Introduction: What makes the price go up & down?

Prior to conducting a TGE, token prices (and project valuations) are established on a distinct, ad hoc basis and are determined at the discretion of a small number of individuals – most notably the team behind a project, prospective investors, and facilitators of a public sale. These decisions are made in the "Primary market." Parties involved in the decision utilize Frameworks to make informed estimations about valuations, while legal contracts such as SAFTs or IEO Service Agreements serve as Mechanisms to set token price and the fully diluted valuation (“FDV”) of a project. Once a pre-TGE valuation is set in the Primary market, it will not change until one of two events occurs:

The Mechanisms described in the first event are covered extensively in Pre-TGE Valuation Mechanisms. The transition from Primary markets to Secondary markets will be covered in this phase of our guide.

Transitioning from the Primary to Secondary Market

The “Secondary” market opens once your project’s native tokens become freely traded. Unlike the intermittent nature of “Primary” market valuations, project valuations in the Secondary market are continuous, meaning that they evolve over time, without interruption, as a function of supply & demand.

The content to follow will outline key activities involved in making the transition from Primary to Secondary markets. Helpful prompts and tasks will be assigned to guide you through the process. Ultimately, our goal is to put projects in the best position to optimize post-TGE token and protocol performance. Major topics covered will be:

1. Underpricing Token Launches & the “First-day pop”
2. Market Maker Collaboration
3. Exchange Listing
4. Optimizing Your Token Pricing & Emissions Schedule

Before diving into these topics, it's important to establish a baseline understanding of supply & demand mechanics in crypto, and how they influence price discovery. If you’re a PhD in market microstructure then feel free to skip these sections and jump straight into Strategic Launch Mechanisms – otherwise, read on!

Tokens can be freely traded post-TGE

Tokens in Web3 can be traded in a permissionless manner between users via protocols such asUniswap or Opensea. Centralized exchanges such as Binance, Coinbase, and OKX can also facilitate trading of tokens between prospective buyers and sellers.

Price is a function of Supply & Demand

The supply & demand dynamic is the relationship between the available supply of a token and the demand for that token from potential purchasers. When assessing the Secondary market for various tokens, we make the following assumptions:

• A higher token price will:
  • Drive current holders to sell
  • Hold prospective buyers back
• A lower token price will:
  • Hold current holders back from selling
  • Drive prospective buyers to purchase tokens

These assumptions represent movements along each of the curves. Prospective buyers obviously prefer to purchase cheap tokens. If given the opportunity to purchase cheap tokens, the quantity demanded would be greater than if they were prompted to purchase tokens at a higher price. Similarly, prospective sellers obviously prefer to sell tokens priced at a premium. If given the opportunity to sell tokens at a high price, the quantity in supply would be greater than if they were prompted to sell tokens at a lower price.

The intersection of the supply and demand curves marks the equilibrium, or “market price”, at which demand equals supply.

Example: An outward shift in demand means that at every given price, the quantity demanded is higher. Assuming supply remains constant, this will result in a price increase at equilibrium. This is reflected in the below image on the left. In contrast, an inward shift in demand means that at every given price, the quantity demanded is lower. Assuming supply remains constant, this will result in a price decrease at equilibrium. This is reflected in the below image on the right.

Example: An outward shift in supply means that at every given price, the quantity supplied is higher. Assuming demand remains constant, this will result in a price decrease at equilibrium. This is reflected in the below image on the left. In contrast, an inward shift in supply means that at every given price, the quantity supplied is lower. Assuming demand remains constant, this will result in a price increase at equilibrium. This is reflected in the below image on the right.

Why does all of this matter?

Most projects will conduct a token generation event with only a portion of their Maximum Token Supply in circulation at TGE; therefore, the project’s circulating supply will increase gradually as tokens are distributed to insiders (ex: investors, team, advisors) and emit to network participants (ex: liquidity miners, stakers, nodes).

As more supply hits the market it needs to be compensated with equivalent demand to maintain a steady price. The diagram above shows the growing circulating supply over time that is preprogrammed by the emission schedule. This supply will need to be met by an equally growing demand.

The reason that this is important in Web3 more so than in traditional stocks is that tokens are used as incentives.

We cannot simply dole out token incentives without having sufficient demand to absorb them and thus maintain the monetary incentive power of the tokens. Creating demand for a token is the key to balancing the supply/demand dynamic. Demand for a token comes from many places but generally speaking, it should map some (or all depending on the case) of the value created by the project. This is what we call token value accrual and is a form of value capture (see Token Value Capture).

Plotted differently, we can see the red area showing our calculation emissions, whereas the green line shows the predicted demand. It becomes evident that supply is exceeding demand and thus might have a negative impact on the tokens price.

Helpful prompts

• Consider the inflationary tendencies of your token. How will the circulating supply change over time?
• What factors will drive demand for your token? How can you ensure that demand will match or exceed supply to maintain a stable or appreciating token price?

