Introduction: Initial token pricing & expectations for "pops"

The transition of blockchain projects from Primary to Secondary markets is very similar to the process by which traditional companies transition from privately owned to publicly traded via an initial public offering (“IPO”). The first day of trading – in both equities and cryptocurrency markets – is action-packed with higher-than-average volume, liquidity, and volatility. The price performance of both stocks and tokens on their first day of trading has significant influence on the public’s perception of future performance. Those with positive returns are perceived as winners, while those with negative returns are perceived less favorably. Web2 companies and Web3 blockchain projects only get one shot at making the transition to becoming publicly traded, so getting the process right is absolutely critical.

Big returns are a consequence of significantly more buyers than sellers in the Secondary market, with buyers motivated to purchase the stock at prices they believe to be undervalued. Large first-day pops reflect poorly upon the Underwriting investment bank as it means there was significant money left on the table due to underpricing the offering relative to demand. While there are many factors at play including the size of the offering as well as the percentage of total shares available, the goal of a successful IPO is generally to be “oversubscribed” and price an offering above the indicative range with a strategic mix of investors to support future price performance.

First-day pops in Web2 markets tend to be more significant during “hot” bull markets and less exciting during “cold” bear markets. Web3 markets follow a similar trend; however, the scale of first-day pops in Web3 is significantly greater than those in Web2, regardless of the market cycle. First-day pops in excess of 1,000% occur frequently in Web3, and have become an unspoken expectation for popular blockchain projects. Unlike Web2, large first-day pops in crypto are celebrated and provide validation of a project’s potential while also serving as a form of viral marketing.

Almost all stakeholders aligned to a blockchain project are incentivized to encourage a massive first-day pop for a newly issued token. Because of this, tokens are purposefully underpriced when they are initially listed on centralized and decentralized exchanges. The result of this phenomenon is K Charts with large “green candles” with elongated “wicks” in the initial one minute following a token’s listing on major exchanges. The returns on the “first-minute pop” are usually the most significant. After the first candle, prices generally experience a sharp correction, followed by a period of high volatility, before finding stability at prices slightly below the closing from the first candle. Despite the intraday price correction, the first-day returns remain significant. See the below illustration for an "ideal" series of candles on a K Chart immediately following a token's launch:

The prevalence and magnitude of the first-day pop in Web3 also carries elevated expectations from speculators regarding token price performance. During bull markets, it is not uncommon for retail speculative communities to expect returns of 5-10x from a newly issued token’s “first-day pop.” Expectations remain high, albeit slightly more conservative, during bear market cycles. “Moon sheets” generate excitement amongst retail investing communities by displaying competitors valued at many multiples higher than tokens that are about to list. For example:

Regardless of the market cycle, navigating the “first-day” pop is a critical component of your Go-to-Market Strategy; therefore, educating yourself on this niche concept is imperative since you only get one shot at “going public”. The content to follow will provide a brief description of why first-day pops are so much larger for blockchain projects than traditional companies. We will then provide prompts and tasks for you to strategically price your token (and value your protocol) as you transition from the Primary to Secondary market.

Going Public in Web2

Investment Banks “Underwrite” the IPO process in traditional (Web2) markets and are incentivized to support first-day pops that are exciting, but not too exciting, with desirable returns ranging from 5% to 15%.

Investment banks work closely with the issuing company to conduct the following activities:

1. Determine a range for an initial offering price of the company’s stock as well as how many shares to issue at such price range.
2. Either sell the stock from the issuer up to some amount with a “greenshoe option” to increase the size on a “best efforts basis” or bear the risk on their own balance sheet in a “bought” deal with a similar option to upsize
3. Sell the stock to institutional investors within the Underwriter’s network.

For example, when a privately owned company contemplates going public, they may engage an Investment Bank such as Goldman Sachs, JP Morgan, Morgan Stanley, and Credit Suisse to serve as their Underwriter. If the company decides to move forward with the IPO, the Underwriter will support the process by running a “roadshow” with institutional investors to build their investor book and set an offering price range per share based on estimated demand from their institutional investor base. The Underwriter will try to price the company’s stock very close to what they anticipate its expected market value to be in the Secondary market, once it is freely tradeable amongst investors. After the company’s shares become publicly traded, the Underwriter also provides liquidity and deploys price-stabilizing trading strategies to minimize volatility and promote efficient trading conditions for the stock.

