Tokens are a revolution that provides their holders either ownership or decision-making power. Token economics pertains to the token's distribution, value accrual method, emission schedule, and sinks. By allowing a flywheel to boost use, a well-designed token economy helps good projects accelerate their development. If the project is successful, the value created may be distributed to token holders.

While solid token economics may supplement strong goods, success is ultimately determined by the product's strength. Poorly constructed token economies, unsurprisingly, do not aid successful projects since they often function as an additional source of friction. Weak token economics combined with a poor product equals disaster.

Changes in token distributions have been ascribed to the increased attention on token economics and, more particularly, token unlocks. Despite its bad associations, initial coin offerings (ICOs) established a fair playing field in which most participants participated in a project at the same cost. However, in recent years, the situation has transformed to one in which professional investors have a major advantage - from increasing allocations to a considerably reduced cost base compared to individual investors. Both market cycles contained "fair" and VC-dominant token distributions, although the latter seems to be more prevalent currently.

Understanding the Fundamentals

A successful project must have a valuable, marketable product as well as well-designed token economics. The key to attaining the latter is to weave the token into the product to create a powerful flywheel that enhances the product's use. Many businesses use tokens to reward founders and investors. The token has no monetary value and often serves no purpose. A well-designed token economy is crucial, but it will not enhance a sub-optimal product.

A good token design may include a fair distribution, a reasonable float level/emission schedule, and utility/value accrual. Balancing the aims of quick development fuelled by token incentives and a sustainable token economy is a balancing act that only a few projects have managed.

One statistic we prefer to consider when finding a good balance is emission-adjusted revenue. GMX generates twice as much money as token emissions. The revenue/token emissions ratio is continually rising upward, indicating that the user base is engaged, loyal, and less likely to adversely disrupt the protocol after incentives expire. GMX stakers get 30% of swaps and leveraged trading fees. A balanced token distribution adds another point to the total.

Although helpful, emission-adjusted income does not provide the whole picture. Uniswap offers a fantastic product. There are no token emissions, and it is one of the most profitable ventures. More than 60% of the current supply has been given to the community. However, the token has no accrual value. Its single use case is the capacity to engage in the governance process, which clearly leaves a lot to be desired. However, this demonstrates that a poor token design does not always harm a strong product, but it also does not assist it.

SUSHI's token economics are perhaps superior to UNI's. It features a balanced distribution, a large float, and value accrual for stakers/holders. SUSHI ticks all the criteria in terms of token economics. With income being 7.6x the cash value of emissions, the revenue/token emission ratio is exceptionally high, second only to Uniswap. Nonetheless, the ratio is heading lower due to weakening fundamentals. The SUSHI instance demonstrates that superior token economics cannot compensate for the lack of a compelling, distinctive product.

The complexity of token designs has been continually growing. Projects have used complicated strategies to conceal the true token and incentive allocation. This works well until people find out, after which it is tough to reestablish confidence.

LooksRare's "community"-focused debut is a wonderful illustration of this. According to the documentation, 75% of the entire token supply is allocated to the community, which is further divided into airdrop (12%), staking incentives (18.9%), and volume rewards (44.1%).

Source: Looksrare

Volume incentives relate to the LOOKS tokens rewarded to platform traders. Every buyer and seller on the platform receives more tokens (except for private NFT trades). Staking rewards are LOOKS tokens plus trading fees earned (in WETH) that are given to stakers.

Stakers are divided into two types: active stakers and passive staker. Active stakers gain both more LOOKS tokens and trading fees. While their tokens are locked, passive stakers only earn trading fees.

Suppose that all tokens issued as a result of volume rewards and staking rewards were promptly staked. The strategic investors' portion of trading fee rewards would therefore be [(33M/ number of staked tokens)*volume for that day]. Running this calculation from January 10, 2022, to July 15, 2022, yields $38.04 million. Despite not getting further LOOKS, strategic sale investors pocketed one-third of the present market cap via passive staking. So far, the team has earned over 20,151 WETH (about $31.5 million at the current market price).

