As recently as nine months ago, Helium was celebrated as a groundbreaking Web3 application with the potential for widespread use and glowing write-ups in major media outlets. Adoption of the global network of “hotspots that create public, long-range wireless coverage for Internet of Things (IoT) devices” skyrocketed. Approximately half a million miners joined between 2021 and 2022. The price of its native token, HNT, increased 2825% year over year from Jan. 1, 2021 to Jan. 1, 2022.
Just a few months later, the token price crashed back to Earth. Miners have slowed down investment, complaining of insufficient (or negative) return on investment.
Stephanie Hurder is a founding economist at Prysm Group and an academic contributor to the World Economic Forum. Prysm Group Associate Kajol Char contributed to this article. This article is part of CoinDesk's "Trading Week."
Part of the blame surely lies with the ongoing crypto winter, and also a scathing expose published by Forbes with accusations of insider dealing by the founding team. But the fundamental value drivers of the token also contributed to this downturn. In order to weather this storm, Helium will need to avoid a common token economics trap: focusing only on the quantitative elements of token supply without the same rigorous modeling of token demand.
How to think about token demand
In talking to hundreds of crypto projects, we find that projects tend to focus on the same questions:
- How many tokens should we mint?
- How many tokens should we release at launch?
- What number of tokens should be given as rewards to stakeholders over time?
These are all important, but they only address the supply side of the equation. Providing a user a reward of 100 dogecoin (current value $5.89) is surely less attractive to them than one bitcoin (current value $19,130.30), even though the former provides 100 times as many tokens as the latter. The demand for the token – and the resulting equilibrium value – is an essential ingredient in determining how many tokens a project should plan to issue and when.
Demand drivers for a token take a variety of forms. But they all involve answering the following question: Why (besides speculative returns) would someone pay fiat money in exchange for this token? While demand drivers constantly evolve with the industry, they tend to fall into a few categories:
- Means of payment: Users require tokens to purchase platform goods and services, such as storage or computational capacity.
- Staking: Users are required to stake tokens to earn rewards and/or to allow users to contribute resources to a platform.
- Access: Users require tokens to access exclusive services, such as social clubs or programs.
- Security: Token holdings grant a claim on an asset or actual ownership of it.
- Governance: Holding tokens allows users to participate in platform governance processes and take actions such as submitting proposals for upgrades or votes.
A single token can have multiple demand drivers that, jointly moderated by supply, determine the equilibrium value. The Wharton online program Economics of Blockchain and Digital Assets we contributed to discusses methods for building token demand scenarios and assessing equilibrium token value.
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The benefits of modeling demand
In the long term, as crypto markets mature, we anticipate that supply and demand-based valuation will become a requirement for token projects, the same way discounted cash flow (DCF) models form a basis for equity valuations today. But even in the short term, building a quantitative demand model can have numerous benefits for a project team.
Benefit #1: Providing a quantitative check on token use cases
Building a quantitative demand model for a token forces a team to understand the limits of its customer base and token adoption drivers. Suppose a token is meant to purchase goods and services. What share of target markets can the project reasonably expect to capture? What is the expected value of those purchases? How will it evolve over time?
In many cases, these quantitative estimates provide a disappointingly small number. This forces the team to revisit the fundamental uses of the token. They may need to address how to be more attractive to organic users, or to add additional demand drivers to the token.
Benefit #2: Avoiding excessive price inflation or deflation
Even if a token has robust demand projections, achieving the desired equilibrium token properties requires a careful engineering of supply and demand. If the demand for a token outstrips the available supply, tokens become scarce and the price can spike upward, causing hoarding. If there is too little demand compared to issuance, a potential deflationary spiral looms.
Using demand scenarios, projects can pressure test supply specifications such as airdrops, rewards pools and vesting periods to minimize the probability of unattractive price swings due to poorly managed supply.
Importantly, this is true not only pre-launch but also after launch when information regarding demand is realized. Projects can use updated demand models to make adjustments to releases and vesting schedules (where possible) to keep the token economics within desired ranges.
Benefit #3: Achieving target ROI for critical stakeholders
Stakers, validators and investors may be expecting a specific annual percentage yield (APY) range when contributing capital to a project. Teams can use demand projections along with distribution schedules to estimate whether these target return on investment (ROI) ranges will be achieved.
This is particularly important to consider in the early stage of a product launch, where projects may have a lot of hype but not a lot of organic usage. Founding teams frequently want to distribute a large number of tokens to provide increased incentives for ecosystem development and bootstrapping, but this can instead result in hyperinflation and lower returns than would otherwise have been achieved.
Benefit #4: Pressure testing a hard cap
It is no secret that many investors love a hard cap, and more than half of the 100 largest tokens by market cap have one. A common risk when selecting a hard cap is that the project will eventually run out of tokens as the need for rewards outstrips supply. Understanding the number of tokens required to achieve various incentive and reserve goals allows projects to make sure the hard cap is sufficiently large to support platform growth.
How Helium benefits from delving into demand
Helium employs a complex mint-and-burn token economy that includes elements of means-of-payment, staking and occasionally governance-driven demand. Investing in building a full model of supply, demand, and equilibrium value could help Helium navigate, and possibly avoid altogether, current and future crises.
First, having a quantitative projection of critical demand drivers would have allowed Helium to better calibrate its supply parameters during its bootstrapping period. Helium’s issuance curve of token rewards to infrastructure providers is aggressive, with the token distributions significant up front and halving over time. With token prices initially high, driven by hype, the rewards were more than enough to attract user investment. Users spent $53.3 million purchasing and setting up hotspots from June 2021 to August 2022.
However, the value of these token rewards must eventually be supported by demand for the token, and this is where the Helium design seems to have fallen short. Demand for data transfers, the key demand driver of the HNT token and token burning, has been low and dropping. Demand for data transfers totaled only $92,000 from June 2021 through August 2022, falling 93% from their peak in April through August. In the same period, circulating supply of HNT increased over 25%. This mismatch between demand and supply has depressed the token price and the ROI achieved by miners.
By modeling a robust set of demand scenarios, Helium may have been able to detect early on that their issuance curve was too aggressive, and miner ROI too low, in low-demand situations like the present. And even if Helium’s initial analysis had not considered the sharp peak and drop off in demand that occurred mid-year 2022, they could use a model now to revise their issuance curve. A full demand model would inform not just whether the issuance curve should be updated, but by how much.
Second, Helium will face another significant token economics challenge as it approaches its hard cap. Currently, the hard cap of HNT is set at 223 million tokens. Once newly minted tokens are depleted, miners will be rewarded via a net emissions mechanism, in which “burned” tokens are re-issued in proportion to demand factors. But these emissions are capped at a pre-specified rate. When can Helium expect to approach its hard cap? Is the emissions cap at the right magnitude to support the system long-term? Should the hard cap be adjusted up or down? These are questions a demand-based model can address.
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Finally, Helium users recently voted to migrate from Helium’s own blockchain to Solana. Not only does this have critical security and interoperability implications, but it also eliminates validator staking, a driver of token demand. Token holders surely want to understand the impact of this, in combination with other potential benefits and costs, on their holdings. As shown in our analysis of the Ethereum merge included in the Wharton blockchain course, a full demand-based model can address this scenario.
The cryptocurrency market is unpredictable, and token projects need to be prepared to weather significant challenges. Web3 projects that choose to invest the resources to understand token demand, and not just supply, will have the tools at their disposal to navigate the complexities of the next crypto winter and beyond.