Underwriters have a significant vested interest in properly pricing an IPO. Underpricing shares results in fewer funds that would have gone to company insiders seeking to convert their sweat equity to cash, as lower fees collected by the Underwriter based on the amount sold to institutional investors. On the contrary, overpricing shares may result in poor post-IPO performance due to prospective retail investors interpreting the stock as too expensive to purchase, thus resulting in limited buy-side pressure and subsequent price depreciation. This outcome leaves most IPO participants disgruntled given that poor first day performance often hurts the stock’s future potential. In sum, Underwriters are incentivized to set an offering price per share that encourages an exciting, but not too exciting, first-day pop.

To summarize first-day pops in Web2:

Launch Mechanisms in Web3

Very few blockchain projects have the in-house expertise required to launch, scale, and operate a publicly traded company. To compensate for this lack of coverage, most projects outsource ownership of key tasks to external service providers such as Market Makers, Tokenomics Consultants, and Financial Advisors. While many of the external service providers engaged with a blockchain project have a vested interest in the project’s success, there is no specialized institution to guide and support projects as they transition from Primary to Secondary markets.

Also, unlike Web2 counterparts, most blockchain projects don’t have the choice on whether or not they should “go public” – many protocols need to issue a token in order to launch. The result is that Web2 Secondary markets generally feature mature, late-stage companies with well-developed fundamentals, and clear product-market fit, whereas Web3 secondary markets generally feature early-stage projects with under-developed fundamentals and estimations of potential product-market fit. In Web2, 90% of startups fail before going public and only a small number of publicly traded companies “fail” via bankruptcy. In Web3, there are minimal barriers to launching a token; however, 95% of projects fail after they’ve gone public (i.e., token price trends to $0).

These are not necessarily bad things. Rather, it's simply the reality of the new, hyper innovative Web3 ecosystem. It essentially means that we have the equivalent of Seed Stage or Series A companies that are publicly tradable. We are not here to propose an alternative to the established processes, rather our goal is to help you understand the nuanced mechanisms used throughout the transition from Primary to Secondary markets to instill best practices and help you navigate them strategically.

Setting an initial token price

As mentioned, Underwriters in Web2 conduct the following activities prior to an IPO:

1. The Underwriter determines the initial offering price of the company’s stock. The Underwriter will try to price the company’s stock very close to what they anticipate its expected market value to be in the Secondary market, once it is freely tradeable amongst investors.
2. Once this price is determined, the Underwriter sells the stock from the issuer (i.e., the company that is going public) to institutional investors within their network.

None of the above activities exist in Web3. The closest equivalent is an initial exchange offering (“IEO”).

This means that valuations at the onset of Secondary markets are not beholden to the same sorts of checks and balances as exist in Web2. Whereas Underwriters are incentivized to set an offering price per share that encourages a conservative first-day pop, almost all stakeholders aligned to a blockchain project are incentivized to encourage a massive first-day pop for a newly issued token. Because of this, tokens are purposefully underpriced when they are initially listed on centralized and decentralized exchanges.

The Mechanism used to set a token price just before transitioning to the Secondary market is called “setting pre-market orders”. Setting pre-market orders is a process by which a trading account on a centralized exchange can place orders to provide liquidity (we’ll explore liquidity in Liquidity is King) at various prices before the official commencement of trading. Pre-market orders are generally placed by an account owned by the project team or a Market Maker that has been engaged by the project. CEXs refer to this type of account as “white labeled.” Only specially designated “white labeled” accounts can place pre-market orders. Other exchange users – including users that may be eager to buy and sell the token once the Secondary market opens – must wait until trading officially begins to place orders to provide or remove liquidity.

Once trading of the token commences and the Secondary market officially opens, the pre-market orders to provide liquidity will be filled by these “organic” buyers or sellers. When this occurs, the first official trade is consummated.

The opening price is the first component of a token’s K Chart. If a “first-minute pop” occurs, then the candle will be green with a closing price established at a premium to the opening price.

