Price Instability

Tokens today are launched with little regard to price stability. Teams attempt to manifest value into existence, launching tokens out of thin air, backed by nothing save the wispy dreams of electric sheep.

By the most popular playbook, protocols use emissions to bootstrap their communities and incentivize the creation of liquidity pools around a token. It’s common for emission schedules to double the circulating supply over the period of months to the benefit of holders and stakers. But without sufficiently large supply sinks to offset these emissions the growth of token supply outpaces that of protocol utility (demand).

The result is a devaluation of currency.

Trends during the crypto bull market have made it clear: retail investors don’t do math, at least not far beyond the spreadsheeting of APRs across yield farms. Those that do are in the minority, but even the math-pilled pile into projects with little regard for “fundamentals” during periods of exuberance. It’s the dominant strategy—to don the WAGMI banner—in the upswing of a bull run.

However, some classes of tokens require more attention than others, especially under the umbrella of DeFi. In particular, unpermissioned stablecoin protocols demand greater sophistication in their mechanism design to successfully peg the price of a token against shifting demand. Protocol investors should have a strong grasp of tokenomics before making the leap. Protocol designers even more so.

But clearly that hasn’t been the case.

Based on how much was lost through Terra-centered products (~$40B, many failed to evaluate the design of $UST and $LUNA, even locking significant capital atop a stablecoin protocol pegged using a single speculative asset. Even cursory analysis would have revealed a printing press vulnerable to inflationary feedback loops when run in reverse, yet investments poured in at an institutional scale. Maybe it was excessive exuberance, maybe overconfidence in a narrative peddled by the Luna team. After all, social signals pointed towards Do Kwon’s balls being massive enough to hold it all together, even through a bank run.

Here we see one of our supposedly sophisticated founders nuking the collective bank account. What does this say about the rest of us? We’re mecha-broke, founders and investors alike. The result is a broad mis-pricing of speculative assets in the short term where the price history becomes a meme in itself. And though meme investments can mint millionaires to the beat of a printer, they tend to implode when the music grinds to a halt. Bear market dynamics bring it all back down to earth, instead minting one financial tragedy after another 🎭

Bear Market Behaviors

We live in interesting times. Just look around. Technological advancements at break-neck speeds: genomics, energy production, natural language models, text-to-generative-art, satellite imagery, financial markets independent of central authority. But also: increasing wealth disparity within borders, the curtain call of a long term debt cycle, impending global recession, supply chain shortages, potential stagflation, an end to an era of globalization. And a global military pillar threatening the reintroduction of tactical nukes on the battlefield to top it all off.

Oh by the way, the Federal Reserve of the World’s reserve currency expanded its money supply by several trillion dollars in the face of a global pandemic. Seems almost mundane by comparison, doesn’t it? The scale is difficult to conceptualize. Not exactly a head-turner outside of fin-pilled circles. But its effect on the markets was hard to miss, manifesting the V-shaped market recovery so many wished for, if only for a fever dream.

Much of this money went directly into the largest securities markets in the form of Quantitative Easing (i.e. the Fed went on a shopping spree). Back at the start of the pandemic, the Fed poured an initial $700B then $120B/mo into treasury and mortgage-backed securities, only tapering off their purchases at the turn of this year with a balance sheet nearly $5T higher than when they started. These markets, the once beloved playgrounds of yield-guaranteeing hedge funds, grew artificially inflated, pricing out investors who could no longer expect to generate the ”guaranteed returns” they had promised their clients.

You can analogize the effect as a fat man eying a hot tub. He waddles over and sits down, raising the water level around him. He slumps in deeper, and the water begins to pour over the sides. Well, this water (money) had to find a new home. And it flooded into the smaller neighboring hot tubs (e.g. stonk market) in search of alpha, cascading even to venture capital, private equity and cryptocurrencies. Couple this with COVID relief funds distributed across the board and the maturation of financial products centered around crypto assets. The result was DeFi summer. A perfect summer storm of otherworldly gains, bequeathing freedom to the rare breed of degenerates that “take profits.”

But the recent pullback of the Fed under the shadow of persistent inflationary signals has brought financial markets to capitulation. As the fat man stands back up, the waves of excess capital seemingly ebb and vanish into financial aether. And as the fat man executes its hawkish maneuvers, ratcheting up interest rates and such, investment firms readjust their growth valuation models, pull out of liquid investments and search for reentry into a market where the new normal is defined at a lower level. In this transition, (3, 3) often flips to (3, -3) in a cruel chapter of stakeholder misalignment.

[insert $COPE tweet]

And for several projects, this market shift coincides with the end of lockup periods where teams and investors have vested significant portions of the token supply. From a purely financial perspective it’s in their best interest to dump their bags. After all, there’s no glory in a graveyard. No collateral value to salvage from a golden heart.