It feels like only yesterday that staking was the go-to gimmick for web3 projects to add utility to their tokens. In return for locking up their tokens in smart contracts, holders could receive rewards in many forms: more tokens, access, voting rights, etc. The principle behind staking was sensible on paper: it’s all about supply and demand. By incentivizing token holders to lock up their tokens instead of selling them on the open market, the token supply in circulation decreases. Less supply leads to more demand — in theory, at least.
In reality, we know that is not the case, especially in a landscape where thousands of new altcoins sprout up from nothing everyday. One simply cannot manufacture demand from scarcity where there simply was none in the first place, or at least very little. Putting aside the issue that there could be serious legal ramifications to staking under certain circumstances, the mechanics behind staking often end up doing more harm than good. Staking hurts a token’s value in three main areas: 24-hour transaction volume, user adoption, and buy pressure. We will unpack each of the three, one by one.
24-Transaction Volume
24-hour transaction volume is a key performance indicator for mass adoption. Generally speaking, the greater the 24-Hour transaction volume, the more widely adopted the token. If the transaction volume is high, this means the project is still very active, and therefore the price is more likely to fluctuate. If 24-Hour transaction volume is low, then this means that the project is likely dead or dying, and therefore the price is more likely to be stagnant. A token’s value will rise and fall over time, but a resilient token has the ability to rebound consistently. This resilience can be directly attributed to the token’s high transaction volume. The token is widely adopted, therefore there are simply more potential buyers willing to “buy the dip” which allows the price to rebound again.
Network Value to Transaction Ratio (NVT)
24-Hour Transaction Volume can be used to calculate another metric called Network Value to Transaction Ratio (NVT) which is similar to Profit-Earnings Ratio for traditional company valuations. The equation for NVT is the following:
Market cap equals the current market price times the total number of tokens currently in the circulating supply. The transaction volume is the total value of the token bought or sold in a given timeframe. NVT ratio helps an investor determine if a token is over- or under-valued. If the market cap is high, but the transaction volume is low, then that signals to the investor that the project is overvalued with the potential to crash and not recover. This is because it is not widely adopted and does not have enough transactions to sustain the price. Conversely, if the NVT ratio is low due to a high transaction volume, while one could not conclude with certainty that it means the project is undervalued and has the potential for high growth, the token at minimum will be more resilient whenever the price dips.
User Adoption
There is a direct correlation between user base, or with respect to a token, amount of unique holders, and the number of transactions executed daily. While price can be an unreliable performance indicator for the strength of a token and its potential for future growth, an increase in the number of unique holders is a strong indicator that the token is expanding its market share. It is crucial for a web3 company to integrate the cost to market and aggressively expand the user base into its operation budget. Furthermore, a successful web3 project will reinvest some of the profits made from the business back into marketing in order to achieve this goal.
Staking hurts user adoption because it incentivizes holders to not circulate the token. The only way a project will be able to gain new users is through marketing and influencing new users to join in and stake their tokens. A business model that relies solely on attracting new users with the promise to be able to extract rewards by simply purchasing but not using the tokens will surely fail due to the third and final point below.
Buy Pressure
Buy pressure is created when there are more people looking to buy the token than to sell. When there is buy pressure, another way to say this is that there is demand for the token. Staking rewards kill buy pressure, and instead create an overwhelming sell pressure whenever users decide to extract the rewards they’ve earned from staking. As previously noted in the above section, the biggest danger that tokens that implement staking rewards face is that the tokenomics often gives away more tokens than the project is earning back. Any business model that gives away “free money” will inevitably attract those who only seek to extract a value from the token by trading it. Such users are also more likely to abandon the platform if the price declines.
Staking has long been viewed as the go-to method to implement some sort of utility in a project that has none. However, it is based on a misinterpretation of the supply and demand principle and can actually end up being a fatal feature in a project. Nevertheless, there are some good examples of when staking could actually be beneficial to a project. Web3 games, which require the staking of a minimum amount to maintain an account, and therefore increase performance and user experience by allowing the administrators to remove inactive accounts, not only implements staking in a manner that would not run afoul of the SEC, but would also incentivize transaction volume, assuming that regular gameplay involves some spending of the token. Ultimately, a founding team should have a firm grasp of their tokenomics and the pros and cons of implementing staking before deciding to integrate it.
TechJD is the Founder of Ascendant.Finance, which assists web2 businesses to transition to web3, consulting on all facets including SEC compliance, tokenomics, development, and connecting with angel investors. For more information check out ascendant.finance or join the Discord.
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