Token Emissions & Price Equilibrium

It’s helpful to think about your Token Emissions in terms of % increase year-over-year. For example, if your project’s circulating token supply increases by 10% between TGE and 1 year post-TGE, then (in theory) demand for the token must also increase by 10% to keep pace with supply and maintain a stable price. This seems very doable – especially for an early-stage company with product market fit.

For example, if the circulating token supply doubles over its first year, and continues this trend for the next four years, then demand for the token would also need to consistently double each year to keep pace. This represents a 16x multiple or a 1,500% increase in demand over five years. Including this sort of projection in any pitch deck would likely raise some eyebrows. While it's certainly not unattainable, it's a very high bar to set for an upstart company trying to achieve product-market fit in a hyper-competitive industry.

This may seem farfetched at initial glance, but this hypothetical would imply an initial circulating supply equal to 6.25% of the maximum token supply at TGE, 12.5% at year two, 25% at year three, 50% at year four, and 100% of the maximum token supply in circulation at year five, which is not too far from a standard emissions schedule.

Just look at how much dYdX needs to grow in the coming three years.

Similarly, Worldcoin ($WLD) conducted its TGE with roughly 1% of its total token supply in circulation. The project's token emissions schedule indicates that 60% of the total token supply will be unlocked and introduced into the circulating supply in the first three years following TGE. This represents an average of a 40% increase in the circulating supply, week over week. At a market capitalization of roughly $250M as of late Q4'23, the project has effectively communicated to the investing public that they intend to increase demand by $80M, every week, for the next 150 weeks, just to keep the price stable.

Helpful prompts

• What percentage of your maximum token supply will be unlocked at your token generation event ("TGE")? If the percentage is too low, you may run into the pitfall of "low float; high FDV."

• At what rate will your circulating token supply increase in the first few years following your TGE?

What drives token price up & down?

The laws of supply and demand dictate how token price evolves based on shifts in each curve; however, this is an academic framework. For example, an outward shift in token supply due to inflation doesn’t result in an algorithmic depreciation of token price. Similarly, an outward shift in demand for a token due to the perception of improved utility doesn’t automatically increase token price. Instead, shifts in supply and demand influence buying and selling decisions – catalyzing individuals to buy tokens they believe to be undervalued and sell tokens they believe to be overvalued.

For example, a shift in token supply may negatively influence the perception that individuals have of the project’s value. Negative sentiment may catalyze some token holders to sell. Sell pressure directly influences token price by inducing market impact.

See below for an example of the chain of events:

1. A large amount of tokens are unlocked and enter the circulating supply (i.e., the supply curve shifts outward).
2. The perceived utility of a single token is negatively impacted given that inflation makes the token less scarce and more readily accessible.
3. Negative sentiment drives existing token holders to sell some tokens, and prospective token purchasers to abstain from buying at current prices.
4. Sell orders from token holders interact with orders from patient buyers providing liquidity.
5. The consequence of the sell orders is slippage (i.e., market impact) and subsequent price depreciation. A lack of willingness from prospective buyers to purchase tokens fails to counteract the extent of price depreciation.

If you are unfamiliar, learn more about Liquidity, Trading, and Market Impact.

Price Discovery – How Fair Value is Determined in the Secondary Market

When buy and sell orders interact with one another, the result is a movement in price. If there are more buyers than sellers, the price will appreciate. If there are more sellers than buyers, the price will depreciate. Price Discovery is the overall process, whether explicit or inferred, of setting the price for an asset – whether a token, a currency, or a security.

For the sake of simplicity, think of price discovery as a debate that occurs between buyers and sellers. The goal of this debate is for each side to reach consensus on a token price that fairly reflects the asset’s value. People voice their estimations of a token’s value by buying tokens they believe to be undervalued and selling tokens they believe to be overvalued. As each side of the debate voices their opinion of the token’s fair value, they influence the price of the token. The opinions of buyers and sellers are dynamic and multidimensional. Take the following example:

1. ABC Token is priced at $1.
2. Existing ABC token holders can express their opinion regarding whether $1 is the fair value of ABC by either:
   1. Placing orders to sell ABC; or
   2. Placing orders to buy more ABC.
      1. If $1 is perceived to be overvalued, they may sell ABC.
      2. If $1 is perceived to be undervalued, they may purchase more ABC.
3. People that don’t currently own ABC can express their opinion regarding whether $1 is the fair value of ABC by either:
   1. Placing an order to buy ABC; or,
   2. Abstaining from purchasing ABC.
      1. If $1 is perceived to be undervalued, they may purchase ABC.
      2. If $1 is perceived to be overvalued, they may simply abstain from purchasing ABC.

