web3dom #14 - Thoughts on ATOM's price

A while ago, a friend asked about my perspective on ATOM's token price. Explaining this topic in a few words is quite challenging, so I brushed it off at that time. Now, I'm here to address the question and share my thoughts.

It's widely understood that the price of an item holds great significance. As much as I often hope for people to broaden their vision and consider factors beyond token prices, I can't deny the reality that price is important in the world we live in. I do pay attention to prices as well, although I try not to fixate on them too much, so as to concentrate on what matters most.

Other than being a distraction, excessive focus on token prices can easily lead to blind spots. No, I'm not getting into concepts, values, or other metaphysical meanings. I mean concentrating too much on token prices easily leads to neglection of the impact of changes in quantity, resulting in misjudgments of asset value or investment returns.

It’s a common understanding that the total value of assets is calculated as "unit price x quantity." When we hold assets like gold or stocks, we tend to focus on the unit price, hoping that the total asset value will increase with a rising unit price. Conversely, when holding cash, as the unit price remains at $1, we focus solely on quantity, hoping for more cash. 1 cm is always 1 cm, 1 kg is always 1 kg. Physical concepts like these come naturally and lead most people to believe that the unit $1 of currency is stable, similar to other units of measurement.

Common conversation between me and my mother like "vegetables used to cost a few dollars per catty, but now they're couples of tens dollars" exemplifies this misconception. She believes that the unit $ remains fixed and unchanging. So when the price of vegetables rises, it means to her that they’re more expensive, serving as a sign of increasing greed in the society. Yet, it didn’t come across to her that even under unchanged objective conditions, vegetable prices would still rise over the years, not for any specific reason but simply because the current $1 is no longer compatible with the past $1. Although the unit of currency has always been called $, the purchasing power of $1 continues to decline as currency circulation increases. And it is always out of your hands.

Known as inflation, this terminology is familiar to many, where popular understanding often simplifies as "rising prices", and only a few could reversely understand that it's not the goods becoming more expensive, but rather the continuous shrinkage of the purchasing power of the $ unit. After all, this concept goes against human intuition. Imagine if the units of weight, like kg, exhibited the same characteristic, where the mass contained in 1 kg decreases every year. Even if you maintained a slim figure, your weight would still increase, and everyone might as well end up becoming fitness trainers.

Inflation increases the denominator in the equation, which represents the total amount of $ currency in circulation. When the numerator, which is the quantity of $ you possess, remains unchanged, the purchasing power of each unit of $ decreases. This forms the basic financial logic of modern society. While banknotes are continuously printed, if they don't make their way into your pocket and both parameters in the equation "unit price x quantity" remain unchanged, inflation won't affect the total value of personal assets. However, the purchasing power of the same total value of personal assets keeps decreasing.

Considering blockchain as an economy, the native tokens of public blockchains are like fiat currencies of nation-states. There are numerous similarities in the macroeconomics of both.

In the design of the Cosmos Hub, ATOM is designed to experience continuous inflation, much like a national currency. Its inflation rate is relatively high, fluctuating between the range of 7% to 20%, with the current rate at 14.43%. However, there's a significant difference from national governments: only 10% of the continuously inflating ATOM is allocated to the community pool through governance proposals, while the remaining 90% goes directly to the wallets of the people, the "cosmonauts" and validators, with one prerequisite: users need to stake (delegate) their ATOM. In other words, as long as you stake your coins, your assets won't be diluted.

Let's use fictional numbers to help illustrate this:

• Assume the current total issuance of ATOM is 1 bil, the market price is $1.20, making the total market capitalization $1.2 bil.

• On top, assume an inflation rate of 20% and a staking ratio of 66.7%, meaning 2/3 of the coins are staked. One year later, the total issuance of ATOM will increase to 1.2 bil.

• Assuming the market capitalization of ATOM remains unchanged at $1.2 bil, the equation for total market capitalization becomes 1.2 bil x $1 = $1.2 bil, resulting in a price decrease of 16.6%.

• In other words, if the price of the token increases, or decreases by less than 16.6%, the total market capitalization of ATOM will increase.

Now, let's examine how this affects an individual's total asset value:

• Let's say Alice initially holds 1,000 ATOM, stakes them to a validator, and receives newly minted ATOM as rewards proportionally.

• Usually, validators charge a commission to cover server, storage, and bandwidth costs. For the sake of simplicity, let's assume Alice's validator has a 0% commission, neglecting this factor. Due to the 20% newly minted coins distributed among the 66.7% stakers, the staking reward rate is 20%/66.7% = 30%. Disregarding compounding effects, Alice will hold 1,300 ATOM after a year.

• If the market price of ATOM drops by 23% (i.e., 1 - 1/1.3), Alice's total asset value will be 1,300 x $0.77 = $1,000, remaining unchanged.