Although the reward distribution was described in the project paperwork, few individuals really read it. As a consequence, when the community discovered this, it did not bode well for LOOKS. The Twitter estimate was incorrect since the real quantity was half of what was indicated. However, the quantity was much less important than the activity itself.

Furthermore, the distribution shown in the project documentation does not reveal the whole picture. Once the tokens for investors, the treasury, and team members are unlocked, they are also available for LOOKS incentives.

If staked until the final day of token emissions, the team, treasury, and investors earn 5.2%, 6.9%, and 12% more tokens than is stated in the whitepaper. Though not a significant shift, it is significant. The initiative did not mislead anybody since all of this information is available, but the intricate token design makes understanding the real distribution difficult for the typical holder.

Another illustration in point was the recent introduction of Aptos. Details about the token distribution were made public just before the listing. At first glance, the allocation seems equitable, with the community receiving more than half of the original supply and users receiving 23.4 million APT tokens through an airdrop.

Source: Aptos

If you go down a little, you'll notice that the Aptos Foundation (410,217,359.767M) and Aptos Labs have the community allotment (100,000,000M). "This pool of tokens is reserved for ecosystem-related products, like grants, incentives, and other community development efforts,". Aptos is just holding these tokens, which will be dispersed over time." Despite the fact that this is common, it is easy to ignore the staking gains from token inflation.

Tokens, whether locked or unlocked, may still be staked to receive the staking rewards, which are unlocked by default. Assume the staked supply percentage stays constant (currently 82%). In such a situation, we may calculate supply expansion estimates based on the rate of inflation (7% yearly, to be decreased by 1.5% until a terminal rate of 3.5% is attained).

The community accounts for just 2.85% of the staked supply, while the other stakeholders account for over 97%. Given that staking incentives are given pro rata, the "community" will earn 23.4M APT, dwarfing the 798M+ APT tokens issued to stakeholders.

Despite the fact that 510 million APT tokens have been issued to the community, it is unclear what will happen to the staking incentives collected while the tokens are in Aptos' hands. If the custodians maintain the staking incentives, the real distribution will appear quite different over time as the community's portion of tokens is continuously decreased. Governance voting is influenced by the percentage of staked tokens. Given Aptos' majority, governance rights are only a facade. Although this has not resulted in significant price adjustments, it is difficult to foresee a future in which this persists.

A Risk/Reward game

Staking's Risk/Compensation Profile Consider this: I stake $100 in XYZ tokens with a project that promises a 100% APY. I can double my money in a year by just pushing a button. Isn't it wonderful? No, not exactly.

The staking payout is often delivered in the form of more XYZ tokens. If the price of XYZ was $1 when I staked, I would get 100 XYZ. I would have 200 XYZ from the yield after a year. However, this is based on the incorrect premise that the token price would stay constant. Given the volatility of the crypto markets, it is possible that the price of XYZ would fall below $0.3, in which case my 200 XYZ will be worth less than my original dollar investment. The fundamental reason market players were washed during DeFi summer was a failure to comprehend the influence of price on cumulative yield.

The underlying liquidity of the token is also very important. Assume that there are only 100k XYZ tokens at first. In the unusual event that my XYZ tokens trade at $1 a year after I staked them, the liquidity for the tokens would most unlikely stay constant. If the liquidity pool has $100,000 in USDT (or similar), an individual may only cash out $100,000 if they own the full supply. The token's value would be devastated. Let's fast forward a year. Assuming that 100% of the original supply was staked, the circulating supply after a year would be 200k XYZ. The exit dynamics, however, remain the same. The first few sellers may be able to realize their paper gains, resulting in a stampede to the exits.

Finally, evaluate the Risk/Reward of staking vs. just holding. Most, if not all, projects have a lock-up period linked with their staking mechanism. Keeping everything else the same as in the previous case, let's say the lock-up time is one week. User A staked their tokens, while User B did not. Unfavorable news emerges, causing the price of XYZ to collapse by 60%. User B acted quickly and was able to sell at a modest loss. User A's tokens were trapped in the staking module and could not be sold. By the time they got their tokens, the price had dropped by 80%, and despite holding twice as many tokens, the net dollar worth of their investment was much lower.