The opinions of existing and prospective token holders can be communicated either aggressively, or patiently. When we think about the nature of potential buying and selling behavior, aggressive individuals are considered to be “takers” (i.e., those that remove liquidity) and patient individuals to be “makers” (i.e., those that provide liquidity).

If we were to map out the above example to determine various personas for existing token holders and non-token holders, then we must consider four variables:

1. Does the individual currently hold ABC?
2. Does the individual believe ABC to be overvalued or undervalued at $1?
3. Will the individual act as a buyer or sell?
4. Will the individual trade aggressively or patiently?

As a result, we can construct the below table with various personas to represent participants in a price discovery "debate."

For example, Alice currently holds ABC and thinks it is undervalued at a price of $1. As a result, she wants to buy more ABC, and will execute her buy order aggressively. She submits a market order to buy ABC and immediately purchases from a patient seller. Bob also holds ABC and thinks it is undervalued at $1; however, unlike Alice, he is willing to be patient and therefore submits a limit order to buy ABC at a price slightly below $1. Bob must wait until an aggressive seller is willing to engage with him until his order is filled and a trade is consummated.

On the other hand, Carol – who also holds ABC – thinks ABC is overvalued at a price of $1. As a result, she wants to sell her ABC, and will execute her sell order aggressively. She submits a market order to sell ABC and immediately sells to a patient buyer. Dave also holds ABC and thinks it is overvalued at $1; however, unlike Carol, he is willing to be patient and therefore submits a limit order to sell ABC at a price slightly below $1. Dave must wait until an aggressive buyer is willing to engage with him until his order is filled and a trade is consummated.

The result of the debate between Alice, Bob, Carol, Dave, Eric, and Frank is trade activity and liquidity provision as the supply of ABC tokens being sold intersects with the demand to buy ABC tokens. See the illustration below as an example of price discovery.

In this particular example, there were more buyers than sellers. Accordingly, the debate would have concluded with Alice, Bob, Eric, and Frank as the “winners,” given their articulation of opinions was the loudest and most dominant. Carol and Dave would be considered the “losers”. For example, Carol sold aggressively to Bob and Frank, who had more than enough appetite to patiently purchase ABC to absorb her sell pressure with minimal market impact. However, Alice and Eric tried to buy aggressively from Dave but he did not have sufficient supply to satisfy their appetite. Thus, Alice and Eric had to continue their search for patient sellers (liquidity) and therefore induced significant market impact. As a result of the debate, the price of ABC appreciated.

The above example represents a single instance of price discovery; however, recall that valuations in the Secondary market are continuous, meaning that the “debate” will exist in perpetuity. For example, at the new price of $1.10 per ABC, the individuals from the previous debate may have a new opinion on whether the token is undervalued or overvalued. Alternatively, new participants may enter the debate and overwhelm the previous “winning” side.

Why You Need to Care About Price Discovery

As long as a token is freely tradable, price discovery will never end, and its price will be entirely dependent on the appetite of buyers and sellers in the Secondary market. Buying and selling decisions in the Secondary market are influenced by the perception of an asset as overvalued or undervalued, and these perceptions are largely influenced by supply and demand. Supply is dictated by Token Distributions & Emissions Schedules and Demand is dictated by Token Demand Drivers. These are core components of the Tokenomics you are designing and refining, so it should start to feel like things are coming full circle at this point in the process!

If a token has no monetary value due to a poor supply/demand dynamic then users will not be incentivized to perform desired tasks that are essential to scale the network. As a result, the project will be left with a hollow or ineffective incentive mechanism and no means of growing in value.

Because of this, it is improper and simply incorrect to suggest “token price doesn’t matter” when assessing the future viability of a decentralized protocol. Lackluster token price performance results in unattractive monetary value for token incentives. Hollow, ineffective token incentives will be inadequate to cultivate a diverse decentralized network and catalyze a flywheel effect of future growth.

It is critically important that you avoid aggressive token emissions from incentives unless you are confident there is sufficient demand to absorb them. Only by having demand match or exceed supply are you able to maintain the monetary incentive power of the tokens. Thus, carefully crafted Tokenomics are critical to the success of all token projects.

Helpful Prompts

• Understand Price Discovery: Familiarize yourself with the concept of price discovery and how it will affect your token's price in the secondary market. Remember, post-TGE price discovery is a continuous process influenced by the perceptions of buyers and sellers.
• Prepare for Market Shifts: Be ready for shifts in supply and demand curves which represent fundamental changes in the market’s appetite and willingness to buy or sell your token. A token price is never a smooth ride.
• Be prepared to monitor Token Performance: Once your TGE occurs, you'll need to constantly monitor the Secondary market. Keep an eye on your token's price performance. Lackluster performance can negatively impact the effectiveness of your token as an incentive mechanism. TGE is not a "set and forget" activity, we will dive deeper into post-TGE activities in the sections to come.