Bitcoin, you might have heard, is better than the world-dominating US dollar because of its finite supply. Even though the US dollar is the world’s reserve currency and Bitcoin is not, Bitcoin is still loads better because it is minted not by a fallible central bank but by automated computer code. Or so Bitcoin’s proponents would have you believe.
It’s all politics, really. But peel back the invective and there’s a very real feature of cryptocurrency that excites those who crouch and curl up into a ball whenever the Treasury prints money, or the Fed hikes interest rates—and it has to do with token supply.
A cryptocurrency’s total token supply refers to all the units that its blockchain or smart contract can issue, as determined by its creators—or, following the creation of novel forms of token governance, its shareholders, who vote by way of decentralized autonomous organizations, or DAOs.
Supply and Issuance
Supply relates to issuance. Token issuance occurs by a variety of mechanisms—energy-intensive proof of work for Bitcoin, environmentally clean proof of stake for Ethereum, or balls-to-the-wall token printing for obscure rebase tokens like Olympus or Ampleforth. Blockchains like Bitcoin or Ethereum issue new cryptocurrencies while smart contract protocols (i.e., applications that sit atop blockchains), like Aave or Compound, issue tokens.
The issuance mechanisms of cryptocurrencies vary dramatically across protocols—indeed, the ability to spin up endless new methods is part of the reason why crypto has attracted so much attention, both good and bad. But a common feature is that networks tend to have pre-determined monetary policies baked right into their underlying code.
How ‘Tokenomics’ Influences Token Supply
Such features, often generalized under the umbrella term ‘tokenomics,’ determine the rate of the circulating supply of tokens—how quickly funds enter into public consumption and the incentives that make this happen. Tokenomics can also cap the total supply: the number of tokens that can never be surpassed.
In Bitcoin’s case, for instance, no more than 21 million tokens can ever enter circulation—once that cap has been reached, the network will never issue any more coins. Bitcoin is issued as a reward for miners, who earn freshly-minted Bitcoin for validating transactions on the network.
Critically, these rewards are halved every few years, slowing the pace at which the supply is mined to completion. One popular—albeit wobbly—theory posits that these “halvings,” by decreasing Bitcoin’s supply, make the asset more scarce and drive its price up.
Technically, the above theory is not quite about supply in the traditional sense, but rather Bitcoin’s “stock-to-flow” ratio, which refers to the amount of outstanding tokens there are (that is, the stock) relative to the pace of the “flow” of new coins. Many Bitcoin enthusiasts believe the crypto’s preprogrammed and steady decrease of flow makes it a deflationary, “hard” currency that cannot be debased through reckless printing.
Other token supplies can be unlimited. Such networks often set the rates of inflation by network activity, price, or the never-ending march of time. Ether, the native token of Ethereum, for instance, has no upper cap to its supply because it is not chiefly designed to be a deflationary currency, but rather a useful internal payment mechanism that can be scaled up indefinitely in line with the growth of the underlying network.
Who Governs the Ungovernable?
Who determines changes to token supplies depends on the network. As in the case of Bitcoin, its supply is hardcoded and basically immutable, since the software is dispersed across thousands of nodes that have little incentive to change it. With other protocols, DAOs govern the show. For example, in the event of BNB, its creator Binance for several years burned (destroyed) tokens as it saw fit in order to boost the economy.
Other networks, particularly those backed by venture capitalists in initial coin offerings (ICOs), drip tokens into the market every so often. XRP, for instance, has been dripping founder tokens into the economy for years—unfortunately, this is the subject of a lawsuit between the currency’s at-arms-length creator, Ripple Labs, and the U.S. Securities and Exchange Commission, which believes that these sell-offs amounted to unregistered securities sales. (Ripple has long denied that it even created XRP, instead insisting that it was “gifted” the token and acts merely as its steward.)
How Token Supply Affects Market Cap
A cryptocurrency’s market capitalization is the result of such “tokenomics,” reflecting the sum of all tokens in circulation multiplied by the most recent price. A token’s fully-diluted market capitalization is the sum of all tokens that could enter circulation, effectively multiplying all possible tokens by the most recent price. The latter metric is less frequently used.
If there’s one takeaway from all this, it’s not that Bitcoin is better or worse than the US dollar because of its fixed token supply. It’s that cryptocurrencies offer an unlimited opportunity to create novel markets—yes, many of them entirely fraudulent—by playing around with the concept of token supply.