Understanding the concept of a hard cap asset in relation to cryptocurrency markets is the theme of this article. We’ll give you background information and show you how to use the info when valuing crypto coins.
With the emergence of blockchain technology, there has been a significant boom in new terms. One that has garnered a great amount of popularity in recent years is ‘Initial Coin Offering’ (ICO). This term refers to a particularly common method of fundraising whose existence is thanks to blockchain technology. To this day, ICOs keep on bringing in millions of dollars for the construction of startups.
A lot of investors are already knowledgeable about the basic idea behind ICOs. However, much like with other innovative concepts, there is more to it than a single-sentence definition. The steep learning curve has the potential to keep the majority of people from understanding the specifics. Overall, it is difficult for them to grasp the issuance of tokens and the measurement of the fundraising’s ‘success’.
Indeed, many are familiar with the concept of an ICO, but very few know about the terms of measurement. Specifically, that of ‘hard caps’ and ‘soft caps.’ This article will focus primarily on the former, but it will shed light on the latter as a means to compare the two.
Initial Coin Offering
Before we get into what a hard cap is, we must first take a brief look at ICOs. First and foremost, ICO is an acronym for ‘Initial Coin Offering’. This is a crypto spin-off of the Initial Public Offering (IPO). This is the process that pertains to offering shares of a private corporation to the public in a new stock issuance. The two share a few similarities, as well as major differences, but we will not focus too much on that.
In the case of traditional startups, there are a few ways to go about raising the funds a development needs.
- They can start off small and later grow as their profits allow. With this method, the company is not indebted to any shareholders. Moreover, they may have to wait longer for scalable growth while they build up a business.
- In lieu of this, companies can look to outside investor(s) for early support. These early investors provide a cash infusion to the startup company. Though, there is the expectation of owning shares and potentially profiting from their portion of the ownership stake.
What typically happens is a company looking to create a brand new coin, app, or service will launch an ICO. Investors that show an interest will buy into the offering. Most of the time, they get these first out ‘shares’ for a price that is at a discount. In order to participate, they will purchase the brand new tokens using Ether, bitcoin, or USD. In exchange for their approval and support, investors will receive a new cryptocurrency token. One that is specific to the ICO project.
If you want to read more about ICOs, read “What is an ICO?”
The Modern Crowdsale
When you take ICOs at face value, they appear very similar to other fundraising methods. For that matter, they bear a striking resemblance to methods that have been popular for decades. Put simply, one would be quick to think that there is nothing new about ICOs. Regardless, it is common for people and teams with big ideas to look to the public for financing. Through this, they hope to create a final product of value or necessity.
It is clear to see that ICOs take inspiration from IPOs. To reiterate, this is when private companies first sell their stock shares to the public. The transition from a private company to the public can be a crucial time for private investors to fully realize gains from their investment. This is because it usually consists of share premiums specifically for current private investors.
However, there is something important to keep in mind. Whenever a member of the public invests in an ICO, they do not receive stock ownership in a company. They are instead simply purchasing a digital currency or token that plays a role in the network. What’s more, theoretically speaking, it could rise in value later on down the line. During the sale, the bulk of ICOs allows users to ‘buy-in’ exclusively with digital currencies. Bitcoin and Ethereum are two notable examples.
A common description of ICOs is that they are disruptive. The reason for this is courtesy of their reduced barrier for entry. In theory, anyone can launch an ICO or provide a contribution to the funding of an ICO. As a result, it can effectively create a new wealth of opportunity for developers all over the globe.
There are some ICOs that choose to set a limit on the total amount of coins that can be bought. Others, on the other hand, decide to offer a limitless supply throughout the duration of the sale.
ICOs that choose to establish a ‘cap’ will often have a maximum amount that they can fund. Furthermore, one that will refund any transaction that occurs as soon as there are no more tokens to sell. In essence, these operate strictly on a “first come first served” basis. It’s true that this puts a limit on the maximum amount of funding that the team can procure. However, champions of supply models that have a limit believe that it creates a strong sense of value.
Setting a limit to the number of tokens on sale ties to digital currencies that employ a maximum supply cap. While its launch was not through an ICO, Bitcoin is a great example of a cryptocurrency with a maximum supply cap. Many supporters look to Bitcoin’s fixed supply as one of its use cases. This is mostly because the digital asset is akin to a digital version of gold.