Even though the opening price is not established until “organic” customers submit an order to buy or sell a token, the pre-market orders effectively establish what the opening price will be. Accordingly, the opening price is not determined by market-wide supply and demand, rather, the opening price is determined based on a small amount of trade activity conducted at prices that have been selected prior to the open of the Secondary market, and before any external indications of demand or pricing preferences have been indicated.

Take the following example:

Project ABC has a Maximum Token Supply of 1B and wants to establish an opening token price of $0.10 to reflect an FDV of $100M, which the founding team believes to be fair. To direct the opening token price of $0.10, the team will place the following pre-market orders:

1. Limit buy order for one ABC token at a price of $0.09999
2. Limit sell order for one ABC token at a price of $0.10000

Assuming the first order submitted by an “organic” marketplace participant will be an order to buy ABC, the buy order will execute against the pre-market limit sell order at a price of $0.10000, and a trade will be consummated. This initial trade price of $0.10000 would imply an FDV of $100,00,000. If the first order submitted by an “organic” marketplace participant is an order to sell ABC, the sell order will execute against the pre-market limit buy order at a price of $0.09999, and a trade will be consummated. This initial trade price of $0.09999 would imply an FDV of $99,990,000 which is only $10,000 less than the “fair value” determined by Project ABC.

The equivalent of pre-market orders can be set on a DEX powered by an AMM by “seeding” a liquidity pool. Seeding a liquidity pool is essentially the decentralized equivalent of creating a trading pair on a CEX given that it can be done so in a permissionless manner. If the same project from our previous example wanted to establish an opening price of $0.10, they would take the following steps:

1. Select a decentralized exchange powered by an infinite AMM (i.e., one with no pricing thresholds or target ranges). For example, the founders of Project ABC may select liquidity pool ABC/USDC on Uniswap V2.
2. Deposit 500 USDC to the liquidity pool
3. Deposit 5,000 ABC to the liquidity pool
4. Given that infinite AMMs require equal dollar amounts for each asset and this deposit is being used to “seed” the liquidity pool, the protocol will treat the deposit as a way to set the price; therefore, 5,000 ABC is determined as holding equal value to 500 USDC, thus the price of ABC is $0.10.

In return, the AMM will issue receipt tokens (often in the form of a Liquidity Provider NFT) to the wallet that deposited funds to provide liquidity, signifying the wallet’s ownership of the pool. Once liquidity has been added to the pool, the seeded liquidity pool will utilize AMM pricing mechanisms (discussed further in Liquidity) to enable trading of ABC as intended.

Underpricing tokens is the norm

Pre-market orders for a digital asset market are often purposefully underpriced by projects. For example, if a project believes its token’s fair value to be $10.00 (implying an FDV of $100M based on a 10M maximum token supply), it may actually want the “initial trade price” to be $1.00 – a full 90% discount. To facilitate an initial trade price of $1.00, the project would place pre-market orders as below:

1. Limit buy order for one ABC token at a price of $0.99
2. Limit sell order for one ABC token at a price of $1.00

But why would a project purposefully underprice their tokens? If they believed an FDV of $100M was a proper valuation for the protocol they built, why would they choose to have the Secondary market open at a token price that implies an FDV of $10M? While there is no way to know the intentions behind project founders with absolute certainty, we know that underpricing is a common practice at TGE. Take the following examples of projects that have underpriced their opens relative to their previous fundraising valuations:

Some of the most logical explanations for underpricing a TGE are listed below:

Again, there is no way to know for sure why most blockchain projects purposefully underprice their token’s debut in the Secondary market. We can speculate on rationale – for example, there is certainly merit in underpricing tokens to allow network participants a favorable entry price. Regardless of the reasoning or logic, we can say that first-day pops in Web3 are significantly larger, and occur more frequently than they do following IPOs in traditional (Web2) markets. We can also establish with a high degree of confidence that these first-day pops are largely attributable to underpriced initial trade prices.

Given that most blockchain communities rely almost solely on price as an indication of a token’s utility and the fundamental value of its associated network, many retail speculators interpret first-day pops as growth in the value of the underlying protocol. Such reliance on price as an indication of fundamental value means that projects are essentially forced to adhere to established norms of underpricing if they hope to attract supporters and catalyze support as they begin to build a decentralized global community.

