FDV: A Tale of Two Minds

When first hearing about a shiny new token, one of the first things most people do is go to coingecko, check the price, look at the market cap, and glance towards the elephant in the room, the big number: FDV, or “Fully-Diluted Value”. The degen in all of us sees a high FDV (in the 10–11 figure range) and immediately assumes that upside is limited, there’s little upwards price potential, and we’re too late. But is there more to the narrative?

(Although this post applies to all projects in crypto generally, at the end of this post, UXD protocol introduces a burn proposal to help with the narrative of high FDV/low float projects. Skip to the end section if you only wish to see this.)

A Tale of Two Minds

Plato famously divided the soul into three parts: the rational soul, the desiring soul, and the spirited soul. In short, these parts of the soul were responsible for rational thinking, fundamental cravings/desires (food, water, etc), and love for victory and honour.

2500 years later, and we can aptly replace “soul” with “mind” for most purposes, and “victory and honour” with “money, social status, and 9-figure APYs”. Doing so gets us pretty close to the internal mental conflict of many crypto traders.

FDV is a curious metric because of how it interacts with the rational and spirited minds of the crypto trader, sometimes in quite subtle ways. The goal of this post is to really pull the cover back on FDV, describe why it matters, why it doesn’t and how it is so incredibly misunderstood.

The Rational Mind

Let’s start with a first-order rational description of FDV.

Definitionally, Fully-Diluted Value is the Market Price of a token times its Max Possible Supply. This means, Fully-Diluted Value represents what the Market Capitalization would be if all tokens that are ever allowed to be issued by the protocol, were in fact issued, and they traded at the exact price they do today.

Taking UXP as an example, the token currently trades at a price of ~$0.07 at the time of writing. There are 10 billion total tokens that can possibly be issued by the protocol, giving an FDV of (10 billion)($0.07) = $700 million.

Already this logic has introduced two pieces that need to be evaluated:

1. Tokens allowed to be issued by the protocol
2. Tokens trading at the exact price they do today

Let’s start with the first. The concept of “tokens allowed to be issued by the protocol” might be one of the biggest red herrings in all of crypto, because in itself it is not a terribly informative number. This is the argument against FDV, in itself mattering, because it requires additional context. Most notably, the inflation schedule for a protocol is far more important than its FDV. Why? Consider the following two protocols:

• Protocol A has an FDV of $200mm. Its current market cap is $10mm (meaning 5% of the token has been issued). Protocol A plans to issue the remaining 95% of tokens over the next 95 days, and perhaps this plan is unknown to Token holders. Even if it is known, token holders watch their ownership % of floating token supply get diluted by a factor of 20x over this few month period and would have to impute price impacts over that period.
• Protocol B has an uncapped supply. Its FDV is therefore infinite. But, Protocol B has controls in place to guarantee that its inflation schedule is 5% per year for the next 100 years. Token holders know from day 1 how much their ownership % will be diluted over time and can plan accordingly.

In the above examples, the concern isn’t with the FDV per se it’s with the rate of dilution. Another example shows that FDV is much less important than the probability that such tokens are ever issued. Consider the following two protocols:

• Protocol A has a high FDV, and 20% of the Max Possible Supply floats on the market. The protocol details a smart-contract guaranteed plan for issuing 80% of the Max Possible Supply over the next 4 years, so there’s a 100% probability that the supply reaches its cap in 4 years’ time.
• Protocol B has the same high FDV, and 20% float. The 80% remaining are in a DAO treasury and can only be spent by the approval of existing token holders. This control fact alone significantly decreases the probability that many of these tokens ever see the light of day, as token holders are unlikely to dilute themselves unless there is a good reason to do so.

A token with a low probability of being issued can be thought of as less dilutive than a token with 100% probability of being issued. The result is that the marginal token in the second case really should “contribute less” to the FDV than the marginal token in the first case. This example also highlights that the mechanism through which new tokens are issued (fixed inflation schedule vs DAO governance) tends to change this probability.

Ok, so what do we have so far? The above logic implies that there are clear cases in which FDV alone is not the most important metric for understanding dilution/issuance mechanics, and understanding the inflation/emission schedule and the probability of those emissions is altogether more important for understanding the concept of “Tokens allowed to be issued by the protocol”, which was part 1 of our FDV definition.

It’s also worth contextualizing “Tokens allowed to be issued by the protocol” with the concept of “Authorized Shares” from traditional finance (only in concept, not in legal status!). Authorized shares are the number of equity shares a company is legally allowed to issue pursuant to its legal documents. Replace “equity shares” with “tokens” and “legal documents” with “smart contracts”, and this becomes the “Tokens allowed to be issued by the protocol”. FDV is a concept unique to crypto, and traditional equity markets give almost zero merit to the concept of Authorized Shares.

