This is not financial advice. This is an opportunity I have exploited in the past and my reasoning behind it. It might be out of date now. I dunno. What do you think?
There are certain cryptocurrencies out there that we can be very certain are going to lose value. How we can be sure? Because they are being printed so quickly that it is virtually impossible for the project to grow quickly enough to cover the inflation. Every week new tokens are created meaning each token in existence is worth a smaller proportion of the whole.
Remember that the true value of a token is donated by its market cap and not by its individual price. If you double the number of tokens it does not matter if the overall value of the project goes up each token will be worth less of the total. And with hyper-inflationary tokens it can be impossible for the overall value to increase by enough to keep up with the inflation.
Why Do These Tokens Exist?
Decentralized finance has become known for yield farming. A typical yield farm goes like this:
- A project will come along that needs people to provide liquidity or use the platform to make it useful. For instance exchange (like Uniswap or Curve) and lending platform (like Compound or Cream).
- They will incentivise early adopters by printing governance tokens and giving it to users and liquidity providers.
- Farmers will move from project to project solely for the purpose of ‘farming’ the governance tokens and selling them for yield.
It is a catch-22. The tokens are valuable because they represent control (and share of profit) of a protocol that has a lot of use. The rarer the tokens are the larger control each one has. But the protocol can’t stop printing new tokens or else the users will move on to a different platform that pays them better.
This means that governance tokens keep getting printed and each one represents a smaller and smaller share of the market cap.
I Am Not Betting For Or Against The Project
Let’s be clear. I am not making any predictions about the project itself. This is simple maths and is true whether the value of the project goes up. If you double the number of tokens in existence then each token will be worth half the amount of market cap.
Let’s Look At An Example
Curve is a very good project and one of the poster children for decentralized finance. I use it most days and believe it will be here to stay for a long long time. But they have a very steep inflation curve as their token CRV is being gradually released to farmers, investors and the team. Here is their inflation schedule.
As I write this (10 Oct) there is currently 115m CRV in circulation. In a years time, there will 810m. That is almost 800% inflation in the next 12 months. Meaning the market cap would need to rise by 8x just to break even and a CRV buy now.
Let’s look how this has played out so far. Here is their marketcap from Coingecko. As you can see the market cap value of Curve has been up and down but is currently a bit higher than at launch.
Now let’s look at price. Ahh. It is down a lot.
Now CoinGecko is not going to be completely accurate (it is very hard to accurately keep up with market cap for these inflationary tokens) but you get the idea.
And Curve has one of the more sensible inflation curves out there. There are other (probably short-lived) projects that are literally doubling every week.
How Do You Short Them?
Let’s talk briefly how shorting works. You can either do it through a derivative where someone takes the other side of your bet. Or you can borrow the actual token, sell it and hope to buy it again later to give back for less money.
This is harder than it sounds as there are not too many people willing to take the other side of the position. In a mature market, you would expect the interest required to borrow the tokens to be higher than inflation. But Defi is far from mature.
Cream.Finance is a peer-to-peer decentralised lending platform that allows you to borrow or lend various tokens. It is based on Compound and has pretty much the same interest curve regardless of whether the token is highly inflationary or not. Read episode one for more details on how Compound style lending works.
Which means that you can borrow CRV for less than inflation. Currently CRV can be borrowed at 106% per year (remember there is 800% inflation scheduled over the next year).
Here is an example of a short trade using ETH as collateral:
I am not saying to do this strategy but you get the idea. Remember that Curve is a good project and so 8x market cap increase is possible. A fully diluted market cap of $1.6 billion is certainly possible. And there are lots of people already shorting it.
But you get the idea and there are plenty of trash hyper-inflationary tokens out there. The challenge is how to short them.
Not Financial Advice
This is not financial advice and I don’t think you short Curve. I have made money from shorting inflationary tokens but things may have changed since then. The market is getting wiser and future inflation is starting to be priced in. Also keep in mind that shorting is more risky than going long.