Summary of key information
- The prevalence of high token valuations and low initial circulating supplies has become a topic of discussion in the crypto community in recent months. This situation stems from concerns that such market structures leave little sustainable upside for traders after a token generation event ("TGE").
- Data from CoinMarketCap and Token Unlocks show a growing trend of tokens launching with low circulating supply and high valuations. In particular, approximately $155 billion in tokens are expected to be unlocked from 2024 to 2030. The large number of tokens entering the market will bring selling pressure if there is no corresponding increase in buyer demand and capital inflows.
- Factors such as an influx of private market capital, aggressive valuations, and optimistic market sentiment have contributed to the trend of tokens launching at high fully diluted valuations (“FDVs”).
- The current market setup makes it necessary for investors to make choices and discern by considering the fundamentals of projects, such as token economics, valuation, and products. Project teams may also need to consider the long-term impact of decisions related to token economics design.
- Venture capital firms continue to play an important role in our industry and can work with project teams to ensure fair supply distribution and reasonable valuations.
Market Observation
- The prevalence of tokens with high valuations and low initial circulating supplies has become a topic of discussion in the crypto community in recent months. This market structure leaves little sustainable upside for traders when a TGE occurs, and this concern is not unfounded.
- It is increasingly common for tokens to launch with a low circulating supply and a large share allocated for future release. In bull market conditions, these tokens may appreciate quickly due to limited available liquidity when trading. However, when a large supply of tokens floods the market upon unlocking, such price growth is clearly unsustainable.
- Concerns have been expressed about the FDV of newly launched tokens being comparable to mature layer-1 or DeFi tokens that have stood the test of time and have proven user traction. Overall, market participants now acknowledge the impact of tokens characterized by low circulation and high FDV.
Low flow rate, high FDV
- It can be observed that there is a clear trend for recently launched tokens to launch with high valuations and low circulating supplies. This is especially evident when we compare tokens launched in the past few years - tokens launched in 2024 have the lowest market capitalization (MC) to FDV ratio. This indicates that a large number of tokens will be unlocked in the future.
Figure 1: MC/FDV for tokens launched in 2024 is the lowest in the past three years
Source: Twitter (@thedefivillain), CoinMarketCap, Binance Research, as of April 14, 2024
Figure 1 shows the market capitalization and FDV of tokens launched in the past three years, highlighting the differences in the growth of these metrics over time. It is worth noting that although 2024 has only just begun, the FDV of tokens launched in the first few months is already close to the total for 2023, which highlights the prevalence of overvalued tokens.
With a 12.3% MC/FDV, tokens launched in 2024 will have a large number of tokens entering circulation in the future. This also means that in order to maintain the current price in the next few years, these tokens need about $80 billion in demand-side liquidity inflows to match the increase in supply. Although market cycles will change, this may not be an easy task.
Examining some recently launched coins reveals the root cause of the large FDV numbers seen in 2024. Figure 2 shows several coins launched in recent months, along with the corresponding percentages of circulating and locked supply. With circulating supply as low as 6% and none exceeding 20%, the root cause of the trend becomes apparent.
Figure 2: Recently launched tokens have low circulating supply
Source: CoinMarketCap, Binance Research, as of May 14, 2024
For the same amount of demand, low circulating supply helps increase the initial token price given scarce liquidity, thus driving higher FDV.
Comparing the peak FDV of the same group of tokens to the median FDV of the top ten tokens on the market (excluding BTC, ETH, and stablecoins) provides an idea of the relative valuations of recently listed tokens. At their peak, some tokens had valuations similar to the largest tokens that have been on the market for years.
Figure 3: At their peak, some recently launched tokens had valuations similar to the largest tokens on the market
Source: CoinMarketCap, Binance Research, as of May 14, 2024
That said, it’s important to note that FDVs alone do not paint a complete picture, and they are more meaningful when FDV ratios that do not take into account operational metrics (e.g., FDV/Total Value Locked, FDV/Revenue, etc.).
In the past few months, there have been many projects that have launched their tokens, many of which have low circulation and high FDV. Due to the large number of such projects, we have selected only a few for demonstration. Please note that this is only to illustrate the prevalence of low circulation and high FDV tokens, and is not a negative assessment of the value or potential of the selected projects, as there are many other factors at play.
