Crypto-currencies may be facing a prolonged bear market. Companies that issued tokens, or digital currencies, over the past two years through initial coin offerings (ICOs) may have to sell more of these assets to finance their operations. There’s just one problem: there are very few takers.
After the blockbuster success of ICOs in 2017, with funds raised at more than $6bn, crypto-currencies nosedived, wiping out about 85% of their total market value since hitting a peak of more than $800bn in early 2018. Bitcoin, the original crypto-currency, has dropped more than 80% since hitting an all-time high of nearly $20,000 in December 2017.
A global regulatory crackdown led by the US Securities and Exchange Commission (SEC) has created fear about greater oversight and acceptance of the currencies for payments among the companies issuing the tokens and the investors that bought them, taking the wind out of the once red-hot digital assets. Data from Dead Coins, which tracks crypto-currency startups, show that about 1,000 of these companies either failed in the last year or their projects have now been abandoned.
For digital currencies still in the market, the prospect of incoming supply — some with a predetermined schedule — could pose a challenge to their businesses given the current downturn in the market.
“Many people don’t fully understand the impact of new supply on this market particularly when there’s low liquidity,” said Ryan Selkis, co-founder of Messari, a crypto-data platform in New York. “I don’t think anyone has any idea how much-hidden inflation there is in the form of token reserves that are going to be unwound gradually.”
Data from Messari shows that 71 coins of the more than 400 tokens on its database have issued less than 50% of their targeted total supply, which means there is a flood of these assets that could be sold to the market or distributed in some shape or form.
ZCash, a more than two-year-old digital currency with strong privacy features, has 28.05% of its total supply issued so far, according to Messari data. This means its token holders could see the supply mushroom more than three-fold in the years ahead, which would pressure coin values unless outweighed by demand.
The supply pressure is not just coming from companies that need to sell tokens to finance their operations, but also from early investors in ICOs that were given investment contracts that give them the right to future tokens. The terms of those contracts are at the discretion of the company raising the funds, or the issuer of the token.
Those tokens have liquidity provisions that allow investors to sell them, but have found it difficult to do so because the coins are now underwater, analysts said. “I think a lot of these tokens have been issued on the assumption of a very bullish crypto-market on all fronts,” said Kyle R Chapman, a partner at Boston-based COSIMO Ventures, a private equity and venture capital firm focused on early-stage technology companies.
Although a cap on the total number of any one token was designed as a measure to help preserve value, it has not prevented a supply glut as demand has plunged. The total number of bitcoins that could ever be created, for instance, is about 21-million, of which about 17.5-million, or 83%, have already been minted.
By contrast, the governments and central banks that control so-called fiat currencies such as the dollar can issue more at will, diminishing their value over time.
Some digital currency issuers have tried to minimise the impact of price declines by undertaking measures to reduce token supply, with varying degrees of success. Less than a year after crypto-inheritance startup DigiPulse sold its token to the public in October 2017, the company moved to de-tokenise its business by accepting fiat currencies, with the aim of eliminating speculation on its currency. The company eventually shut down.
By accepting fiat money as payment, these companies effectively abandon their ICO investors and render their virtual unit less valuable, said consulting firm EY in a report on ICOs released last October.
Other companies have resorted to burning their own tokens and removing them from circulation, similar to share buybacks. By cutting the number of tokens, companies hope to make the currencies that remain in circulation rarer and more valuable.
In token-burning, miners and developers typically purchase coins from investors and then send them to specialised addresses that have unobtainable private keys. Without access to a private key, no one can use these tokens, putting them outside the circulating supply.
Companies such as Tron, a decentralised application platform, and Binance, a crypto-currency exchange, have burned their tokens. The problem with token-burning, however, is that companies need funds to buy back the tokens from investors before they can burn them, said COSIMO’S Chapman. But many of these startups do not have the cash to burn their tokens because of the decline in the value of their own coins.
It has become a vicious cycle, analysts say. Companies need their investors to use their tokens to grow their platform and network, but their currencies have become pure speculative investments.
However, by removing their tokens from circulation, the startups limit the growth of their products, which rely on the use of these digital assets.
“Their business model is predicated on increasing the value of their protocol tokens,” said Josh Stein, CEO at Harbor in San Francisco, which runs a platform that helps convert securities into tokens backed by assets such as real estate. “The big beat-down in valuations is a big threat to their business models.”