Brief content
Elastic supply tokens have a variable circulating supply. The idea is that instead of price volatility, the supply of tokens changes through rebasing events.
Imagine that the Bitcoin protocol can regulate the amount of Bitcoin in users' wallets to reach a target price. You have 1 BTC today. You wake up tomorrow and now you have 2 BTC, but each one is worth half of what it was yesterday. This is how the rebasing mechanism works.
Introduction
Decentralized finance (DeFi) has witnessed the explosive growth of new types of financial products on the blockchain. We have already discussed the profitable farm, tokenized Bitcoin on Ethereum, Uniswap and flash loans. Another segment of the crypto space that is interesting to watch is elastic supply tokens or rebasing tokens.
The unique mechanism behind them allows for many experiments. Let's see how these tokens work.
What is an elastic supply token?
A token with an elastic supply (or rebasing) works in such a way that the circulating supply expands or contracts due to changes in the price of the token. This increase or decrease in supply works with a mechanism called rebasing. When rebasing occurs, the token supply increases or decreases algorithmically based on the current price of each token.
In a sense, elastic supply tokens can be used in parallel with stablecoins. They aim to hit their target price, and the rebasing mechanic helps with that. However, the key difference is that token rebasing aims to achieve this with a variable (elastic) supply.
Wait, don't too many cryptocurrencies work with variable supply? Yes, to some extent. Currently, 6.25 new BTC are minted with each block. After the halving in 2024, this value will be reduced to 3.125 per block. This is an estimated rate, so we can estimate how much BTC will exist in the next year or after the next halving.
Elastic supply tokens work differently. As already mentioned, the rebasing mechanism periodically adjusts the circulating number of tokens. Let's say we have a token with an elastic supply that seeks to reach a value of 1 USD. If the price is above 1 USD, rebasing increases the current supply, reducing the value of each token. Conversely, if the price is below $1, rebasing will reduce the supply, making each token worth more.
What does this mean in practical terms? The number of tokens in users' wallets changes if rebasing occurs. Let's say we have a hypothetical Rebase USD (rUSD) token that is priced at 1 USD. 100 rUSD is safely stored in your hardware wallet. Suppose the price drops below 1 USD. After the rebase takes place, you will only have 96 rUSD left in your wallet, but at the same time each one will cost proportionally more than before the rebase.
The idea is that your assets, proportional to the total supply, have not changed when rebasing. If you had 1% of the offer before the rebase, you should still have 1% after it, even if the amount of coins in your wallet has changed. Essentially, you keep your stake in the network regardless of price.
Examples of rebasing tokens
Ampleforth
Ampleforth is one of the first coins to work with an elastic supply. Ampleforth aims to be an unsecured synthetic commodity where the price of 1 AMPL is 1 USD. Rebasing occurs every 24 hours.
The project had relatively little success until a liquidity mining campaign called Geyser was introduced. What is particularly interesting about this scheme is its duration. The project distributes tokens to participants over a 10-year period. Geyser is a prime example of how liquidity incentives can create significant traction for a DeFi project.
Although technically a stablecoin, AMPL's price chart shows just how volatile tokens with elastic supply are.
The price of AMPL is targeting $1, but nevertheless, it can be quite volatile.
Please note that this price chart only shows the price of individual AMPL tokens and does not take into account changes in supply. However, Ampleforth is very volatile, making it a risky coin to play.
It might make sense to chart elastic supply tokens in terms of market cap. Since the price of individual units doesn't matter much, market capitalization can be a more accurate barometer of a network's growth and popularity.
AMPL market cap with logarithmic scale. Source: coinmarketcap.com.
Yam Finance
Yam Finance is one of the other elastic supply token projects that has received some support. The overall design of the Yam protocol is a sort of hybrid between Ampleforth's elastic offering, Synthetix's staking system, and yearn.finance's fair launch. YAM is also aiming to reach a price target of 1 USD.
YAM is a fully community-owned experiment, as all tokens were distributed through liquidity mining. There was no pre-mining and no distribution to founders. The purchase of these tokens took place through the farm scheme.
As a brand new and unknown project, Yam made $600 million in its staking pools in less than two days. What could attract a lot of liquidity is that the YAM farm was specifically targeted at holders of some of the most popular DeFi coins. These were COMP, LEND, LINK, MKR, SNX, ETH, YFI, ETH-AMPL and Uniswap LP tokens.
However, due to errors in the rebasing mechanism, much more supply was produced than planned. Ultimately, the project was restarted and moved to a new token contract thanks to a community-funded audit and collaborative effort. The future of Yam is completely in the hands of YAM owners.
Risks of tokens with elastic supply
Elastic supply tokens are very risky and very dangerous investments. You should invest in them only if you fully understand what you are doing. Remember that looking at the price charts is not that useful because the number of tokens you hold will change after the rebasing happens.
Of course, this can increase your profits, but it can also increase your losses. If the rebasing happens when the token price drops, not only will you lose money due to the token price falling, but you will also own less and less tokens after each rebasing!
Because they are quite complicated to understand, investing in token rebasing will likely lead to losses for most traders. Invest in tokens with elastic supply only if you can fully understand the mechanisms behind them. Otherwise, you won't be in control of your investments and won't be able to make informed decisions.
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Results
Elastic supply tokens are one of the innovations in DeFi. As we have seen, these are coins and tokens that can algorithmically adjust their supply to try to reach a target price.
Are elastic supply tokens just an interesting experiment, or will they gain significant popularity and carve out a niche? It's hard to say, but there are definitely new DeFi protocols in development that try to develop this idea.
