Elastic Supply Tokens Explained
A token with an elastic supply has a circulating supply that changes frequently. It is the idea that rather than experiencing price fluctuations, what is changing is the token supply through a process called rebasing.
What if the Bitcoin protocol could adjust the amount of bitcoin in each user's wallet in order to achieve a particular price? Right now you have 1 bitcoin. If you wake up tomorrow, you will find that you have 2 BTC, but each one is worth half what it used to be.
Introduction
On the blockchain there have been an explosion of new types of financial products that are available for Decentralized Finance (DeFi). Among the topics we have already discussed are yield farming, tokenized bitcoin on Ethereum, Uniswap, and flash loans. Another interesting segment of the crypto space has been the rebasing of tokens, or elastic supply tokens.
Due to their unique mechanisms, a great deal of experimentation is possible. We will examine how they operate.
What is an elastic supply token?
Elastic supply (or rebase) tokens work in a way that their circulating supply is either expanded or contracted depending on the price of the token. It is possible to increase or decrease the supply of goods and services by using a mechanism called rebasing. Whenever a rebase is performed, the supply of all the tokens in a network is increased or decreased automatically, based on the current price of each token.
A stablecoin is a form of elastic supply tokens that has some similarities with elastic supply tokens. The purpose of the rebasing mechanism is to facilitate their aim of attaining a target price. However, the key difference is that rebasing tokens attempt to achieve this with a constantly changing (elastic) supply.
Aren't there many cryptocurrencies that operate with a changing supply of the currency? In the present day, 6.25 new BTC are being minted with every block. There is going to be a reduction in the block size after the 2024 halving, where it will be 3.125. As this is a predictable rate, we can also estimate how much Bitcoin will exist next year or after the next halving.
A supply-elastic token works differently. Periodically, the token circulating supply is adjusted through the rebasing mechanism. Consider an elastic supply token whose value is set to 1 USD. The rebase increases the current supply when the price exceeds 1 USD, reducing each token's value. In contrast, if the price is below 1 USD, the rebase will decrease the supply, increasing the value of each token.
On the other hand, how does this affect you on a practical level? A rebase changes the amount of tokens in the user's wallet if it occurs. We have a hypothetical token called Rebase USD (rUSD) that is aiming for a price of 1 USD. In your hardware wallet you have 100 rUSD safely stored away. Imagine that the price falls below 1 USD. You will have 96 rUSD in your wallet following the rebase, but they will be worth proportionately more than before.
It is implied that your holdings have not changed proportionally to the total supply as a result of the rebasing. Even though the number of coins in your wallet has changed, if you had 1% of the supply before the rebase, you should still have 1% after it even if the number of coins in your wallet has changed. You retain your share of the network regardless of the price.
Rebasing token examples
Ampleforth
There are very few coins that work with elastic supply, but Ampleforth was one of the first. In order for Amplify to function as a synthetic commodity, it will need to be uncollateralized, and each AMPL will target a price of 1 USD.
The project had a relatively low level of traction prior to the introduction of a new campaign focused on mining liquid assets called Geyser. Geyser is particularly intriguing because of its duration. Participants receive tokens over the course of 10 years. Geyser is a great example of how liquidity incentives can assist a DeFi project in gaining significant traction. In spite of being technically a stable coin, the AMPL price chart illustrates the volatility of elastic supply tokens.
During the analysis of the price chart, keep in mind that the chart only shows individual AMPL token prices, not the changes in the supply of AMPL tokens. In spite of this, Ampleforth is a coin that is highly volatile, making it a very risky coin to play around with.
Considering market capitalization, it might make more sense to chart elastic supply tokens as per market cap. Given the fact that individual unit price does not matter as much as market cap, it can be a more accurate barometer of a network's growth and traction.
Yam Finance
The YAM Finance project is another elastic supply token project that has gained some traction over the past few months. The Yam protocol is in many ways a mashup between the elastic supply of Ampleforth, the staking system of Synthetix, and the fair launch of yearn.finance. The YAMs project also aims to reach 1 USD in price.
In other words, YAM is a cloud-based experiment that is entirely community owned, as all tokens are distributed through the process of liquidity mining. No premine, no founder allocations - so there was an even playing field for everyone who wanted to earn tokens by participating in yield farming.
Despite being a completely new and unknown project, Yam had already secured 600 million dollars of value in its staking pools in less than a week. A large part of the reason why YAM farming has attracted so much liquidity is that it caters specifically to the holders of some of the most popular DeFi coins. Specifically, these tokens are COMP, LEND, LINK, MKR, SNX, ETH, YFI, and ETH-AMPL Uniswap LP tokens.
A bug in the rebasing mechanism resulted in much more supply being minted than had been planned due to a bug. A community-funded audit and joint effort enabled the project to be relaunched and migrate to a new token contract. YAM holders control the future of Yam.
The risks of elastic supply tokens
The investment of tokens with elastic supply is extremely risky and very dangerous. Investing in them is something you should only do if you are sure you know exactly what you are doing. It is important to remember that looking at price charts may not be of much use, since the number of tokens you hold will change following rebasings.
While this can help you increase your gains on the upside, it can also result in greater losses as well. When rebases occur while the token price is going down, not only will you lose money as the price of the token declines, but you will also own fewer and fewer tokens after each rebase!
It is likely that for most traders, investing in rebasing tokens will result in a loss as they are relatively difficult to understand. Be sure to understand the mechanisms behind elastic supply tokens before investing. Otherwise, you are not in control of your investment and will not be able to make informed decisions.