Token Supply 101: Fundamentals of token supply — and monetary policy
Some of the biggest “eureka moments” as crypto enthusiast come from looking deeper at the same topic again and again: token supply. It is crucial for investing, understanding and mastering cryptocurrencies. Let’s explore its basics and how it can deeply affect a project’s token price and market cap.
I will aim to keep the conversation high level and the vocabulary as simple as possible in order to reach the widest possible audience (and hopefully get a few “aha!” moments in the readership).
Definitions
Token supply means a given number of tokens. However, token supply comes in different flavours:
- Initial Token Supply: number of tokens in circulation when tokens start to be traded on the secondary market (crypto exchanges — i.e. Binance).
- Current Token Supply: number of tokens in circulation at moment “t”.
- Total Token Supply: that number is fixed, it is the total number of tokens that have been (or will be) created. This number is decided before the first coin is ever created.
- Unlimited Supply: stands for Unlimited Total Token Supply. Term used when the total token supply is not fixed (e.g. Ethereum).
- Maximum Token Supply: Total Token Supply minus Burnt Tokens.
Burnt tokens are tokens that have been voluntarily sent to a wallet that no-one has access to (a.k.a. no one has the private key): tokens are virtually “destroyed”. Of course, this number is undefined in the case of tokens with unlimited supply. - Minted Tokens: tokens that have been created so far. That is it, much like “real money,” some projects decide to create more tokens over time. The general tendency is to have a fixed amount though: i.e. mint/create all the tokens for the ICO. In the old days, this used to be called “pre-mined” because all tokens are already created at the beginning and don’t need to be created at a later time.
Minting tokens does not mean they are in circulation, some of the tokens created can stay locked (out of circulation) for decades.
The above terms are foundations of the token economy. If you do not understand any of the terms, I invite you to re-read the definition given above or do some research until you get it.
Token Supply Relativity 101
Before moving to the topic of monetary policy, I’d like to get you to understand this:
The absolute number of tokens created, or held by any party, or in circulation, isn’t so important.
Let me explain: what matters most is the relative number of tokens created, or held by any party, or in circulation, or burnt, etc.
What I mean by relative number of tokens is the percentage of tokens.
For instance, let’s imagine you go to a music festival and anyone who wants to buy anything within that event has to use some festival vouchers that you buy at the entrance. Well, let’s call these vouchers “tokens”.
Let’s say that, in case 1, the festival decided it will create 100'000 tokens that will be worth 100'000 dollars. It means that if I give 1'000 dollars, I will get 1'000 vouchers.
Let’s say that, in case 2, the festival decided it will create 1 million tokens (vouchers) that will be still be worth 100'000 dollars. It means that if I give 1'000 dollars, I will get 10'000 vouchers.
Note that in both cases, I end up holding the same relative amount of tokens: 1% of all tokens.
The same goes for crypto, when discussing topics related to token supply, what you should really care about is the relative amount of tokens in consideration (i.e. what percentage of the total supply are we talking about).
Monetary policy 101
You have probably heard of monetary policy in the past. Inflation, deflation, inflationary policies, or even about “quantitative easing.”
Monetary policy is the process by which the monetary authority of a country, typically the central bank or currency board, controls either the cost of very short-term borrowing or the monetary base, often targeting an inflation rate or interest rate to ensure price stability and general trust in the currency. Source: monetary policy defined on wikipedia
When a a central bank decides the currency price of its currency is too high, a simple way to make it lose value is to simply create more of it (yes, print more money).
Reducing the price of a currency is what we call “inflationary policy”.
Inversely, if a country decides the price is too low, a simple way to make it gain value is to reduce the amount in circulation: destroy/burn money. (hey that news, never heard of countries doing such thing, crypto projects do do that though!).
Raising the price of a currency is what we call “deflationary policy”.
Why use inflationary or deflationary policies!?
When having an inflationary policy: you create more of a given currency so that those who want to buy it have more access to it (it creates abundance). So its price decreases because it is more available and less scarce. Value is scarce, remember that.
Inversely, for deflationary policy: you destroy part of a given currency so that those who want to buy it have less access to it (it creates scarcity). So its price increases.
What does tall of this have to do with cryptocurrencies?
In crypto, the exact same thing happens. If a project decides to put an additional amount of token in circulation (remember, only the relative amount matters), it creates abundance, hence inflation. Hence the token price decreases.
Inversely, when a crypto project decides to burn tokens, it creates scarcity, it is a deflationary policy: the token price rises. So you want to be very aware of the circulating supply, the total supply, and when big pieces of locked up or vested token supply become circulating supply.
What about Bitcoin?
Bitcoin has a total token supply fixed to 21 million. But it has so far created ‘only’ a bit over 17 million tokens (82.23% of the total supply). Bitcoin currently (in 2018) has an inflationary policy (regularly creating new coins) of circa 4% per year. In mid 2020, Bitcoin inflation rate will switch to around 1.80% (the famous ‘halving’ of the inflationary rate).
Once all bitcoins are created (estimated sometimes in the next 15–20 years), bitcoin will stop being inflationary and will have a stable supply.
Currently, Bitcoin inflation rate is ~4%, it will switch to ~1.80% in mid 2020
What about Ethereum?
Ethereum does not have a fixed token supply: yes, it has an unlimited token supply. On top of that, Ethereum has a very high inflationary policy so far. In 2017, Ethereum inflation rate was 14.75%.
Vitalik Buterin did mention the idea of fixing the total supply though, so things could change. Here is also a very interesting thread on Ethereum’s Stackexchange forum regarding Ethereum’s inflation rate.
In 2017, Ethereum inflation rate was 14.75%
What about Altcoins?
Altcoins have very different monetary policies from one to another. This depends on the experience of the team, the advice they get & the opinions/theories these decision takers have/believe-in.
As a rule of thumb, one wants to avoid having big parts of the token supply being unlocked at once, especially for bonus tokens. These tokens will most likely be sold, so it could affect the overall token value.
It is still a very experimental part of the crypto space as the field is very young, hence there is very little data to back claims. But as a rule of thumb, releasing a huge part of the token supply at once means diluting the investors token value so one may want to avoid doing this.
Things may change in the future though: the market is maturing fast, the crypto ecosystem is educating itself at a fast pace & brilliant global minds are jumping into the field every day. We might see data analysis about crypto projects monetary policies coming to the public space rather sooner than later.
So what now?
So I hope that you now understand why token supply design IS monetary policy.
Finally, I invite you to find out if the projects you like have even thought/planned it, and if so, what this monetary policy looks like.
The token supply design IS monetary policy
On our end, we will surely come across the “token supply” topic in further articles & most probably dive deeper into it in dedicated articles.
Thank you for reading.
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