All else being equal, supply increases -> price decreases.
The answer to the second question is: about half the rate of supply growth.
Data for the top 718 tokens by market cap from 2020-2022 (skipping those with less than two years) shows that a 10% increase in the total supply of tokens results in an average price drop of about 5.1%.
In other words, an increase in token supply can increase the token’s market cap (since market cap = total supply × price, and only half of an increase in supply is offset by a drop in price).
Think about this for a moment, because in theory, this shouldn't happen.
If market cap represents the valuation of the entire project, then the total market cap should not change whether it is divided into 1,000 or 1,000,000 tokens. Or is the number of tokens not important to the overall value of the project?
In stock markets, there’s a well-known related phenomenon called the “stock split premium” — when a company splits its stock, its market value tends to rise, even though in theory it shouldn’t have any effect.
Why is this happening?
One reason that applies to both tokens and stocks is this: when price is lower, it reduces barriers to entry for buyers -> demand increases -> holder base grows -> liquidity goes up -> price goes up.
But apparently, this effect is stronger in cryptocurrencies than in stocks. Why?
Because projects often use new tokens for airdrops and rewards to incentivize/attract new users, that is, directly increase holders without even going through the secondary market.
This has strange implications for the project’s token strategy.
For example, when a project issues 10% more tokens, it can give half of them to existing holders, for example as staking income, so that they don’t lose too much (expected price drop of 5%, but they get 5% more tokens), and give the other half to potential new users to incentivize their adoption.
This could be a viable way to increase adoption and market cap without damaging relationships with existing holders. Note that this may only work for healthy projects with a stable holder base and a real product that people want to use.
There are many other nuances to this relationship between token supply and price:
Does it matter whether the market is a bull or bear market?
Very important.
In a bull market, supply expansion has less impact on prices. The reason is intuitive – demand is higher in a bull market, which helps offset the impact of supply.
In a bear market, a 10% supply increase results in an average 7% price drop.
The project team is clearly aware of this - the overall token supply growth has been reduced across the board this year. The average annual token supply growth rate is 7 percentage points lower than last year.
Still, the average supply growth rate is 30% (median 10%) through 2022. Whether that’s big or small depends on your perspective.
Does the size of a token matter?
important.
The negative relationship between supply growth and price seems to only apply to more established coins/larger market caps.
For small-cap coins (market cap < $1.5M), increasing supply may actually lead to higher price growth.
Why?
Because as mentioned at the beginning, increasing supply and getting tokens into more hands helps increase liquidity and trading demand in the secondary market, which in turn boosts prices.
This effect seems to be more dominant for small market cap coins, but once you get above a few million dollars in market cap, it becomes less and less noticeable.
Does it matter whether we are talking about positive or negative growth in token supply?
This is also very important.
Supply reduction has a stronger effect on price than supply expansion, much stronger in fact. A 10% supply reduction of tokens -> a 32% price increase. A 10% increase in token supply -> a 4.9% price decrease.
It’s not certain what the rationale for this is, but one guess is that cryptocurrency investors like the idea of reduced supply – the narrative of token burning and buybacks itself creates additional demand and “reflexively” reinforces the impact on price.
Does it matter if a token has a maximum supply cap?
Not very important.
The relationship between supply growth and price growth does not change, regardless of whether or not the token has a finite supply cap in the future.
Ironically, tokens with hard supply caps have, on average, fallen more during bear markets than tokens without hard supply caps. This difference is statistically significant.
Some possible reasons I think:
1. Tokens with hard supply caps may attract disproportionately more speculative holders.
The limited supply of Bitcoin has become a crypto meme due to its 21 million cap. Many crypto investment gurus and influencers have included it as a factor in their list of token purchase recommendations. Speculators care more about their recommendations than the actual situation of the project.
But speculators are not real users. Their holdings are more volatile than those who regularly use the product. When you attract more speculative holders, you attract higher price volatility.
2. This may reflect a lack of consideration in the project’s token economics design.
There are a lot of limitations to a fixed supply cap that make it a difficult choice for your project.
But it’s simple and attractive to investors. Any project team, whether or not they’ve thought about how the token supply should develop, can at least do a fixed cap without having to explain it themselves.
The result is that over past cycles, tokens with fixed caps have actually had higher supply growth than tokens without fixed caps — fixed caps are ostensibly a good solution that hides a lot of sloppiness in supply management.
To be clear, this is a complex question that depends on many factors: the stage of the project, its goals, business model, product, etc.
Yes, supply affects price, but that’s only one piece of the token economics puzzle.
