Crypto Tokens and Crypto Coins: What Drives Performance?


Much of the crypto world is, by definition, cryptic and difficult to understand. But two crypto trends are abundantly clear: both talent and money are flooding the digital currency market. Almost every day there is a new announcement of software developers from Google or financiers from JPMorgan joining new crypto companies that are about to revolutionize something.

In fact, while the total market capitalization of cryptocurrencies has fallen from its previous heights, it is still above the $2 trillion mark. This is the equivalent in value of the entire German stock market, which includes top companies such as Siemens, BMW and Volkswagen.

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Today it is as easy to invest in crypto as in stocks, but what you are actually buying is not so clear. When investors buy Shiba Inu, a token with a market cap of $15 billion and a pet Shiba Inu hunting dog, SHIB tokens are deposited into their digital wallets. But what do they really have? And what drives SHIB’s performance?

Theoretically, the more popular the token, the higher the price. But does this relationship hold in practice? Let’s investigate.

Chips vs. coins

Before we dive in, we first need to define some basic crypto terminology: a token is a blockchain-based smart contract, and a cryptocurrency is the native token of a particular blockchain. For example, ETH is the currency of the Ethereum blockchain, but SHIB is an Ethereum-based token. Although all coins are tokens, not all tokens are coins.

The number of tokens has increased over the past two years and tokens now outnumber coins by a factor of eight. Ethereum and Binance Smart Chain account for roughly 85% of the market share of the blockchain infrastructure layer where tokens are bought and sold. This raises the question of whether all 1,000 coins currently available are necessary. In the long run, they probably won’t.

Cryptocurrencies: number of tokens and coins

chart showing cryptocurrencies: number of tokens and coins
Sources: CoinMarketCap, FactorResearch

Funding with tokens

Crypto start-ups are funded with equity and tokens. Raising capital through equity means issuing shares that are privately owned by angel investors, venture capitalists and the like. These shares represent a stake that entitles the recipients to dividends and income when the company is sold.

Token funding is very different: it gives investors no legal claim on the underlying business. As a result, investing in tokens and stocks is not really comparable.

Naturally, startups pursuing token funding must convince investors that there is value to be gained by participating in the token sale. The typical argument is that the start-up’s product requires the use of tokens. This can create quite complex ecosystems that resemble small economies with their various stakeholders: the start-up is the equivalent of the government, the product a substitute for goods, the users for the consumers and the witness of the currency or medium of exchange. .

Since each token represents a currency, supply and demand should determine its price. Issuers of tokens and coins can influence the supply: Bitcoin, for example, limits the total number of tokens to 21 million, and Ethereum has bought ETH tokens and “burned” them. Since tokens represent cryptocurrencies, their demand should be influenced by their popularity.

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What is the correlation between token price and token volume?

However, the relationship between the startup product and the underlying token is not straightforward and therefore difficult to assess. Shareholders would like to own shares in a booming business that generates income. But token investors have no claim on those cash flows.

Worse, token investors face an information deficit, as start-ups do not release financial data about the underlying business. This puts them at a huge disadvantage compared to equity investors.

The best way for token investors to understand the value of their holding is to interpret the change in token volume as an indicator of demand for the associated product. The more popular the product, the greater the demand for the token, which should reflect an increasing volume of the token on the exchange.

But this relationship is not kept under control. The constant correlation between changes in token volume and token price across all tokens between 2014 and 2022, both monthly and annually, is close to zero. This indicates that there is no positive relationship between the business of the start-up and the price of its token.

Correlations between token price and token volume

Chart showing correlations between token price and token volume
Source: FactorResearch

But what about the correlation between token volume and the price of all tokens? The crypto space has its share of bad actors, and some token issuers may be more interested in misleading uninformed investors than building long-term businesses.

So what if we limit our universe to only the most successful stocks by market cap: the top 1000, the top 100, the top 50, and the top 10? The last of these categories has a combined market cap of approximately $100 billion and includes Chainlink and Uniswap. These tokens are associated with products that have some of the largest user bases in the crypto community. If they were normal companies, their assets would be quite valuable.

Again, the correlation between volume and price is negligible regardless of how it is measured. So maybe the product and the token have no relation to each other in the crypto space.