• In other words, if ATOM increases in price, or decreases by less than 23%, Alice's assets will appreciate.

These calculations are rudimentary and quite simplistic, but most people, even ATOM holders, tend not to delve into these details and instead form impressions of profit or loss based solely on token prices. For those who don't hold ATOM, they rely even more on price charts to judge the performance of this asset.

This forms a different kind of misconception, one that contradicts the previous one. When it comes to fiat currencies, we tend to fall into the misconception that the unit price is stable. For ATOM, it's the opposite: we can easily fall into the misconception that quantity is stable.

Regardless of whether one agrees with ATOM's tokenomics design, it's crucial to understand its original intent.

From the very beginning, ATOM was designed to experience uncapped inflation. Barring speculative considerations, there's no reason for the price to keep rising unless demand continues to increase or a burn mechanism is introduced, based on the most basic supply and demand theory in economics. Due to the logic mentioned above, as long as the price remains stable, even if the inflation rate is at the lower limit of 7%, stakers of ATOM can still earn around 10% over a year.

ATOM's inflation rate self-adjusts to target a dynamic range based on a staking ratio of 67%. As staking takes 21 days to withdraw, it means that no one can quickly buy 34% of the voting power to veto proposals or generation of new blocks once the staking ratio meets the target. This ensures high security for the entire chain. When the staking ratio of ATOM falls below 67%, the inflation rate gradually increases to encourage users to stake, up to a maximum of 20%. Conversely, when the staking ratio exceeds 67%, the inflation rate gradually decreases until the lower limit of 7% is reached.

The fundamental principle of blockchain assumes that user behavior is driven by self-interest, not just goodwill. In a high-inflation tokennomic model like ATOM's, users who hold ATOM are constantly engaged in a game. The benefit of just holding without staking is flexibility; you can sell at any time, whether to cash in on an increase or to escape from a decrease. It's all about profit and loss. However, the downside is also clear. Just like in a country with significant inflation, the proportion of holdings is constantly diluted every minute. On the other hand, choosing to stake represents a vote of confidence in the community. It's a commitment. The corresponding benefit is that the proportion of holdings continues to increase. The downside is waiting at least three weeks to withdraw regardless of price movements. Missing sudden price spikes for arbitrage is a minor issue; in extreme cases like the death spiral of LUNA, by the time you've withdrawn for safety, the price has already dropped by 99.99%.

Let's roughly calculate my ATOM holdings. The current price of ATOM is US$7.41, about 20% of its peak price, or roughly 3 times the price at the start of Cosmos Hub in 2019. On top of this basic reference, we would need to calculate the total asset value. I purchased ATOM in batches in 2019 and 2020. Over three to four years, the compounded staking returns nearly doubled my holdings. However, due to economic needs, I haven't bought more ATOM with my rewards for some time. Instead, I've started cashing out to cover daily expenses. Though it’s not a lot of money, it's just for food, books, subscriptions, and I used a bit of the surplus to buy two scanners.

Additionally, staking ATOM over the years has brought me many airdrops, the largest of which are OSMO and JUNO. At their peak, they directly doubled the value of my original ATOM holdings. While their prices are now quite low, these are true windfalls, and I have no complaints. However, airdrops are purely accidental and not a part of ATOM's tokenomics design. If you receive them, consider them luck and be thankful, but don't have any expectations, especially in today's diminished airdrop culture.

In summary, ATOM has provided me with decent returns over the past few years, which can't be seen from the historical price chart. However, this is missing the important point that lies with its sustainable game mechanism: ATOM forces holders to choose between "holding tokens" and "holding stakes." Stakeholders who are willing to give up some liquidity for the ecosystem and cast a vote of confidence might not necessarily make money, but their proportion will definitely increase, which means their voting power will grow. From an individual micro perspective, this change might not be perceptible. However, from the macro perspective of the whole community, every time a block is generated, the proportion of "coin holders" decreases, and the proportion of "stakeholders" increases, providing an advantage for those who stay long-term.

I wouldn't say that the price of ATOM is a false proposition, but unless it's for short-term speculation, the price must be considered in its full context for meaningful discussions. Different cryptocurrencies adopt different tokenomic models. Bitcoin is intentionally designed to be deflationary, with a decreasing new supply and theoretically a continuously rising price, from which you shouldn't expect it to provide stable returns. Ethereum has no upper limit and experiences slow inflation, yet introduced a burn mechanism in 2021, which when greater than the inflation rate leads to deflation, also being the current situation. Additionally, staking Ethereum can yield around 5% in annual returns. As for ATOM's high inflation design, it represents a completely different approach from those of Bitcoin and Ethereum. It might not be an investor's boon, but it interprets the meaning of "staking" to the greatest extent.

Carrie Lam responds to the previous English metaphor (no stake in society) that protesters “lack constructive effort” as a misunderstanding.