Why don’t equity markets care? Because of the two factors discussed above. 1. traditional management (protocol team) provides “forward guidance” (medium posts, tweets) on how many Authorized Shares will become outstanding each year, which gives some certainty around inflation/issuance schedules. Moreover, equity markets view the probability that all Authorized Shares are ever issued to be quite low, they’re just there if needed. And, as discussed later in this article, there is a trust assumption around traditional equity management teams, making this forward guidance on share issuance credible.

Moving to the second point: “Tokens trading at the exact same price they do today”. What determines price today? At any given point, a token price is a simple balancing of supply and demand. By definition, at the current token price, supply=demand=market cap. FDV makes the insane assumption that we can perfectly scale up supply and demand by a constant factor, i.e. each token issued is met by the demand to buy that token at the current market price.

But, no one can reasonably predict the supply/demand dynamics in the next hour in the crypto world, let alone in several years (the point at which many projects will hit their Max Possible Supply). Pretending that you can predict this far into the future, the Rational Mind says, is anything but rational. Demand will increase/decrease depending on crypto market sentiment, the progress of the protocol, new product offerings, competitors, etc. It’s impossible to equilibrate today what will happen tomorrow.

However, there is something useful to be gleaned from the FDV from a supply/demand perspective: FDV gives a lower bound on what demand must eventually be at the Max Possible Supply in order to keep price constant. If demand for each incremental token is projected to decrease, then the eventual market cap will be less than today’s FDV. It is therefore rational for a protocol to only issue tokens as demand concurrently increases.

In summary, the Rational Mind has told us that FDV is a rather incomplete metric, traditional equity markets don’t care about such a concept at all, and it’s irrational to try to project demand into the future. Does that mean FDV is wholly worthless? Not quite.

The Spirited Mind

Keynes was one of the 20th century’s greatest economic minds, having written The General Theory of Employment, Interest, and Money and laying the groundwork for modern macroeconomics. (Many people reading will be familiar with the below concept, but it’s included in this article for completeness!) In chapter 12, Keynes uses an analogy to help explain the psychological component of equity market prices:

Suppose a newspaper puts out a “beauty contest”, and prints pictures of one hundred individuals, and asks individuals to chose the top six most beautiful people. The answers will all be tallied, and whoever chooses the top six people correctly (as voted on by others’ choices for the top six), will receive a prize.

If you were entering such a contest, the first thought would be to pick the six people you find most beautiful. Now a moment’s thought may reveal that just because you find someone beautiful doesn’t mean the average respondent will too. A second order thought process would be to pick the six people that you think the average respondent will find the most beautiful. But the rational thought doesn’t stop there. As Keynes puts it: “It is not a case of choosing those [faces] that, to the best of one’s judgment, are really the prettiest, nor even those that average opinion genuinely thinks the prettiest. We have reached the third degree where we devote our intelligences to anticipating what average opinion expects the average opinion to be. And there are some, I believe, who practice the fourth, fifth and higher degrees.”

In actuality, the game becomes guessing what you think other people will think that other people will guess. In essence, each of these degrees are a distinct style of investing. Value investing a la Ben Graham practices the first order, “pick what you like”. Casual stock investors and people with the ability to perceive trends often follow the second order. Professional equity traders and crypto, with its (3,3) game theory, ponzinomics, and other absurd mechanisms are the most akin to the third degree.

What does this have to do with FDV? FDV is a reliable metric insomuch as the average person believes that the average person will think FDV is a metric of primary importance. If everyone believes FDV is a useful/important metric, the prophecy becomes self-fulfilling and its importance is forced into existence. I doubt anyone can mention a project without hearing someone reference its FDV, and so FDV has taken on the importance that, regardless of one’s personal opinion of FDV, there is consensus that there is consensus about its usefulness. It seems that this is the cause of much of the “FDV is a meme vs FDV is incredibly important debate”. Both things can be simultaneously true. High FDV may not matter to the Rational Mind, but if it matters to the Spirited Mind, it matters.

It’s worth noting that these sort of “contradictory” metrics can be found in traditional finance as well, with metrics as fundamental as EV/EBITDA or Price/Sales sometimes being reduced to absurdity on a Rational Mind basis, but still very much mattering on a Spirited Mind basis.

