Some thoughts on market cap, FDV valuation, token economics, and unlocking. I've noticed that even many seasoned crypto-tweeters don't know how to use these metrics to guide their investments or trades.

The market value of a crypto asset is derived by multiplying the coin price by the number of tokens currently in circulation.

FDV, which means "Fully Diluted Valuation", is another valuation metric, and is derived by multiplying the coin price by the total number of tokens.

The market value is always less than or equal to the FDV.

The FDV number is larger because the term "market cap" only counts tokens that are currently available for trading and ignores certain tokens that are waiting to be unlocked. These locked tokens usually come from a range of different categories, and can be team tokens and investor tokens (which may be unlocked in the next few weeks to years), or tokens that will be issued through mining programs over the next 100 years.

Market capitalization = demand, FDV = ?

You can think of "market cap" as the total public demand, which rises and falls as prices go up/down and demand changes, but market cap is basically the total amount of public dollars the market wants to buy tokens at the current price.

Market capitalization is a measure of public demand to buy, while FDV is not at all, but rather an indicator of supply, which is why the concept of "FDV" can be confusing.

When the market demand for unlocked tokens increases and leads to an increase in the market value of the tokens, the FDV will also increase proportionally (even if the market demand for these locked coins does not necessarily increase). Scam scenario

Imagine a scenario where a project X has a funding round in January where it raises $2.5 million from private investors at a $50 million valuation. The private investors got their hands on the tokens at a token price of $0.01, but their tokens are subject to a one-year lockup.

The project X was launched in February, and early adopters received some airdrops in March. Not many people were following the project, and participants only wanted to allocate $5 million to this new token, so the tokens had a market cap of only $5 million in March.

However, the airdrops represent just 1% of the total supply with a circulating market cap of $5 million, so the FDV is $5 million * 1 million = $500 million, and right now, the token is priced at $0.1, which is a 10x return for seed round investors.

Now imagine that by May, the project was a hot speculative target, it was already listed and traded on all the major exchanges, and there were rumors that they had entered into partnerships with Apple, Disney, Oprah Winfrey, and God.

YouTube video owners are making videos about the project and now, more public money wants to invest in this token so they go to Binance to buy it. The amount of public money willing to allocate to the token has increased 20-fold, from $5 million to $100 million.

But no new tokens have been unlocked because the team and seed round institutions have been locked in for 1 year and now the token has a market cap of $100 million and a coin price of $4 compared to FDV of $20 billion, a 400x return for seed round investors.

Market demand has increased by $95 million and this has led to an increase in the "valuation" of the project by $20 billion, with the $2.5 million invested in the seed round now valued at $1 billion, and the token owned by the team now "worth" 4 billion.

However, seed round investors with locked-in tokens are willing to dump those tokens at any time for a 100x profit. This means that even if the coin price drops 75% from the current price after their tokens are unlocked, they will still be happy sellers.

And project owners willing to sell their tokens at a valuation of over $1 billion to ensure there is long-term working capital will still be happy sellers even if their tokens fall 95% after unlocking.

A bullish case for unlocking?

So, how does a bullish unlock actually happen if the unlock increases supply but not demand?

Well, locked tokens can actually have their own active market. Professional and sophisticated investors use trusts and legal executions as security to trade locked tokens. Basically, they buy or sell locked tokens at a discount to the market price and sign a contractual obligation with the counterparty to send these tokens when they are unlocked. Sometimes these locked tokens are even extended for the duration of the lock-up period during the OTC sale (especially if the project party is the seller).

Imagine that some initial seed round investors sold their locked position to another VC at 10x profit, and that VC sold their position for 5x. Now, the cost basis of the "unlocked" tokens is not far from the current market price, with some market participants expecting a 100x profit for holders. Since some investors expect the unlocking event to be bearish, but it is actually neutral, removing the bearish catalyst could result in a net bullish event.

If the OTC market for locked tokens is quite active and the "weak hand" has sold the tokens to higher confidence investors, then the unlocking event actually just removes the "fear".

This is what happened with Solana, where SOL SAFTs were sold at a 66-80% discount before being unlocked in December 2020. Holders of locked tokens were very concerned that the unlock would cause the price of the coin to fall, while more confident buyers bought a large number of these locked tokens. When the unlocking occurred, these professional investors were getting 3-4 times the return.

