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A Step-by-Step Guide to a Key Metric in DeFi
By: Rahul Nambiampurath
Cryptocurrency circulating supply is equivalent to outstanding shares of a publicly traded company. This metric counts the number of coins available for trade, as opposed to the number of maximum coin supply.
The circulating supply helps us calculate the market capitalization of every coin. Additionally, regulating scarcity mitigates demand and impacts the coin’s price. Cryptocurrencies diverge in their circulating supply approaches, which is why it is important to understand these concepts.
Let’s say you want to buy ADA coins for Cardano staking. Across all centralized and decentralized exchanges, there are 33.75B ADA available. This is ADA’s circulating supply, as 75% of its maximum supply of 45B ADA. In turn, we can calculate ADA’s market cap by multiplying that circulating supply with the price of each ADA coin.
33.75B ADA (circulating supply) x $0.45 (per ADA) = Cardano (ADA) market cap of $15B
Likewise, if we multiply ADA’s maximum supply by the price of each ADA token, we arrive at the market value of all ADA tokens that will ever exist at $20B. This doesn’t take into account the circulating supply, which is why we call it the fully diluted market cap.
In traditional finance, a fully diluted market cap of a company would count all dilutive securities, such as warrants or options, that could be converted into stock shares. Therefore, in both crypto and equity markets, a fully diluted market cap measures the maximum potential of an asset.
Circulating supply measures the asset’s present value. However, it bears keeping in mind that blockchain assets have different rules. For example, if a user loses his private keys to a wallet, those funds are then cut off from being traded by everyone.
Everyone knows that Bitcoin has a total maximum supply of 21M BTC. Since Bitcoin launched in 2009, miners have been gradually receiving bitcoins when processing transactions, i.e., adding them as new data blocks on the blockchain. By receiving these rewards, miners issued more BTC into circulation.
At first, they were getting 50 BTC per transaction. After three halving events, their reward is now only 6.25 BTC. This is Bitcoin’s way of mitigating demand, by carefully managing its circulating supply. In traditional economies, central banks control the supply of currencies such as the U.S. dollar through printing of bank notes and interest rates.
Circulating supply, whether it is fiat money or cryptocurrency, has an important function as inflation control. In the case of Bitcoin, 19.1M BTC have been mined, which is about 91% of its total supply of 21M. However, does that mean that all of those 19.1M BTC are available for trade?
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No. Crypto wallets represent access to blockchain networks because they hold private keys to unlock that door. With the keys lost, the access is lost. In turn, those funds are irretrievable. In 2017, a Chainalysis report estimated that up to 3.79M BTC are lost, mostly forgotten on long-defunct hard drives.
Moreover, it is estimated that Satoshi Nakamoto (Bitcoin’s creator) owns about 1M BTC, which has never been moved to a wallet/exchange. Altogether, this would place Bitcoin’s actual circulating supply at 14.3M. In turn, this gives crypto whales immense power to affect Bitcoin’s price.
If Nakamoto, or someone who retrieves a lost private key, would suddenly release 1M BTC into circulating supply, the token’s price would fall.. That’s because there would be more Bitcoins in the market than there is demand.
While Bitcoin has an embedded inflation control logic through its halving mechanism, other blockchain networks are more flexible, for better or worse. This refers to Proof-of-Stake (PoS) blockchains, such as the emerging new version of Ethereum, Cardano, or Avalanche.
Native coins on those networks serve multiple functions. Not only can they be used to pay dApp services, like lending or NFT trading, but they are also used for staking. PoS stakers can become validators to receive rewards whenever their coin/token stake is used to add transactions. This is the mechanism by which new coins are introduced into their circulating supply, just like with Bitcoin miners.
However, token holders on PoS networks can also use their tokens to vote on the amount of rewards each validator receives. In turn, this regulates the circulating supply, which affects the price of each token. Case in point, when Ethereum introduced its EIP-1559 upgrade, base ETH gas fees were burned instead of returned to miners.
Because Ethereum has no maximum ETH supply, this burning mechanism (sending ETH to a dead wallet) regulates ETH circulating supply by reducing the inflow of new ETH. As a result, in Q1 2022, Ethereum’s inflation rate went from 1.10% to 0.51%. That’s quite a difference from the 40-year-high US inflation rate in H1, 2022, isn’t it?
For Ethereum investors, this means that ETH gains value. After all, Ethereum hosts thousands of dApps and has half a dozen Layer 2 scalability solutions. As Ethereum’s utility increases, the demand for ETH will then increase. In other words, a more regulated Ethereum’s circulating supply, via EIP-1559 upgrade, appreciates ETH value.
In contrast, PoS blockchains that don’t have a burning mechanism but have a maximum token supply, can always regulate their circulating supply by changing validator rewards. On Avalanche (AVAX), which is limited to 720M AVAX, validator staking reward is at an annualized rate of 9.02% AVAX.
If the Avalanche ecosystem receives less utility, AVAX token holders can then vote to reduce that staking reward. This would reduce its circulating supply, as fewer new AVAX would enter the market. By doing this, the AVAX coin price would then appreciate accordingly.
This is another important aspect of circulating supply — token price as expressed in decimals. Research has shown that investors tend to pick cheaper coins. Dogecoin is the best example of this dynamic.
Despite the fact that DOGE’s circulating supply is infinite, at 5.5B annually, because they are priced so low, and with some help from Elon Musk, DOGE memecoin has a greater market cap than a legit infrastructure coin like AVAX with its capped maximum supply.
Given these examples, it is now easy to understand why circulating supply is so important for the token’s ultimate value. If more people understood this metric, it would’ve been highly unlikely for DOGE to ever go over $1M, let alone $1B market cap.
Always research what the purpose of each coin is, how is its circulating supply regulated, and how the tokens are distributed to affect the circulating supply. These are the key drivers that determine their value, regardless of bear and bull cycles.
Series Disclaimer:
This series article is intended for general guidance and information purposes only for beginners participating in cryptocurrencies and DeFi. The contents of this article are not to be construed as legal, business, investment, or tax advice. You should consult with your advisors for all legal, business, investment, and tax implications and advice. The Defiant is not responsible for any lost funds. Please use your best judgment and practice due diligence before interacting with smart contracts.
Rahul Nambiampurath•
Owen Fernau•
Samuel Haig•
Samuel Haig•
Rahul Nambiampurath•
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