Original title: Low Float & High FDV: How Did We Get Here?

Original author: Binance Research

Original source: bnbstatic

Original translation: Kate, MarsBit

Key Points

◆The popularity of tokens with high valuations and low initial circulating supply has been a topic of discussion in the crypto community in recent months. This stems from the concern that this market structure leaves little sustainable upside for traders after the token generation event (“TGE”).

◆Data from CoinMarketCap and Token unlock confirm the growing trend of token issuance with low circulating supply and high valuations. Notably, it is estimated that approximately $155 billion worth of tokens will be unlocked from 2024 to 2030. A large number of tokens entering the market can create selling pressure if there is no corresponding increase in buyer demand and capital flows.

◆The influx of private market capital, aggressive valuations, and optimistic market sentiment have contributed to the trend of issuing tokens at high fully diluted valuations (“FDV”).

◆The current market setup makes it imperative for investors to select and discern by considering fundamental aspects of projects, such as token economics, valuation, and product. Project teams may also need to consider the long-term impact of decisions related to token economics design.

◆VCs continue to play an important role in our industry and can work with project teams to ensure fair supply distribution and reasonable valuations.

Market Observations

The prevalence of tokens with high valuations and low initial circulating supplies has been a topic of discussion in the crypto community in recent months. This stems from concerns that such market structure leaves traders with little to no upside when a TGE occurs.

This concern is not unfounded. It has become increasingly common for tokens to launch with a low circulating supply and allocate a large portion for future releases.

In bullish market conditions, the price of these tokens may appreciate rapidly due to the limited liquidity available for trading at launch. However, it is clear that this price growth is unsustainable when a wave of token supply hits the market after unlocking.

In addition, it has been noted that newly launched tokens have FDVs comparable to established layer-1 or DeFi tokens that have stood the test of time and have proven user appeal. Overall, market participants now recognize the impact of tokens characterized by low circulation and high FDV.

In this report, we explore this market trend in more detail. We first detail our observations on the growing popularity of tokens issued with high FDVs and discuss potential market impacts and their significance. We then analyze the root causes of this trend, specifically how activity in private placement markets is a contributing factor. Finally, we propose several considerations to identify and mitigate the negative impacts of this trend, focusing on recommendations tailored for investors and project teams.

Low Circulation, High FDV

There is a clear trend of recently launched tokens with high valuations and low circulating supply. This is particularly evident when we compare tokens launched over the past few years - tokens launched in 2024 have the lowest market capitalization (“MC”) to FDV ratio. This suggests a large number of tokens will be unlocked in the future.

Figure 1: MC/FDV of tokens launched in 2024 is the lowest of 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 over the past three years, highlighting the growing gap between these metrics over time. Notably, despite being only a few months into 2024, tokens launched in the first few months already have a FDV close to the 2023 total, highlighting the prevalence of overvalued tokens.

The MC/FDV for tokens launched in 2024 is 12.3%, with a large number of tokens entering circulation in the future. This also means that in order for these tokens to maintain current prices over the next few years, approximately $80 billion of demand-side liquidity will need to flow into these tokens to match the increase in supply. Despite changes in market cycles, this may not be an easy task.

Examining some recent token launches reveals the root cause of the sharp increase in FDV in 2024. Figure 2 shows several tokens launched in recent months, along with the corresponding circulating and locked supply percentages. With circulating supply as low as 6% and no one exceeding 20%, the root cause of this 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 initial token price due to scarce liquidity, which drives higher FDV.

Comparing the peak FDV of the same set 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 on the market, which have been around 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 is important to note that FDV alone does not paint a complete picture and is less meaningful than FDV ratios that take operational metrics into account (e.g., FDV/Total Value Locked, FDV/Revenue, etc.).

Over the past few months, many projects 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 of them for demonstration purposes. Please note that this is merely to illustrate the prevalence of low-flow and high-FDV tokens and does not reflect a negative assessment of the value or potential of the selected projects, as there are many other factors at play.