But if product utility doesn’t drive token performance, what does? The obvious answer is speculation.

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In cases like Shiba Inu, this is quite obvious. SHIB is a meme token without any underlying product. At best, it’s a bet for other investors to pile in and push the price up. This represents speculation in its purest form. Investors simply play a game of musical chairs and bet that they will find a seat before the music stops.

Top Token Price and Volume Correlations, 2017 to 2022

Chart showing token price and token volume correlations, 2017 to 2022
Source: FactorResearch

Axie Infinity provides a good case study of how this dynamic plays out. An online game where players battle to win tokens called Axie Infinity Shards (AXS), Axie Infinity became popular in 2021 as a source of income in emerging markets such as the Philippines and Venezuela. The token system, based on the Ethereum blockchain, was designed so that players must purchase digital pets called Axies with AXS in order to compete.

The price of an AXS token rose from $5 in May 2021 to a high of $160 in November 2021, before declining to around $47 at the time of writing. Volume increased significantly when prices rose in July 2021, but not during the AXS bull market in the six months that followed. There were periods when price and volume moved in tandem, but on average the correlation was only moderately positive at 0.5.

Axie Infinity Shard (AXS) price vs. volume

Chart showing the Axie Infinity Token (AXS) price versus volume
Source: FactorResearch

Coin price and volume correlations

But tokens are only one side of the crypto equation. What about coins? Do they exhibit the same dynamics? Theoretically, the price of both tokens and coins should depend on their usage. With tokens, the price should be determined by the company. But, as we have seen, this relationship is difficult to verify.

The price of coins, on the other hand, should depend on the number of transactions that occur on their associated blockchains. The more start-ups launch their tokens on Ethereum, the more likely the demand will be and the higher the prices of ETH coins.

But again, the correlation between coin volume and price was as low as it was for tokens. This suggests that the utility of coins also does not have a significant influence on their prices.

Coin price and volume correlations, 2014 to 2022

Chart showing coin price and coin volume correlations, from 2014 to 2022
Source: FactorResearch

There may be no connection between the coins and their use through bitcoin (BTC) and Ethereum (ETH), the two coins with the largest market capitalizations of $900 billion and $400 billion, respectively. Correlations did not exceed 0.5 for any of them over the past six years.

Bitcoin and Ethereum: Price and Volume Correlations

Chart showing Bitcoin and Ethereum: price and volume correlations
Source: FactorResearch

Additional thoughts

Of course, the correlation between stock price and trading volume is also quite low, so the premise of this analysis is easy to challenge. Many bear markets over the decades have seen the stock prices of companies with great fundamentals fall. Both tokens and stocks sometimes benefit and suffer from investor greed and fear.

So what is the difference between investing in crypto and stocks? The key distinction is that large companies can distribute earnings as dividends to shareholders regardless of the market environment. There is no parallel to cryptocurrency investing. There is also no buyback equivalent when equity investors receive a premium for their shares.

Even worse, forex investing is a zero-sum game. For every investor who profits from a USD or BTC position, another loses the equivalent amount.

Fortunately for crypto investors, fiat currencies have been on the losing side of this trade for some time now. But this trend is unlikely to last long unless blockchains begin to offer more utility and become more than just vehicles for speculation.

For more information from Nicolas Rabener and the FactorResearch team, sign up for their email newsletter.

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All posts are the opinion of the author. Therefore, they should not be construed as investment advice, nor do the views expressed necessarily reflect the views of the CFA Institute or the author’s employer.

Image credit: ©Getty Images / TERADAT SANTIVIVUT

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Nicholas Rabener

Nicolas Rabener is the CEO of FactorResearch, which provides quantitative solutions for factor investing. He previously founded Jackdaw Capital, a quantitative investment manager focused on equity market neutral strategies. Previously, Rabener worked at GIC (Government of Singapore Investment Corporation) focusing on real estate across asset classes. He began his career working for Citigroup in investment banking in London and New York. Rabener holds a master’s degree in management from the HHL Leipzig Graduate School of Management, holds the CAIA charter and enjoys endurance sports (100 km Ultramarathon, Mont Blanc, Mount Kilimanjaro).

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