The other primary effect of FDV on the Spirited Mind is the strong anchoring effect. Most people are familiar with the idea, but still susceptible to it anyways. Once the mind becomes familiar with a certain number or set of reference numbers, related numbers are understood in the context of those numbers, even if the comparison is not as relevant. For example, two Protocols with the same FDV will immediately experience some sort of equivalence in the mind of users/traders, without paying attention to any of the rational factors listed earlier. This is natural, and takes almost superhuman discipline to prevent the visceral reaction. Moreover, returning to the previous argument, if everyone believes that everyone strongly experiences anchoring, then the effect of anchoring will become much more prevalent regarding trading decisions.

Trust & Flexibility

The other unspoken component of FDV at the intersection of the Rational and Spirited Minds is Trust. One of the reasons people do not like high FDV/low float is due to the introduction of a trust assumption, in a world of a decentralized trustless mantra. On the second point from earlier about the probability of issuance of tokens, said probability is directly proportional to the trust of the underlying DAO/team. In the case of AAPL stock, the equity markets have a high level of trust in AAPL management being forthright in their communication, and so are able to discount issuance tail events to zero. In the case of ten anons running a crypto protocol, the trust assumption is rightfully much, much lower. No matter how communicative or trustworthy said anons/DAO might seem, there’s a trust assumption and that (rightfully so) makes crypto veterans uneasy.

However, the other side of the coin here is Flexibility. In many cases, Flexibility or autonomy is synonymous with introducing a trust assumption. The thing that makes people uneasy is the “fact that the team/DAO can do whatever they want with the to-be-issued supply”, but the point of the setup to begin with often is that “the team/DAO can do whatever they want with the to-be-issued supply”, i.e. there’s flexibility to adapt to new opportunities, new market conditions, and new productive uses for the token. In some sense, FDV/float represents the “degree of tightness” of the handcuffs on the team/DAO. If this ratio is 1, then there is no trust assumption, but also no flexibility. If the ratio is large, there is a massive trust assumption, but also tons of flexibility. The right answer is probably somewhere in between.

Concluding Thoughts

In summary, FDV is a fickle beast. The Rational arguments probably fall in favor of it not being terribly important, but the Spirited arguments to its importance are no less valid. The Solana ecosystem in particular is grappling with issues of high FDV/low float projects as we speak, and projects need to be communicative about their tokenomics moving forward.

Everyone has seen the widely circulated Solana ecosystem starter pack:

Returning to the first component of the definition of FDV: “Tokens allowed to be issued by the protocol”, as well as the “Trust & Flexibility” discussion, UXD Protocol believes that projects need to tighten their handcuffs and either partake in token burns or offer binding inflation schedules to help remedy the effects of high FDV/low float.

UXD Burn Proposal

UXD Protocol believes that the best way for UXD specifically to lower the implicit trust assumptions and create a more sustainable ownership structure longer term is to introduce a UXP gov token burn. UXD Protocol wants to be completely transparent about the implications of a burn proposal, and so includes effects on ownership of the protocol, etc below. With that in mind, UXD Protocol intends to introduce the following burn proposal some time in the next few months.

Proposal

• Burn 30% of UXP Governance Token Max Possible Supply, or 3 billion (3,000,000,000 UXP Tokens).
• Burned Tokens will come from “Community Fund” which currently holds 57% of UXP Governance Token Max Possible Supply, or 5.7 billion (5,700,000,000 UXP Tokens).
• Institutional UXP Governance Token Holders (such as Multicoin Capital) that we know have participated in the IDO will be asked not to vote on such a proposal.
• UXP Core Team members will not vote on such a proposal.
• Staked UXP Tokens will be able to vote on the proposal (details to follow).
• Definitionally, this burn would increase the % ownership of all current UXP holders by ~43%, this includes all current holders, Team, Investors, Treasury, Token Sale, and any other UXP Gov token holders (staking rewards holders, discounted bond sale holders, etc).

As a reminder, UXP Governance Token distribution is currently as follows:

Post burn proposal, the allocations would be as follows:

Because this proposal will only be voted on by the community (non-core team, non-investors to the extent such investors comply), it will only pass if the community agrees that the pros (more sustainable tokenomics) outweigh the potential cons (higher ownership percentage for all current holders, including team + investors). Most burn proposals fall subject to this con, as it is nearly impossible to renegotiate investor + team legal contracts post facto. If the community does not wish to go ahead with the proposal, UXD Protocol will propose a restricted inflation schedule in order to “tighten” the token issuance handcuffs.

Cheers!

Disclaimer: UXD Protocol does not consider UXP Governance Token as a security or other “investment contract”, and nothing in the above article should be taken as investment advice. Any comparisons to equity contracts or other investable securities are for illustrative purposes of analogy only and do not indicate any further relation to said equity contracts or other investable securities. The intent of the burn proposal is not related to any form of investment returns.