Author: 0xLouisT
Compiled by: TechFlow
In Greek mythology, Ikaros and his father Daedalus built wings out of feathers and wax to escape a trap set by King Minos. Daedalus told his son, "Fly too low, and the ocean will wet your wings; fly too high, and the blazing sun will melt them."
But Icarus got so caught up in the thrill of flying that he flew higher and higher, forgetting his father's warning. The heat from the sun melted the wax that held his wings together, and Icarus fell into the sea. The moral of the story is that excessive egos often lead to self-destruction.
In the current cycle, I see striking similarities to the story of Icarus. Just as Icarus was drawn to the ecstasy of flight, many crypto projects have been drawn to the lure of high valuations. In both cases, they have led to their own destruction through unsustainable promises and inflated valuations.
Why is there this FDV craze?
What’s behind this craze for low flow rates and high FDV? Several factors are at play:
Anchoring Effect: This cognitive bias affects decision making and is dependent on an initial reference point. If founders believe their project is worth $1 billion, they may launch with a $10 billion FDV, setting a benchmark in the market’s mind. Even if the token drops 90%, it will still return to what the founders believe is a fair value.
VC Valuations: The glut of VC funding in 2021/2022 has led to inflated private valuations. VCs overpay in each round, and the public market is not interested in these high valuations. Since no project is willing to do a Token Generation Event (TGE) at a valuation lower than the last private round, they are forced to find ways to launch at higher valuations.
Incentives and Finances: A paper $10 billion FDV boosts the project’s finances, allowing it to attract top talent, provide incentives to hold tokens, provide ecosystem subsidies, and build partnerships—with significant paper Face value drives growth.
Supply Allocation: Distributing tokens to the community has become more difficult post-ICO and following SEC regulatory actions. Airdrops and community incentives often fail to distribute meaningful percentages of tokens at launch, which remains a challenge for the industry.
OTC Sales and Hedging: High launch prices enable cash outflows through discounted OTC sales or hedging positions using perpetual contracts (perps), although this is difficult to do on a large scale.
Perception of success: This reflects the way we think. Higher valuations create the illusion of success, and people are attracted to seemingly successful projects and want to participate.
How did this all happen in the first place?
If you create a token A with a supply of 1 billion and pair it with 1 USDC in a Uniswap pool, the notional value of token A is $1, so its FDV is $1 billion. This valuation is completely artificial; the actual value of the token is very limited.
The same is true for high FDV tokens, where the actual circulating supply is only a small fraction of the total supply. After the selling pressure from the initial airdrop subsides, the majority of the supply is held by market makers and whales who are able to influence market prices. Therefore, a $1 billion FDV can be achieved with only tens of millions of dollars in funding.
High FDV Related Issues
This high FDV dollar creates a significant imbalance in the cost structure and supply allocation between TGE liquid buyers and private equity investors (see chart). This excessive imbalance exacerbates ongoing tensions between the two groups until market prices return to reasonable levels.
TGE buyers lost money immediately after buying, while VCs were incentivized to sell after their holdings unlocked. When community buyers realized this trend, they stopped buying, which explains why interest in new tokens has plummeted recently.
A healthier situation should show less imbalance between community and VC prices, thus promoting true price discovery (see below).
In an efficient market, price discovery is inevitable. While you can artificially influence price discovery in the short term, this only delays the return of prices to true value. However, the paths of market development are interconnected, so a sustained downward trend is much more painful than reaching equilibrium directly.
in conclusion
An important nuance in the myth of Icarus is the caution against flying too low. Just as Icarus was warned that flying too low could weaken his wings, issuing tokens at too low a valuation could inhibit growth potential. This could discourage partnerships, make retention difficult, and impact overall success. Issuing tokens before a project is mature enough is just as important as avoiding high FDV situations.
Key Points
FDV is not a Meme: Avoid issuing tokens at high FDV. Like Icarus, trying to manipulate the market through inflated valuations is likely to backfire in the long term. High FDV tokens are a warning sign for liquid investors – who typically avoid or even short assets with inflation risks.
Raise venture capital wisely: Raise capital only when necessary and consistent with your growth strategy. Choose the venture capital firms you want to work with, not just the ones with the highest valuations. Avoid accepting unsustainable valuation pressures.
Avoid premature token launches: Don’t launch a token simply because you achieved a high FDV in the private market. Make sure you have clear signs of market traction and product fit before proceeding with a token launch.
Token distribution: This is a topic that deserves a separate discussion, but for efficient price discovery, the circulating supply should be maximized when issuing tokens. The goal should be at least 20% to 50% of the total supply, rather than just 5%. However, the current regulatory environment may make this circulating supply target difficult to achieve.
Interact with Liquidity Managers: Liquidity managers are sophisticated investors who take the risk of the project after the TGE, and therefore, they play a crucial role in price discovery, as opposed to venture capital.