If there is no OTC market and no demand for locked tokens, then the only way for locked investors to realize profits is to sell them to AMM or Coin On when they unlock, and these events could be a timid game among seed round investors.

I can imagine that by 2022, 90-95% of token unlocks will be bearish. How do you identify if an unlock is bullish or bearish?

Typically, professional investment funds have to decide whether to buy locked-in tokens at a discount or buy tokens already in circulation on the open market. And investors with longer time horizons usually try to buy at the lowest possible price and therefore don't mind buying locked tokens.

Rather than just trying to participate in the OTC market (contacting locked buyers, bidding on OTC services, subscribing to OTC RFQs), the main way to determine if unlocking is bullish for a project is to assess "is this project good?" A good proxy might be the number of active users, TVL, or product market fit.

If there is institutional interest in certain tokens, then the fund is likely to try to buy the locked tokens (if any).

Long-term investors also typically have more sophisticated valuation models, so imagine they are more like "smart money". They are trying to buy at the best price point in a 10-year time frame, so if they think they can buy at a lower price in a few years, then they will choose to wait, and these investors are less likely to participate like retail investors fomo.

This means that as prices parabolicize, the valuation of locked tokens and the valuation of the public market separate, as the smart money is less likely to buy at too high a valuation and holders of locked tokens have an increasing incentive to sell (and become happier as discounts increase). In contrast, over time, as the market grows organically and steadily, the cost basis of locked tokens is more likely to move upward to approach open market valuations.

As the market enters its later stages, it is often the case that smart money is risk averse and prefers liquidity, so this may also account for the lack of easy unlocks late in the bull market.

Unlocking Schedule

It is also important to understand the unlocking schedule and to estimate the current cost basis of OTC tokens.

Bitcoin currently has a market cap of $970 billion and an FDV of roughly $1.07 trillion, and this additional $100 billion will be unlocked over the next 100 years as part of the dwindling block rewards. If you were to graph the "unlocking" of bitcoin throughout the mining process, it would look something like this.

Bitcoin starts with a supply of 0 and then increases by 50 BTC per block, halving the block reward approximately every 4 years, which will continue to happen until all 21 million BTC have been mined.

On the other hand, projects that raise funds through private placements and issue tokens to investors, their supply plan might look like the following.

In this example, the supply of tokens starts out greater than zero (perhaps the project raised money from the public or made a short sale) and then the tokens from the investing institutions, teams, and advisors are unlocked in large numbers each year.

There are many other possible chart examples with different inflation timelines, I have only used the two ends of the spectrum as examples.

The most common form of vesting schedule I see for team or investor tokens is usually a lock for x years followed by a linear unlock for y years (where 0.5<x<1 and 1<y<3), while a common time for some great projects is a lock for 1 year with a linear unlock for 2 years. If the founding team is struggling to raise capital, they can set more favorable terms (fewer locks/faster grants).

Why is this important?

It is important to understand any changes in supply and demand throughout the trading or investment process. A small cap gem, may quickly become a large cap token and you may not know if it has a good unlocking schedule.

But again, tokens with high FDV and impending catalysts may occasionally be good trades, as locked tokens may temporarily exit the market and other traders may be spooked by the high FDV.

It is important to understand the market cap and FDV so that you can also compare the two to similar competing programs. It is important to try to get information or a good estimate of the cost base of locked-in token holders, as this helps to understand if there is demand for additional bids from professional investors or if there are a large number of high multiple profit investors eager to sell.

With every high FDV project, their overall valuation will eventually be unlocked and one should consider when and how this will happen. Sometimes, in order to maintain and justify the price of a project token, the project owner must execute exceptionally well. Summing up

Crypto valuation models are difficult because of the high ceiling and the novelty of directly financializing everything in a 24/7 liquid market. Relative valuations can also be misleading due to certain anchoring effects.

In some projects, investors and founding teams seem to be incentivized to maximize their project's overall valuation (and thus private wealth) by putting as much public market money as possible into the smallest possible float, and by doing so, a project can generate huge book profits for investors and teams.

Some projects will attempt to force price agnostic demand through gatekeeping mechanisms (e.g. "you must own it to participate"), which are mostly identifiable in gamefi and common in crypto. Usually in these projects, the gap between public valuation, private valuation, and reality is large.

If a project has a higher FDV a year or two after inception than some of the larger tech companies in the world, it may be worth thinking about: who holds such a large amount of new wealth, at what price did they acquire it, and who will they sell it to?