Combating Crypto Winters by Understanding the Demand for Cryptocurrency Tokens

A few months later, the token price crashed to Earth. Miners have slowed down their investments, complaining of insufficient (or negative) returns on investment.

Stephanie Hurder is a founding economist at the Prysm Group and an academic contributor to the World Economic Forum. Kajol Char, associate at Prysm Group, contributed to this article. This article is part of the “ Trading Week » from CoinDesk.

Part of the blame surely lies in the ongoing Crypto winter, as well as a scathing expose published by Forbes with accusations of insider trading by the founding team. But fundamental factors in the value of the token have also contributed to this slowdown. In order to weather this storm, Helium will need to avoid a common economic pitfall when it comes to tokens: focusing solely on the quantitative elements of token supply without the same rigorous modeling of token demand.

In talking to hundreds of Crypto projects, we find that projects tend to focus on the same questions:

All of these are important, but they only relate to the supply side of the equation. Offering a user a reward of 100 Dogecoin (current value $5.89) is surely less attractive to them than ONE Bitcoin (current value $19,130.30), even if the former provides 100 times more tokens than the latter . Demand for the token – and the resulting equilibrium value – is a critical ingredient in determining how many tokens a project should plan to issue and when.

Demand drivers for a token take various forms. But they all involve answering the question: why (besides speculative returns) would anyone pay fiat currency in exchange for this token? Although demand drivers are constantly evolving with the industry, they tend to fall into a few categories:

A single token can have multiple demand factors which, jointly moderated by supply, determine the equilibrium value. Wharton’s online program, Economics of Blockchain and Digital Assets, to which we contributed, covers methods for creating token demand scenarios and assessing the equilibrium value of tokens.

In the long term, as Crypto Markets mature, we anticipate that valuation based on supply and demand will become a requirement for token projects, similar to Discounted Cash Flow models ( DCF) now constitute the basis for stock valuation. But even in the short term, building a quantitative demand model can have many benefits for a project team.

Benefit #1: Provide quantitative control over token use cases

Building a quantitative demand model for a token requires a team to understand the boundaries of its customer base and the drivers of token adoption. Suppose a token is intended to purchase goods and services. What share of the Target Markets can the project reasonably hope to capture? What is the expected value of these purchases? How will it evolve over time?

In many cases, these quantitative estimates provide a disappointing figure. This forces the team to revisit the fundamental uses of the token. They may need to figure out how to be more attractive to organic users or add additional demand drivers to the token.

Advantage #2: avoid excessive price inflation or deflation

Even if a token has robust demand projections, achieving the desired balance token properties requires careful supply and demand engineering. If demand for a token exceeds available supply, tokens become scarce and the price can skyrocket, causing hoarding. If demand is too low relative to emissions, a potential deflationary spiral looms.

Using demand scenarios, projects can pressure test supply specifications such as airdrops, reward pools, and vesting periods to minimize the likelihood of unattractive price fluctuations due to a bid poorly managed.

It is important to note that this is true not only before launch, but also after launch when demand information is obtained. Projects can use updated demand models to make adjustments to release and acquisition schedules (where possible) to KEEP token economics within desired ranges.

Benefit #3: Achieve Target ROI for Critical Stakeholders

Stakeholders, validators, and investors can expect a specific annual percentage yield (APY) range when contributing capital to a project. Teams can use demand projections as well as distribution schedules to estimate whether these target return on investment (ROI) ranges will be achieved.

This is especially important to consider early in a product launch, when projects may see a lot of hype but little organic usage. Founding teams often want to distribute large numbers of tokens to provide increased incentives for ecosystem development and startup, but this can instead lead to hyperinflation and lower returns than would otherwise have been achieved.

Advantage n°4: test the pressure of a rigid cap

It’s no secret that many investors like hard caps, and more than half of the 100 largest tokens by market cap have one. A common risk when selecting a hard cap is that the project will eventually run out of tokens because the need for rewards exceeds the supply. Understanding the number of tokens required to meet various incentive and reserve targets allows projects to ensure the hard cap is high enough to support platform growth.

Helium uses a complex token economy that includes elements of payment methods, staking, and sometimes governance-driven demand. Investing in building a comprehensive equilibrium supply, demand, and value model could help Helium weather, and perhaps even completely avoid, current and future crises.

First, having a quantitative projection of critical demand factors would have allowed Helium to better calibrate its supply parameters during its seed period. Helium’s token reward issuance curve to infrastructure providers is aggressive, with token distributions being large initially and halving over time. With initially high token prices driven by hype, the rewards were more than enough to attract user investments. Users spent $53.3 million purchasing and setting up hotspots between June 2021 and August 2022.

However, the value of these token rewards must ultimately be supported by the demand for the token, and this is where the Helium design appears to have failed. Demand for data transfers, the main driver of demand for HNT tokens and token burning, is weak and declining. Demand for data transfers totaled just $92,000 from June 2021 to August 2022, a 93% drop from its peak from April to August. During the same period, the circulating supply of HNT increased by more than 25%. This mismatch between supply and demand has lowered the token price and the return on investment made by miners.

By modeling a robust set of demand scenarios, Helium may have been able to detect early on that its emissions curve was too aggressive, and miners’ ROI too low, in low demand situations like the current one. And although Helium’s initial analysis did not take into account the peak and sharp decline in demand that occurred in mid-2022, they could now use a model to revise their emissions curve. A comprehensive demand model would indicate not only whether the emission curve needs to be updated, but also to what extent.

Second, Helium will face another significant symbolic economic challenge as it approaches its hard cap. Currently, the HNT hard cap is set at 223 million tokens. Once the newly issued tokens are exhausted, miners will be rewarded via a net issuance mechanism, in which “burned” tokens are reissued in proportion to demand factors. But these emissions are capped at a predefined rate. When can Helium hope to reach its hard cap? Is the emissions cap high enough to sustain the system in the long term? Should the hard cap be adjusted up or down? These are questions that a demand-driven model can answer.

Finally, Helium users recently voted in favor of migrating Helium’s own blockchain to Solana. Not only does this have critical security and interoperability implications, but it also eliminates validator staking, a driver of token demand. Token holders surely want to understand the impact of this, in combination with other potential benefits and costs, on their holdings. As our analysis of the Ethereum merger included in the Wharton Blockchain course shows, a fully demand-driven model can address this scenario.

The Cryptocurrency market is unpredictable and token projects must be prepared to face significant challenges. Web3 projects that choose to invest the resources necessary to understand token demand, not just supply, will have the tools needed to navigate the complexities of the next Crypto winter and beyond.