Conversely, other ICOs decide to go the route of not limiting the number of coins that can sell during the sale. A majority of these projects will sell tokens for a specific period of time. There are some, though, that choose to employ different models like inflation, drawing from fiat currencies. Moreover, they don’t apply restrictions on how many tokens people can buy during the initial offering.
There are a lot of arguments for and against digital currencies possessing a maximum supply cap. Be that as it may, the debate ultimately boils down to preference. Project developers choose the best model. Likewise, the public chooses the projects they fund.
What is a ‘Hard Cap’?
With the establishment of what ICOs are and introducing the methods of success measurement. We can finally get into hard caps.
A ‘hard cap’ is the maximum amount of money that a cryptocurrency can receive from investors during its ICO. The determination of this ceiling is by the project’s creators. Any attempts to buy a token or digital currency that already reached its hard cap will typically go through reimbursement.
To summarize an ICO’s purpose, it is the process by which new cryptocurrencies make their coins public. Furthermore, when they start to sell them directly to people. This process is under a time limit, as is the case with most instances of fundraising. People invest their money in these coins out of a belief that they will later be worth more. They hope that the value will increase at a later date; much more than what it was upon purchase.
Overall, a hard cap is the major financial goal and it is always larger than whatever the small cap is.
Hard vs. Soft
When it comes to evaluating an ICO, prospective investors usually understand the significance of both capped and uncapped ICOs. Still, there are many that still don’t fully understand the difference between soft caps and hard caps. Or understand the token emissions schedule, for that matter. With that in mind, let’s go over the differences between the two caps.
A ‘soft cap’ is the minimum amount that a project can fund in order to be an official success. The developers of the ICO are the ones who establish this metric. Moreover, it is the team’s way of specifying the minimum amount of money that’s a requirement to continue the project.
Oftentimes, if there is a failure to meet a soft cap, the team refunds all purchases. Furthermore, speaking in official terms, the project is unsuccessful. Sometimes, though, the project may proceed with whatever they could raise. This is even if the amount is under its soft cap. Without oversight, this is mostly the decision of individual projects.
When you get down to it, a soft cap and hard cap are both fundraising goals. A hard cap is the absolute upper limit that a team will take. A soft cap, on the other hand, is a bit more speculative. A soft cap is a much lower limit; basically how much a team is hoping to raise. If a team receives donations that surpass their hard cap, investors will get the funds back. Failure to do so is usually a big red flag for investors.
Failure to reach their soft cap means that there will sometimes be a return of funds. At this point, the project is essentially on life support. However, there is some ambiguity concerning soft cap, and whether or not the team returns funds or decides to proceed regardless.
The ‘Capitalization Rate’ (i.e. the ‘cap rate’) is a fundamental concept, especially in fields like real estate investing. For those knowledgeable in finance, but new to real estate, here is an easy way to understand a cap rate. Think of it as the reverse of the price-earnings ratio (P/E) that the stock market typically uses. This helps with valuing a company measuring its current share price relative to its per-share earnings (EPS).
The P/E ratio measures the price – or market value – of a stock divided by its earnings with each share. The cap rate, however, measures the annual income of a property, divided by its cost or value.
So, what exactly does the cap rate tell us? Well, for a simple answer, the cap rate measures a property’s yield in a time frame of one year. This effectively makes it easier to compare one property’s cash flow to another. And it can do so without including any debt existing on the asset. Basically, it provides the property’s natural rate of return.
An additional way to look at cap rates is to think about it as a measure of risk in the deal. What kind of return would you expect when you consider the risk of the property or asset? With everything else being equal, properties that are older and possessing fewer credit-worthy tenants may have more risk. Thus, it would be lower in price which in turn results in a higher cap rate. Several factors that may also contribute to the risk premium include:
- Diversity among the tenants
- Length of leases in place
- Condition of the property
- The location
Therefore, there can be a substantial impact on the property’s value and its cap rate as well.
When to avoid using them
Cap rates are indicative of an important valuation tool, but only when under the appropriate use. Be that as it may, the cap rate alone should never be the sole deciding factor when making an investment. For that matter, it is important to point out that there are cases where cap rates don’t apply. For example, cap rates are not a useful tool in the evaluation of fix-and-flips and other short- term investments. Specifically, where the main goal is to exit quickly by way of sale. These types of investments are not capable of generating income from rent. Thus, one cannot measure them on a cap rate basis.