In sum, massive first-day pops are good for all major stakeholders aligned to a blockchain project – at least in the short term. There are indeed risks associated with first-day pops in Web3, which we’ll discuss in a moment.

To summarize:

Risks of underpricing tokens

As mentioned previously, token projects seek to attract network participants at favorable valuations — as highly incentivized active network participants create more robust networks. When first-day pops are too high, the market is typically overcrowded with speculators, drowning out the opportunity to build a solid holder base.

Significant first-day pops may also imply fully diluted valuations that are perceived as egregious by speculators, which may result in limited demand to purchase the token at prices immediately following the TGE. An absence of demand will likely result in price depreciation as the token's supply curve shifts outward based on its emissions schedule programmatically releasing tokens into circulation.

Downward price action in the moments immediately following TGE can be damning for a project's long-term success. Remember - token price performance matters!

Negative price performance catalyzes a negative feedback loop – for example:

• Poor Token price performance means that network incentives are “hollow” with unattractive monetary value (regardless of the quantity of tokens rewarded)
• Hollow incentives leads to an inability to attract customers
• An inability to attract customers means that there is unlikely to be much activity on the protocol.
• Low protocol usage means there will be minimal revenues generated on-chain.
• Low revenues means that there is no “value” being captured that can then be accrued back to token holders.
• No value accrual or “feedback loop” means that the speculative demand for the token will diminish, thus further exacerbating the negative token price performance.

And thus, the virtuous cycle repeats itself...

Underpricing tokens & "Low Float; High FDV" are a deadly combo

"Low float; high FDV" occurs when a project conducts a TGE with only a small percentage of its maximum token supply unlocked and in circulation. In doing so, the project implies a relatively low Market Capitalization relative to the project's Fully Diluted Valuation. This is sometimes referred to as an "MC / FDV Ratio". For example, if a project conducts its TGE with a Market Capitalization of $10M and a Fully Diluted Valuation of $200M, its MC / FDV ratio would be 0.05.

When a project with a low MC / FDV ratio (ex: less than 0.10) enters the Secondary market, speculators may perceive its Market Capitalization as "undervalued" relative to comparable projects and aggressively purchase the token with the hopes of future profit. These speculators may not be aware of the aggressive inflationary tendencies of the project due to its Emissions Schedule.

The consequence of this aggressive buying is market impact (i.e., slippage), and significant token price appreciation (i.e., "pumping"). After a significant rally, the token price may stabilize at a Market Capitalization that seems "fair" relative to other comparable projects; however, if these projects have properly designed their Tokenomics they are likely to have a much larger percentage of token supply in circulation. Thus, the Fully Diluted Valuation of the project would significantly overvalued relative to these comparables. Hence the reference to "Low float; high FDV":

• Low float: low percentage of token supply in circulation (i.e., "floating")
• High FDV: overvalued fully diluted valuation relative to comparables with a similar market capitalization.

Many projects try to generate momentum and retail excitement at their launch with a deadly combination of "strategic mechanisms". For example:

• Low "float" at TGE (i.e., low % of maximum token supply unlocked and in circulation)
• Discounted pricing to previous valuations (i.e., purposefully underpricing tokens)
• Thin liquidity on offer on CEX whitelabeled opening order books (or thinly seeded DEX AMM pools)

The consequence of this combination is usually a MASSIVE post-TGE pop, and tons of trade activity, closely followed by aggressive sell pressure and minimal bid-side liquidity. These inevitably leads to down-only price action and deteriorating retail sentiment. There's nothing more damning to a crypto community and user base than consistent token price depreciation. See the below example for a popular base layer that executed its launch in a similar manner.

Summarizing launch mechanisms in Web3

To summarize, a token’s “opening price” is determined directly by a project team or its market maker. For example, pre-market orders determine an opening price on a CLOB (continuous limit order book - for more details read Liquidity is King), and the amount of funds used for initial seeding of a liquidity pool determine the opening price on a DEX. The amount of liquidity posted on offer via pre-market orders on a CLOB or deposited to a liquidity pool on a DEX have significant influence on the magnitude of a post-TGE pop. Thin liquidity on the offer of a CLOB or small deposits to a liquidity pool can lead to significant market impact from a relatively small amount of buy orders once the market opens and trading officially commences. The result of significant market impact is a massive post-TGE pop, which is manifested by a large green candle.