Fully Diluted Valuations Are Important

Fully diluted values are useless, according to some crypto investors, and market cap is the only number that counts. Proponents argue that since the tokens are not in circulation, they have no effect on the price. The opposing viewpoint is that if the market cap represents the current level of public demand, low-float projects must grow public demand for their token by many orders of magnitude to retain the same price. As a result, if market capitalization is a demand indicator, FDV is a supply metric. The FDV/MC ratio acts as the multiplier by which supply is expected to grow.

Solana-based protocols/applications are distinguished by a low-float/high FDV, which served as our justification for selecting these specific tokens.

Several projects use a "low market cap, high FDV" strategy to keep token prices high. The following is the project playbook:

Assume a project named XYZANA obtains $10 million from investors at a value of $200 million. The price per token is $0.05, with a 6-month cliff period followed by a 12-month unlock term.

The starting circulating supply is 1% (airdrop, liquidity, prizes, etc.), and public demand is $20M. (MC). The FDV is worth $2 billion, the price is $0.5, and investors have profited tenfold.

The initiative continues to acquire traction, resulting in an additional $180M of secondary market demand, so that FDV = $20B, the price is $5, and investors are up 100x.

6 months following the launch, the investor and team tokens begin to be unlocked. The supply will more than triple in the following year. Even after an 80% collapse, investors will continue to sell since they are still up 20x. At the same pricing, the team tokens are worth $1.2B (assuming a 30% allocation), and they are content to pocket a third of it in exchange for 18 months of "effort."

FIDA (Bonfida) and GMT (STEPN) were already down 97.9% and 90.5%, respectively, with barely 10/6.03% of the supply in circulation. The price per token in the private auction was $0.1 (FIDA) and $0.005 (GMT), implying that investors would still benefit from the transaction (3.8x for FIDA and 75x for GMT).

This model ignores the fact that a higher token price, and hence FDV, in the early stages leads to more serious future dilution in USD terms.

Market Dynamics Affecting an Unlock

Solana ecosystem tokens have a reputation for having low floats. Yet, the low market cap and high FDV curse exist even outside of this environment. However, the results are not always consistent. Tokens are sometimes subjected to significant adjustments, while other times, they are untouched by the unlock. So, how can we determine which criteria are important in evaluating the ramifications of a token unlock? In this part, we examine a few elements that influence the likelihood of what will occur.

Huge token unlocks

Without a doubt, the proportion of supply that is unlocked is a critical driver of its influence on pricing. When the supply multiplies, it becomes difficult to counteract the negative impacts.

FLOW began the day at $17.68 on October 15, 2021. It closed at a low of $9.2 (Kraken) and a high of $6. (CoinList). As 300M FLOW (6x the circulating supply) tokens were released, a maximum of $5.1B in selling pressure might have occurred. Investor allocation accounted for 75% of the unlocked amount, team 12%, ecosystem fund 2%, and inflation 12%. (over seven months).

Of course, the price fell as a result of the selling. Despite a 48% fall, investors were still up more than 100x and could have kept selling in profit.

Illiquid Token Liquidity

The projects in the preceding cases did not strive to generate more liquidity, which would have resulted in a muted effect. There are two aspects to creating liquidity:

A deceptive method of developing positive tales to increase temporary demand immediately before an unlock.

The predominance of over-the-counter marketplaces, enables investors to profit without altering the market price. This enables the concentration of tokens in the hands of more committed investors.

Two days before the supply was slated to surge by 133%, Oasis Network launched a $160 million ecosystem fund (1.471B ROSE). Investors accounted for 51.6%, key contributors accounted for 20.3%, community and ecosystem represented 27.6%, and strategic partners/reserves accounted for 0.84%.

Several projects launched an ecosystem fund within that time period, causing token prices to rise. Some ventures used the narrative to generate "exit liquidity" for prospective sellers in order to mitigate the price effect. In the instance of Oasis, the price more than doubled in the days leading up to the unlock, only to decrease in the days after.

