Tokenomics Gone Wrong
Nearly all the crypto-assets currently launched by web3 companies suffer horrible tokenomics design. In this blog post, I will be discussing examples of horrible tokenomics design from a quantitative aspect. This work is a follow up to a previous blog post “How to Design Web3 Tokenomics”. Web3 founders are the main target, but crypto investors in general might find the content interesting to help them make investment decisions.
Token Allocation & Vesting
In order to simplify our explanation I will cover only a token that is listed on a single decentralized exchange because things would get a lot more complicated if we include centralized exchange liquidities in our calculations. Let’s take a look at a new crypto-currency added to Coingecko which is called Peppa Inu ($Pepa), it obviously sounds like a meme coin devoid of any real value, so it’s perfect for our evaluation.
At the time of this writing, $pepa was $0.000000000029534 with a 61.7% growth in the last 24 hours and a 4,123% growth in the last 8 days.
Let’s take a look at the token allocation. There are 210,000,000,000,000,000 tokens in circulation of which 71,000,000,000,000 tokens are in the liquidity pool that is composed of $387K (50% of which is BNB: USD $193,500). This means 210,000T — 71T = 209,929T tokens were sold in pre-sale. The total value in circulation being half of $12,436,816 means that current holders including the pre-sale investors have $6.2M of accumulated wealth, but the actual bank (liquidities) are only $193,500. Thus, at any point, when early investors decide to start selling, there is only $193,500 of money that can be taken out of the bank. There is no mention of vesting for pre-sale investors, but they own 209,929T / 210,000T = 99.996% of the circulating supply. The project attempted to obfuscate how bad the tokenomics was by burning 50% of the total supply at the launch. So, clearly this project looks like a scam, but understanding how small the size of the liquidity pool (bank) is in comparison to the in-circulation supply is critical to understanding how certain crypto-projects can crash massively when adoption starts to plateau and early investors start cashing in their gains that generated 4000% in 8 days.
Overall, liquidity pools are always vastly smaller than the accumulated value generated by crypto-assets, except when it comes to stablecoins which supposedly have $1-$1 collateralized treasury backing the in-circulation tokens. With a small liquidity pool, it mathematically guarantees that $1 of buying volume leads to more than $1 of accumulated value to previous holders, making bank runs inevitable and spectacular crashes.
For these reasons, I recommend web3 ventures to launch tokens without pre-minted allocation. The team, and early investors should rely on transaction fees or other mechanisms for their upside instead of token supply. Too many projects have roughly 50% of the token supply allocated to the project team, treasury, ecosystem, rewards, advisors, etc all of which have not contributed liquidities to the bank.
Projects such as $pepa may grow insanely and reward early adopters with riches, but at any point in time when the selloff starts, anyone caught will lose all the accumulated gains without having time to react. Everyone who bought at the peak will lose nearly all their money and turned them off from the crypto-industry entirely. Overall, it makes the industry worse for everyone.
Shib Original Vision
Let’s take a look at another example recently added to Coingecko. Shib Original Vision ($SOV), $149M fully diluted market capitalization with 426% ROI in the last 5 days. Current price being $0.000000152380 with 25% growth in the last 24 hours. Token allocation was done with an investment from the Karma DAO, which received 5.5% of the token supply in exchange from what appears to be an investment of $500K, but all tokens were airdropped without anyone except Karma DAO having to pay to get the tokens. Current liquidities on Uniswap are $2.36M, so half is in ETH (~$1.18M), but since the price has accrued by 426%, we can calculate what were the initial liquidities of the “bank”. Bounding Curves on Uniswap follow the formula X*Y=K, where X = WETH, and Y = $SOV, as well the price of Price(Y) = Y/X, $1.18M in WETH ~650 WETH => Y = $1.18M / $0.000000152380 = 7.7T, so K = 5,030T and since K is a constant, that implies the initial liquidities before the 426% ROI were Price(Y) initial ~ $0.000000029, which means there was 283 WETH initially ~ $500K USD. You would think most people who received the airdrop would sell, but a lot do not, and many buy, and possibly others use these mechanisms for money laundering. Overall, the price of $SOV increased resulting in Karma DAO initially risking the $500K to double their investment as well as accruing $8.2M from the 5.5% of the token supply they received from the $500K investment… not a bad day of work. It is also possible that other participants who received $SOV in their airdrop went to add liquidities on the pool, which makes it more difficult to be sure about the initial liquidities, maybe the original project promoter put even less than $500K, one could join their community to ask how much was initially put in liquidities. Now that the project benefits from large trading volume, it makes sense for some individuals to add liquidities to benefit from the yield farming opportunity. This demonstrates that some individuals can generate money from thin air simply because perceived value of transaction volume can actually become real value. In the case of this airdrop, it generated vastly more wealth than the bank currently holds, so at any point in time, if transaction volume starts to drop, and yield farming becomes uninteresting, the price will plummet to the grave. I would assume Karma DAO will at any point in time liquidate their 5.5% stake of the supply, and pull out their liquidities as well for a hefty profit.
Conclusion
I explained the importance of understanding liquidities (bank) versus accrued token value, and associated economics artifacts to help web3 builders in designing better economies for themselves and their community.
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Keywords: #web3 #crypto #cryptocurrency #ethereum #blockchain #tokenomics