Market Impact and Implications

The issuance of tokens with low circulating supply affects market dynamics, especially increasing selling pressure. According to a report by Token Unlocks, it is estimated that approximately $155 billion worth of tokens will be unlocked from 2024 to 2030. While this number is an estimate, the implications are clear - a large amount of token supply is expected to be released in the next few years, and many tokens will face significant selling pressure without corresponding capital inflows.

In light of this, it is crucial for investors to understand token unlocking schedules and track them to prevent being caught off guard when a significant token unlock occurs.

Figure 4: $155 billion to be unlocked in the next few years

Source: Token Unlocks, Binance Research, as of May 14, 2023

A related observation is the outperformance of Meme coins so far this year. In addition to significant mindshare and strong speculative demand, their token supply structure can also be said to contribute to the year’s gains.

Figure 5: Meme coins have become the best performing narrative coins YTD

Source: Dune Analytics (@cryptokoryo_research), as of May 14, 2024

Most Meme coins have all their tokens unlocked and in circulation at the TGE, which removes selling pressure from future dilution. Many tokens launched with an MC/FDV ratio of 1, indicating that holders will not suffer further dilution from the generational issuance. This structure has played a part in the appeal of Meme Coin, especially as awareness of the impact of significant token unlocking increases. While the success of Meme Coin should not be attributed entirely to disdain for low-circulation tokens, it is clear that retail investors have shown great interest in Meme Coins, even if these tokens may lack utility.

In some ways, this is reminiscent of the famous "GameStop short squeeze" event in the stock market, where many retail investors viewed Meme Coins as a means to counter the institutional advantages gained by participating in private financing. This is because Meme Coins are generally issued in a way that anyone can obtain them, and institutional participants have little opportunity to obtain tokens in advance and at a low cost. As a result, Meme Coin has become an important narrative in the current market, and its large trading volume and strong price fluctuations have always attracted people's attention.

How did we get here?

High valuations, combined with continued selling pressure from token unlocks, are structurally unfavorable for token prices. However, as observed in the previous section, this situation has become increasingly prevalent in recent years. Several factors have contributed to this.

An Influx of Private Market Capital

Venture capital (“VC”) funds have increasingly cemented their key position in the crypto investment landscape. While investment capital naturally fluctuates due to market cycles, the amount of venture capital flowing into the crypto space has been steadily rising. Since 2017, total venture capital investment in crypto projects has exceeded $91 billion, demonstrating the growing prominence of venture capital in providing the necessary funding for projects.

Figure 6: Cumulative venture capital investment since 2017 has exceeded $91 billion

Source: The Block, Binance Research, as of May 13, 2024.

However, the significant increase in investment has also led to a corresponding rise in the influence of venture capital funds in shaping crypto market valuations. As more money flows into the space, and as venture capital firms participate in more deals, they are bound to drive up valuations.

As a result, when tokens are launched on the public market, their prices and valuations are already bid up. In fact, large private market financings result in multi-billion dollar valuations at launch, making it more difficult for public market investors to profit from future growth.

Aggressive Valuations

This year’s strong market performance has fueled sentiment and driven more aggressive deal activity. This has led to some investors becoming increasingly willing to write checks at higher valuations.

Conversely, being picky about valuations can make VCs look bad in the eyes of their limited partners (“LPs”) given that multi-million dollar valuations are the norm, as it means they can’t participate in most deals when deal activity is very high. While market activity remains below its 2022 peak, the number of cryptocurrency transactions in Q1 2024 increased 52.1% month-over-month, the highest level in nearly two years.

Figure 7: Trading activity has increased this year

Source: The Block, Binance Research, as of May 13, 2024.

In addition, VCs are motivated to continue deploying capital during bull markets. As long as the music does not stop, higher valuations will boost VC fund performance metrics. In addition, it is beneficial for projects to raise large amounts of funds at high valuations because it provides them with working capital without severe dilution. This also shows strong support from "smart money".

Overall, raising funds at high valuations in private financing means that stakeholders are motivated to publicly issue tokens at higher FDVs.

Optimistic Market Sentiment

With the cryptocurrency market cap growing by 61% in the first quarter of the year, it is understandable that market sentiment during this period was very positive. Coinmarketcap’s Fear and Greed Index was in the “Greed” and “Extreme Greed” zones for 69 of the 91 calendar days in Q1. Correspondingly, project teams were able to take advantage of this positive investor sentiment, enabling them to raise funds at higher valuations in Q1.