Nym followed Oasis' lead and launched a $300 million ecosystem fund a day before the unlock. Investors received 60.3% of the 80.75M NYM unlocked, while the team received 30.9%, with the remainder going to testnet rewards and mix-mining. The "announcement pump" was surpassed as supply increased by 2.3x, and the price collapsed by more than 70% in 9 days.

Source: Trading view

While it is impossible to determine if Oasis and Nym's activities were intended to produce liquidity, the timing certainly raises concerns. As a result, when favorable news coincides with forthcoming token unlocks, investors should be cautious.

We've already seen the harmful consequences of token unlocks. Solana's token distribution was excessively biased toward investors and team members, with the community receiving just 1.6% of the supply. The token sale price varied from $0.04 (for seed investors) to $0.25. (for strategic investors). It wouldn't be too far-fetched to predict major profit-taking, particularly because supply would expand by more than 7x, with investors increasing by 10-60x.

To everyone's surprise, SOL soared over 25,000% following (from ATL to ATH) and went on to beat almost the whole market. The price movement defied sense, so how did it happen? Through OTC markets, that is.

Perps

Because of the frequency of perpetual futures for altcoins,

Private investors may hedge their locked token
Secondary purchasers can hedge exposure before an unlock
Traders can short in anticipation of a dump.

One of the most significant launches of the previous cycle was the introduction of the Internet Computer Protocol. ICP perpetual futures were released five days before spot trading on all major exchanges. ICP surged by 400% before to the introduction, which was associated with the network's inception, before entering a permanent downturn.

On May 10, 2021, investors had 37% of the token supply, founders/team members held 62%, and the "community" held 1%. Seed investors paid $0.035 per token, strategic investors paid $0.63, and presale investors paid $4.17.

The ATH for ICP varies per exchange, with Binance's current market at $2,831 and Coinbase at $630. Taking the latter into account, investors were up 151-18,000x, valuing their combined investment at $110B. The founder/team allotment was estimated to be worth $183 billion. It would be ridiculous not to anticipate some profit-taking. However, even after a 90% drop from the peak, investors would be up 14-1,771x - amounts at which they could happily continue selling.

The introduction of perpetual futures only days before the launch enabled investors to hedge their holdings and lock in a high exit price. The $170M in OI, along with very negative funding rates, helps to back up the assertion. Although speculators would have made up a portion of the OI, it is difficult to think that it totaled $170 million. These entities were unable to completely hedge their locked tokens due to a lack of needed liquidity, but they were able to make substantial gains on partial holdings.

Most perp listings, it is commonly assumed, result in long-term downtrends for tokens. Although this is somewhat true, the initial liquidity is sometimes insufficient for investors to hedge merely a portion of their locked tokens.

The introduction of perps for OXY is an excellent example. At the peak, investors were up roughly 110x. Their 1B coins were valued at more than $4 billion. Nonetheless, the contract's open interest never topped $14.4M.

The IEO price was $0.10, with the majority of participants being retail. Unsurprisingly, after a 44x increase, they realized profits, resulting in a drop. Secondary purchasers trimmed their losses since they were in the red. It seems to reason that the decline was caused by a lack of additional buyers (due to price appreciation, loss of utility, inflation rate, price action, and so on) combined with profit-taking.

Solana has a thriving OTC market, but this is not typical. Nonetheless, we see certain tokens perform well as they unlock.

AXS is the most recent example that springs to mind. On October 25, 2022, around 21.5 million ($273 million) tokens were projected to enter the market. Nonetheless, AXS started lagging the market considerably after the beginning of the month - far before the unlock date. Investor tokens accounted for 9.2% of the total, staking incentives 22.7%, the team 26.6%, play-to-earn 21.9%, and advisors 11.65%.

Although open interest (OI) was limited, average financing rates were negative. OI began to soar a week before the unlock, with average funding rates becoming aggressively negative. The OI peaked at $193M the day before the unlock and subsequently fell back to pre-unlock levels. Simultaneously, the price increased by over 19%.

