How to think about token prices, emissions, and liquidity
Level 1 - NGMI
Welcome Avatar! Today we demystify some common terms you might have heard in crypto and give some simple tips for thinking about token values.
Don’t Think Price, Think Market Cap
Market cap is approximately price * quantity of outstanding tokens. The dollar value of an individual token tells you nothing. Find appropriate comparable protocols or stocks and compare by market cap (and FDV).
Unit Bias is the irrational tendency to prefer a whole unit, in crypto this manifests both as a focus on the price of ‘one token’ and also a disdain for owning a fractional quantity of a token. (People would rather own 10,000 units of a Dog Coin than 0.08 of a Bitcoin= “not even a whole coin”)
Autist Note: Occasionally the dollar value of one unit of a token is relevant as people look for a Schelling point - Bitcoin “going to $100k”, “Doge to $1” or Luna being worth “more than $100” can trigger investment decisions. Similarly, people may lose hope if ETH trades “below $1,000”. Studies in TradFi have found statistically significant increases in the number of limit orders entered at or very close to round numbers.
Track The Emissions And Unlock Schedule
When new tokens are created, or team / investor tokens are unlocked, this can cause selling pressure. It is important to be aware of emissions and key unlock dates.
Most protocols follow a simple linear vesting model. But.
Emissions will vary on a per-product basis and sometimes you need to dig deep to get the true numbers. Sometimes token emissions (distributed as rewards) are directly proportional to product usage, so while the fixed amount of supply allocated to such rewards is known, their exact timing of release is not. You may need to scrape the blockchain to get accurate data, but the emissions will still be a “best guess.”
It is worthwhile learning to accurately research this information as you will make better investment decisions and may even get hired!
New Investment Needed To Support Price
When newly minted supply comes onto the market, price * quantity of new investment is needed to absorb the supply without a negative price impact.
Not all unlocked supply will be dumped immediately (e.g. farming rewards), but it is logical to suppose that tokens locked behind a cliff/vesting are more likely to be sold when the restrictions expire than tokens which were freely tradable. Depending on the tokenomics, large farmers may be willing to hold a large percentage of their emissions (Bancor was a good example). For an obviously low-effort fork, farmed rewards could be dumped within hours.
Simple example: If a protocol trades at a market cap of $3b and promises 20% APY rewards via token emissions, either $600 million / year of new investment is needed or the price will go down. Will new investors contribute $1.64 million *per day* plus also buy the tokens of anyone who is wanting to cash out? If that is unlikely then you can expect the token price to drop in the near future.
This was true of all the rebase tokens from DeFi 2.0 last year - once the majority of people who would be willing to invest in the schemes had already done so, and the market cap had grown to the point that millions per day of new investment was required to sustain APY in real terms, the collapse started. This was predictable.
Volume
Volume is the dollar value of tokens traded. Average daily volume is the average dollar value of all token trades across all exchanges.
As tokens trade on different exchanges (Binance, Uniswap) and there are different token pairs (ETH/USDT and ETH/USDC for example), you need to add up the total volume from each product and venue.
A proxy for volume is market depth. Market depth answers the question “how much dollar value of a token can I buy or sell before moving the price by 1%”. Average daily volume answers the question “how much dollar value can I buy or sell if I aim to participate in X% of the daily volume”.
Volume dictates participation: whales need high volume to enter and exit their positions. Some tokens will have such low volume that it is not worthwhile to participate in them. Other tokens have so much volume (e.g. BTC) that it is unlikely you can out-compete other investors. You need enough volume to attract other participants but you’re better to be early with less competition.
Coingecko shows a list of exchanges for each token, and the volume there, including the dollar value which can be bought or sold before moving the price by 2%, for both centralized and decentralized exchanges.
Finally, you’ll want to keep track of the ratio between daily turnover and market cap. Despite people looking for “high volume” to confirm moves, a coin up 20% in a day and which has turned over 35% of its market cap that same day is less likely than average to outperform in the immediate future. You can run your own studies on volume effects to help you time exits on coins.
The objective is always to de-risk when the upside potential of an investment reduces, and volume analysis can help with timing as large holders are *forced* to sell when there is high demand, as they cannot do it at any other time without impacting price.
This is an introductory post for people new to DeFi. Don’t miss out on the information you need to make smarter decisions. Subscribe now to get access to dozens of free posts and regular updates on everything DeFi.
Disclaimer: None of this is to be deemed legal or financial advice of any kind. These are opinions from an anonymous group of cartoon animals with Wall Street and Software backgrounds
Thanks!
"keep track of the ratio between daily turnover and market cap"
On which platform can I track "daily turnover"? Don't see it on Coingecko or CMC.