This is evident from the rise in valuations in Q1. Specifically, pre-money valuations for venture-backed crypto companies rebounded by more than 70% quarter-over-quarter in Q1 2024. This suggests that, on average, projects were able to raise the same amount of funds with less dilution compared to the previous quarter.

Figure 8: Pre-money valuation rebound in Q1 2024

Source: PitchBook Data, Inc., Galaxy Research, Binance Research, as of March 31, 2024

Thoughts

For investors: fundamentals matter

The current market landscape makes it increasingly important for investors to be selective and discerning. Given that many projects have high valuations at the outset, the likelihood of achieving sustainable returns by "copycat" new tokens is low. Most of the upside and easy money may have been earned by early private market investors.

Whether investing in private rounds or tokens undergoing TGEs, investors should conduct thorough due diligence and establish their own investment process. A non-exhaustive list of basic metrics and aspects worth studying include:

◆ Token Economics: The importance of unlock schedules and vesting periods cannot 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 that drives token prices down.

◆ Valuation: FDV provides an overall sense of scale, but it is not very meaningful on its own. Assess valuation ratios relative to other competitors and relative to itself 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 live 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? What are their contributions to the project? How engaged is the community? What are they most excited about in the project?

Rather than aggressively chasing the next shiny token, taking the time to evaluate the fundamentals will help identify and avoid any discordant red flags and pitfalls. As Warren Buffett once said, “You only discover who’s been swimming naked when the tide goes out.” Everything seems fine until the music stops playing. Avoid being the bag carrier.

For the project, think long term

Running a project is no easy task, given the multitude of aspects and stakeholders that need to be considered. Decisions are intricate and it’s impossible to please everyone. That said, we believe one of the guiding principles for decision making is to think long term.

◆Token economics: Since token supply is limited, launching a token with low circulation and high FDV may help initial price increases. However, the subsequent unlocking may create significant selling pressure on the tokens. The project's loyal token holders (arguably one of the most important groups in the community) will suffer losses. Poor token performance may also deter new ecosystem participants from joining the network due to declining incentives.

In this regard, token distribution, unlocking, and vesting schedules should be carefully considered. While token economics may be more art than science, and there is no magic number or method, it is clear that the circulation rate of recently launched tokens is very low, as shown in Figure 2. To reduce the risks associated with a sudden increase in supply, teams and investors can consider token burning mechanisms, align vesting schedules with set milestones, and increase the initial circulating supply during the TGE.

◆Product: While tokens can help attract attention and are a great user acquisition tool, a viable product is the key to value creation, user retention, and sustainable growth. Having at least a minimum viable product in place before a TGE will help investors and users better understand the project's value proposition and determine product-market fit. In the best case, launching a product with significant user traction can promote the success of the TGE by boosting confidence and attracting high-quality investors and users. In the long run, this offering increases the intrinsic value of the token and helps the token’s price performance.

With the rebound in funding activity in the first quarter, project founders have been able to take advantage of the boost in market sentiment to obtain higher valuations. However, while raising money at high valuations makes intuitive sense (who would say no to raising the same capital with less dilution?), it has longer-term consequences. Projects that have raised funds well above intrinsic value will have to justify their premiums in future private rounds or in the public markets. Failing to do so, token prices may decline and converge toward their true value. Investors suffer losses, and project teams may struggle to turn around community sentiment.

Conclusion

Token economics are undoubtedly one of the most important considerations for investors and project teams. Every design decision has its pros and cons. While issuing tokens with a low initial circulating supply may drive initial price increases, the steady unlocking and issuance of tokens will create selling pressure that will affect long-term performance. If this trend becomes an industry norm, sustainable growth will become increasingly difficult without corresponding capital inflows to match the unlocking of billions of tokens in the coming years.

VCs continue to play a vital role in our industry, and tokens backed by VCs are not necessarily bad. Project teams and VCs should work together to ensure fair supply distribution and reasonable valuations.

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