It's logical to suppose that entities hedged their AXS partly via perps and unwound the hedges once they got their tokens. As a consequence, prices rose, and speculators betting on the trend were compelled to exit. The hedgers would have sold their spot inventories while unwinding their futures holdings. The accumulated volume delta is an indicator that rises when a limit sale is met and falls when a limit purchase is met. This notion is supported by CVD signatures on Binance's spot and perp markets.

Yuga Labs issued an announcement leading up to the unlocking of a $100M+ APE coin. The announcement was going to be made on Twitter Spaces on September 21, 2022, but members of the Horizen crew were unwell. Their attendance was essential since they were in charge of developing the APE staking procedure. Some questioned the timing of the postponement, considering that the market was still reeling from the aftermath of the FOMC meeting.

The investors owned 77.3% of the unlocked tokens, while the remainder went to the treasury. APE dropped by more than 20% three days before the unlock. At the time, the OI was $117 million. On the day of the unlock, OI fell to $84M, and funding began to decline. Speculators aggressively shorting in anticipation of the unlock and market fall are to blame for the funding reversal. Moments after the unlock, OI began to rise, and APE followed suit, rising by more than 40%.

Source: Coinglass

The unlockers, like AXS, may have hedged their spot assets and, upon unlock, unwound futures while selling the spot. Due to the absence of a response on the day, speculators may have been forced to close their positions, resulting in an increase. Participants who had been sidelined would have poured in, aiding the "bullish unlock."

The last four examples emphasize the relevance of liquidity in token unlocks. Ample liquidity permits "bullish unlocks" to occur, despite the fact that they are just priced-in counterparts of "bearish unlocks." Because locked tokens are not fully-hedged and will be sold when released, "bullish unlocks" are not permitted due to a lack of liquidity. Because of the lack of additional purchasers, these assets remain in a permanent downturn.

Conclusion

Tokens are an essential component of crypto projects. The design of token economies has evolved significantly over time, becoming more sophisticated. They may help a good project succeed while failing to maintain substandard goods.

Fully diluted valuations are important, maybe even more than market caps. This view is supported further by the relative performance of a basket of high-float vs. low-float coins.

When taken at face value, staking the native token for free money seems appealing. However, when we break down the accompanying mechanics, the situation seems dire. Considerations like liquidity, lock-up duration, dilution, R/R of staking, and so on become critical.

Understanding the effect of a token unlock has gotten more difficult with the introduction of perpetual futures and the rising popularity of OTC markets. Professional investors cannot always hedge their investments since the liquidity needed to do so is not always available. This puts the token under constant downward pressure since it lacks willing incremental purchasers. For tokens with the necessary liquidity, unlocks may sometimes result in positive price movement - which is generally a priced-in version since the negative effect is perceived some time before the actual unlock. Some projects take it a step further and create temporary cash via good news.

Most (if not all) projects release their tokens on a set timeline, which is often unrelated to the project's viability. In certain circumstances, the team's and investors' drive to continue creating and expanding a product diminishes. This raises the challenge of how we might motivate team members and investors to produce while without lowering their allocation.

One method would be to use milestone-based unlocks rather than time-based unlocks. The effect of token unlocks would remain unchanged if liquidity is low if the project suffers from the low-float/high FDV constraint. However, it forces the team and investors to deliver before they get their tokens. Delivering a functional product would attract more users and, as a result, increase demand. This might mean that the effect of a token unlock is decreased. Though this is far from the holy grail, it is impossible to envisage a situation in which this structure does not outperform the existing one.

Overall, crypto has to concentrate on improving token structures and providing circumstances to mitigate the effect of token unlocks. Project teams must experiment to see which solutions are effective. As the industry evolves, teams begin to understand what characteristics constitute a successful token, and the market becomes more efficient. We think that once dilution is integrated into pricing/valuation models, token unlocking will no longer have as significant effects on price.

Disclaimer:
This article is intended for and only to be used for reference purposes only. No such information provided constitutes advice or a recommendation that any investment or trading strategy is suitable for any specific name.

Token Unlock: A risk/reward game