Investors need to be aware that the cap rate is not the same as the cash-on-cash return. The determination of that is by the amount of cash flow following the payment of debt service or mortgage payments. Moreover, what is divided by the total amount of cash in the investment? Admittedly, both can be very useful when evaluating the potential profitability of an investment. However, cash-on-cash takes debt on the property into account, whereas the cap rate does not.
With COVID-19 continuing its spread, many are wondering about the state of hard cap currencies. Particularly in light of a new financial crisis.
In these trying times, Bitcoin’s “digital gold” is preserving stability decently. This is because of the cryptocurrency’s low issuance supply schedule, as well as a hard cap of 21 million bitcoins. As a result, the theory on how an economy running on gold would react to an external shock comes to mind. A disruptive force like the current global pandemic we are facing leads to questioning about a future bitcoin economy.
In a report from CoinDesk last month, both Bitcoin and gold were rising. This was because of the U.S. Federal Reserve providing an indeterminate amount of aid to the private market. Looking at it from a supply perspective, both assets were sitting still. Meanwhile, the Fed is making attempts to outpace the virus. The central bank comments on this, saying the following:
“The Federal Reserve will continue to purchase Treasury securities and agency mortgage-backed securities in the amounts needed to support smooth market functioning and effective transmission of monetary policy to broader financial conditions.”
A safe-haven asset?
So, with such a policy’s obligatory inflation concerns, what would an alternative world look like? What if we operate on gold?
Austrian economist at the Ludwig von Mises Institute, Mark Thornton, provides an answer for this. According to him, the value of money relying on gold would not artificially inflate. However, mainstream economists have some concerns regarding central bankers. They worry that they would have far fewer ideas and options to enact in the event of financial collapse.
As is the case with any market, determining the gold’s value is a joint task by two factors: supply and demand. There is, however, some natural limits pertaining to the amount that is available within a given year. The average amount of gold mined per year is roughly 2% of the total supply (that we know of, anyway).
According to Thorton, in recent years, the price of gold was increasing. This is mostly because the price of gold is in dollar terms. As the amount of dollars on the market continues to grow, so too does the price of gold.
In the eyes of many, gold is, in fact, a safe-haven asset. It functions as a hedge on inflation in financial crisis events, similar to what we are experiencing right now. Supporters of Bitcoin, like Messari co-founder, Dan McArdle, believe the conservative features of the crypto will bring long-term value similar to that of gold.
In a tweet, McArdle states the following:
“Bitcoin is a hedge against inflation & loss of confidence in fiat, NOT a hedge against a typical recession.”
For a lot of Austrian economists like Thornton, gold’s value ultimately boils down to economic theory. Specifically, theory comes from the 1871 book, Principles of Economics, by Carl Menger. Put simply, Menger states that everyone determines value subjectively. A society, on the other hand, conjures up a price that someone can buy or sell on the open market.
The overall value of gold is subject to a demonstration by the continuous use of it as a store of value. Thus is especially noteworthy in the midst of recessions or financial crises. Thorton states that:
“The supply schedule for gold is relatively stable. The quantity of gold supplied is a response to the demand for gold and its price.”
In the end, how exactly would an economy thriving on gold differ from the current economy? The co-founder of Goldmoney, Roy Sebag, offers a rough idea. Right off the bat, a stable medium of exchange would force people to be more responsible with their money.
This will eventually lead to two outcomes: A stable money supply would essentially make it tricky to stack up large corporate debts. Consequently, it would restrict the dangers of a financial crisis not unlike the 2008 recession. However, it would also assist in the distribution of wealth across the economy more efficiently. Sebag claims it would do better than current systems.
Sebag says that, first and foremost, a fiat system that inflates the currency to protect against business failings has unsatisfactory results. It typically leads to companies taking out too much debt. Imagine commercial airlines buying back stock in the middle of exciting times. What’s more, imagine them doing this rather than investing in their services. You can see the point Sebag is making on Capitol Hill. To elaborate, Congress is weighing an expensive stimulus package along with protections for an array of firms, like Boeing.
Instead, failures would be able to occur. That being said, they would not transform into something colossal in the first place. On a gold-based system, Sebag says:
“Failure happens often and resilience becomes the integral ingredient in defining prosperity.”