Commentary on "Fair Launches" and Liquidity Balancer Pools ("LBPs")

Liquidity Balancer Pools ("LBPs") have been marketed heavily as "fair launch" mechanisms for projects to utilize as they transition from the Primary to Secondary markets. This is because LBPs can help choose a "reasonable" price for the asset to list at via its underlying "auction" mechanism which elevates liquidity and price discovery through a novel mechanism. This is in contrast to the mechanisms discussed above which leave a large amount of discretion to the team behind a project.

The Forgd perspective on LBPs is entirely based on the fact token price performance matters. Retail FUD and FOMO drive the market, and their opinions are fixated on price performance. FDV and market cap may not necessarily matter to a speculator; however, if a token's price consistently declines, users will not be incentivized to perform tasks that are essential to scale the network because the user experience is subpar. On the other hand, exciting price action catalyzes more user adoption because the user experience is great. This is true regardless of FDV or market cap. Accordingly, projects do themselves a massive disservice to transition to the Secondary Market by leveraging a mechanism that may cause a large imbalance in token supply and demand.

The underlying nature of the LBP model drains demand from the Secondary Market before trading begins (by allowing bullish investors to purchase PRIOR to the commencement of trading). The consequence of this is that supply overwhelms demand when trading starts. Essentially, everyone that may have been super eager to buy tokens was allowed to do so in the Primary Markets, and the LBP mechanism accounted for that demand by increasing the price per token.

When the token actually gets "listed" (either on a CEX or DEX), there is usually a "down only" pricing trend. This is largely because everyone that was super eager to buy the token at TGE already had the opportunity to do so. The market demand has been is satisfied. Once the Secondary Market opens, token recipients on the project's Token Distribution Schedule might want to sell to take profit (ex: airdrop recipients from an ITN, recipients of staking rewards, etc.). There are very few buyers to absorb that sell pressure. The consequence is price depreciation. Retail interprets this as "broken utility" even though the token price can be totally decoupled from utility. "Why is the price going down? Rug? Wen moon?"

Therefore, Supply > Demand and causes downward price action. The "public" observes this as red candles on exchanges, Coingecko, Coinmarketcap, etc. This is probably the single WORST time to have downward pricing because speculators in crypto are predisposed to seeing "pops" in price immediately following a TGE. Thats why we see "moon charts" and news outlets will celebrate things like: "ABC has begun trading on Binance today and is currently trading at a 10.5x relative to its IEO price."

This is unfortunate because the reality is that there were TECHNICALLY "green candles" prior to the token listing on exchanges. Those green candles just weren't visible to the public given that they occurred in the Primary Market.

A final item to note, is that LBPs are not synonymous with "Fair launches". The mechanism has been marketed as "fair" because it helps choose a "reasonable" price for the asset to list at via its underlying "auction" mechanism which elevates liquidity and price discovery through a novel mechanism.

Conducting an LBP doesn't necessarily mean that you launch with a reasonable % of total token supply unlocked. A project that conducts an LBP can still botch their supply-side Tokenomics and launch with low float; high FDV, for example.

Helpful Prompts

• Understand the Concept of "First-day pops": Familiarize yourself with the concept of "first-day pops" and how it influences the public's perception of your token's future performance.
• Strategize Your Token Pricing: Consider the implications of underpricing your token at launch. While it can lead to a significant first-day pop and generate excitement, it's important to balance this with long-term sustainability.
• Consider Market Conditions: Be aware that first-day pops can be influenced by the overall market conditions. They tend to be more significant during bull markets and less so during bear markets.
• Evaluate Your Token's Value: Reflect on your token's true value and how it compares to its initial pricing. Remember, underpricing can attract investors, but it's important to ensure that the price reflects the token's actual worth.
• Plan for Market Impact: Prepare for the market impact that can result from aggressive buying and selling immediately after your token's launch. This can lead to high volatility and significant price changes. Check out Market Maker Collaboration for more information.
• Consider the Risks: Be aware of the risks associated with a large first-day pop, such as attracting too many speculators and not enough long-term investors.