Market Impact and Implications
- Launching tokens with low circulating supplies has impacted market dynamics, particularly by increasing selling pressure. According to a report by Token Unlocks, it is estimated that approximately $155 billion in tokens will be unlocked between 2024 and 2030. (1)
- Although this number is an estimate, the implication is clear - a large supply of tokens is expected to be released in the coming years, and without corresponding capital inflows, many tokens will face significant selling pressure.
- Given this, it is critical for investors to understand token unlocking schedules and track them to prevent being caught off guard when a token undergoes a major unlocking.
Figure 4: A total of $155 billion will be unlocked in the next few years
Source: Token Unlocks, Binance Research, as of May 14, 2023
A related observation is that meme coins have outperformed other coins so far. In addition to significant attention and strong speculative demand, their token supply structure is also arguably a contributing factor to this year’s rally.
Figure 5: Memecoins have become the best performing narrative to date
Source: Dune Analytics (@cryptokoryo_research), as of May 14, 2024
Most meme coins have all their tokens unlocked and in circulation at the time of TGE, which eliminates the pressure to sell for future dilution. Many meme coins launch with an MC/FDV ratio of 1, indicating that holders will not suffer further dilution from token issuance. This structure plays a part in the appeal of meme coins, especially as awareness of the impact of unlocking large numbers of tokens increases. While the success of meme coins should not be entirely attributed to an aversion to low-circulation tokens, it is clear that retail investors have shown significant interest in meme coins, even though these tokens may lack utility.
In a manner similar to the well-known "GameStop short squeeze" event in the stock market, many retail investors view memecoins as a means to counter the institutional advantages that come from participating in private rounds. This is because memecoins are often launched in a way that is accessible to anyone, with little opportunity for institutional participants to obtain tokens in advance and at a low cost. As a result, memecoins have become a significant narrative in the current market, continuously attracting attention with their large trading volumes and strong price fluctuations.
How did we get here?
- High valuations and constant selling pressure from token unlocks are structurally negative for token prices. However, such situations have become increasingly common in recent years. Several factors contribute to this.
An influx of private market capital
Venture capital ("VC") funds have increasingly solidified their critical role in the crypto investment landscape. Despite the natural fluctuations in investment capital due to market cycles, VC capital flowing into the crypto space has been steadily rising. Since 2017, total VC funding for crypto projects has exceeded $91 billion, demonstrating the growing importance of VC in providing the necessary funding for projects.
Figure 6: Cumulative VC funding exceeds $91 billion since 2017
Source: The Block, Binance Research, as of May 13, 2024.
However, the significant increase in investment has also led to a corresponding increase in the influence of VC funds in shaping crypto market valuations. As more money flows into the space and VCs get involved in more deals, they essentially drive up valuations.
As a result, when tokens launch in the public markets, their prices and valuations are already inflated. In fact, large private market fundraisings result in multi-billion dollar market caps at launch, making it more difficult for public market investors to profit from future growth.
Aggressive valuations
Strong market performance this year has boosted sentiment and driven more aggressive deal activity, leading some investors to become increasingly willing to write checks at higher valuations.
Given that multi-million dollar valuations have become the norm, discerning over valuations can make VCs look bad in front of their limited partners ("LPs") by missing out on most deals when deal activity is high. While market activity remains below its 2022 peak, the number of crypto deals in Q1 2024 increased 52.1% Q-o-Q, the highest in nearly two years.
Figure 7: Deal activity has increased this year
Source: The Block, Binance Research, as of May 13, 2024.
Additionally, VCs have incentives to continue deploying capital during bull markets. As long as the music is playing, higher valuations will boost VC fund performance metrics. Additionally, it is beneficial for projects to raise large amounts of capital at high valuations as it provides them with working capital without significant dilution. It also demonstrates strong support from “smart money.”
In general, raising capital at a high valuation in a private round means stakeholders have an incentive to launch tokens publicly at a higher FDV.
