Token Economy Myth | Is Increasing Supply Harmful with No Benefits? How do fixed-supply tokens perform in a bear market?

"Will token supply affect the price? How significant is the impact?" Author Natasha Che, founder of Soundwise, analyzed the top 718 cryptocurrency projects by market capitalization from 2020 to 2022, excluding projects with less than two years of history.

The following content is compiled from @TaschaLabs on Twitter. For detailed content and discussions, please refer to the original link.

She discovered several research findings:

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1. A 10% increase in supply leads to an average price drop of 5.1%.

2. Issuance still results in market capitalization growth.

3. A 10% increase in supply: tokens on average drop by 7% in bear markets and 3% in bull markets.

4. Projects with no total supply limit are more likely to increase in value.

5. A decrease in token supply is more beneficial for prices: a 10% decrease in supply leads to a 32% price increase.

6. Tokens with fixed total supply experience a larger average price drop in bear markets.

1. Impact of Supply on Prices

An increase in token supply leads to a price decrease, with the price dropping approximately half of the supply growth rate. When the supply increases by 10%, the average price drops by 5.1%.

2. Market Cap Increase

If the market cap of a cryptocurrency represents the valuation of a project, theoretically, whether issuing one thousand or one million tokens, the market cap should remain unchanged. However, the author uses the example of stock splits in traditional markets, where the market cap typically increases when a company splits its shares. This phenomenon is even more apparent in the crypto space.

Many projects distribute tokens through airdrops as a means of issuance or rewards to attract new users, increase holders, or as staking incentives, without the need for a secondary market.

Following the logic of the first point, where "an increase of 10% in supply leads to an average price drop of 5.1%," this is not too bad for the token issuer. Even though the token price falls by 5%, the market cap slightly increases, providing more tokens to potential new users for increased adoption.

3. Differential Effects of Supply Increase in Bull and Bear Markets

The impact of increasing token supply on token prices varies in bull and bear markets, mainly because demand is higher in bull markets:

Increasing the supply by 10% results in an average token price drop of 7% in bear markets and 3% in bull markets.

The token issuers are also wise; in this year's bear market, the overall token supply growth decreased by 7% compared to 2021.

4. Increased Supply Benefits Smaller Projects

Unlike the first point where "an increase of 10% in supply leads to an average price drop of 5.1%," for small projects with a market cap below $1.5 million, an increased supply is more likely to result in price increases.

Similar to the second point, more token supply helps increase liquidity and trading demand. However, as the market cap grows, the effect becomes less significant.

5. What about Decreasing Supply?

Reducing token supply has a much stronger impact on prices compared to increasing supply:

• Decreasing the token supply by 10% -> Price increase of 32%

• Increasing the token supply by 10% -> Price drop of 4.9%

The author believes that crypto investors favor narratives of "burning" and "buybacks" to reduce the supply, creating additional buying demand that is reflected in prices.

6. Is a Fixed Total Supply Not Ideal?

The author points out that the token price and the fixed total supply are not correlated.

Furthermore, tokens with a fixed total supply experience larger average price drops in bear markets, which may be due to the following reasons:

1. A fixed total supply may attract more speculators who are not genuine users of the crypto project.

2. This may also indicate a lack of deeper thinking in tokenomics for the project.

3. A fixed total supply imposes limitations that seem to confine the project to being just digital gold without other options.