Optimistic market sentiment
The total crypto market capitalization rose 61% in the first quarter of this year, so it is understandable that market sentiment was very positive during this period. Coinmarketcap’s Fear & Greed Index was in the “Greed” and “Extreme Greed” zones for 69 out of 91 days in the first quarter. (2) Accordingly, project teams were able to take advantage of this positive investor sentiment, enabling them to raise funds at higher valuations in the first quarter.
This can be seen in the increase in valuations in the first quarter. Specifically, pre-funding valuations of VC-backed crypto companies rebounded by more than 70% quarter-over-quarter in the first quarter of 2024. This suggests that, on average, projects were able to raise the same amount of capital with less dilution than in the previous quarter.
Figure 8: Funding valuation rebound before the first quarter of 2024
Source: PitchBook Data, Inc., Galaxy Research, Binance Research, as of March 31, 2024.
Considerations
For investors: Fundamentals are important
The current market setup makes it increasingly necessary for investors to be selective and discerning. Given that many projects have high valuations at the outset, the likelihood of achieving sustainable returns by "blindly following" new tokens is low. Most of the upside and easy money may have already been earned by early private market investors.
Whether investing in a private round or when a token undergoes a TGE, investors should conduct thorough due diligence and establish their own investment process. Here is a non-exhaustive list of some basic indicators and aspects that may be worth looking into:
- Token Economics: The importance of unlocking schedules and vesting periods should not be underestimated as they directly impact the supply of tokens entering the market. Without a corresponding increase in demand, there will be excessive selling pressure, driving down token prices.
- Valuation: FDV provides a rough sense of size but is not very meaningful on its own. Assess valuation ratios relative to other competitors and relative to yourself over time (e.g., FDV/Revenue, FDV/Total Value Locked, etc.).
- Product: Consider where the project is in the product lifecycle (e.g., whitepaper vs. product launch on mainnet)? Is there product-market fit? Observe user activity (e.g., daily active addresses, number of daily transactions, etc.).
- People: This includes the team and the community. What is the background of the founders and how do they contribute to the project? How engaged is the community and what aspects of the project are they most interested in?
Rather than aggressively chasing the next shiny coin, taking the time to assess the fundamentals will help identify and avoid any glaring red flags and pitfalls. As Warren Buffett said, "Only when the tide goes out do you discover who has been swimming naked." Everything usually looks great until the music stops playing. Avoid being the last person to buy.
For projects: consider the long term
Running a project is not an easy task and requires considering numerous aspects and stakeholders. The decision-making process is complex and it is impossible to satisfy everyone. Having said that, we believe that a guiding principle in decision-making is to consider the long term.
- Token Economics: Launching a token with low circulation and high FDV may help with the initial price pump due to limited token supply. However, subsequent unlocking may put a lot of selling pressure on the token. Loyal token holders of the project (arguably one of the most important groups in the community) will suffer. Poor token performance may also discourage new ecosystem participants from joining the network due to reduced incentives.
In this regard, token allocation, unlocking and vesting schedules should be carefully considered. While token economics may be more art than science, with no magic numbers or methods, tokens in circulation have been significantly lower in recent launches, as shown in Figure 2. To mitigate risks associated with sudden increases in supply, teams and investors can consider token burning mechanisms, aligning vesting schedules with set milestones and increasing the initial circulating supply during the TGE.
- Product: While tokens can help gain attention and are a great user acquisition tool, a viable product is key to value creation, user retention, and sustainable growth. Having at least a minimum viable product prior to TGE will help investors and users better understand the project’s value proposition and determine product-market fit. In the best case scenario, launching a product with significant user traction can promote a successful TGE by boosting confidence and attracting high-quality investors and users. In the long run, the product enhances the intrinsic value of the token and contributes to the token price performance.
With the rebound in fundraising activity in the first quarter, project founders have been able to take advantage of the boost in sentiment to secure higher valuations. However, while raising money at high valuations makes intuitive sense (who would resist raising the same capital with less dilution?), it comes with long-term implications. Projects that raise money at valuations far above intrinsic value will have to justify the premium in future private rounds or in the public markets. Otherwise, token prices may continue to fall and converge toward their true value. Investors will suffer, and project teams may struggle to turn around community sentiment.
This article is excerpted from Binance Research (translated into Chinese to allow more Chinese users to see it). Check out the original full report for more detailed information:(Full report link)