Posted February 22, 2024 at 8:00 am EST.
Recent weeks have seen widespread criticism of the late January “airdrop” distribution of JUP, the token of the Jupiter decentralized exchange aggregator on the Solana blockchain.
Critics attacked what they called an unfair distribution, but above all a short-term “liquidity pool” that many saw as a back-door crowdsale at an inflated price. In a recent conversation with Unchained’s Laura Shin, Jupiter founder Meow acknowledged some mistakes as learning opportunities, while refuting other criticisms.
Less scrutiny, though, seems to have been paid to the results of the airdrop (if that’s the right thing to call it). With the distribution of 1.35 billion out of a total 10 billion supply at prices that reached USD$0.71 per token, the implied value of all 10 billion Jupiter tokens went as high as $7.1 billion. That implied value is a metric known as “fully diluted valuation,” or FDV. The $JUP token price has declined since, with FDV now at a more restrained $4.6 billion.
For notable onlookers including Placeholder Capital’s Chris Burniske, those results seemed a little off.
How do people think about the fully-diluted valuation delta between $JUP (~$5.4B), the #1 aggregator on Solana, versus $ORCA (~$365M), the #1 DEX on Solana?
Justified? Irrational? Market structure based?
Genuinely curious 🙏
— Chris Burniske (@cburniske) February 19, 2024
Burniske’s point is that it seems strange for an aggregator to be valued at nearly 20 times more than the upstream exchange whose prices it is aggregating. As we’ll see, Jupiter’s FDV also seems out of line with the value of established non-crypto firms.
Fully Distorted Valuation?
Several commenters pointed out that Jupiter is simply the hot new thing, with exaggerated valuations as a result. But the deeper issue may be the way “fully diluted valuation” inherently distorts our sense of crypto projects’ value, particularly in the wake of an initial sale.
The core issue is that, because only a small share of tokens are actually offered in the open market, the prices reached in an initial sale don’t accurately reflect demand for stakes in the project as a whole. Some refer to this type of token as “low float, high FDV,” because of the constrained supply of tokens subject to price discovery, or “float.”
As a financial metric, FDV could be most directly compared to the “market capitalization” of publicly traded companies. Market cap is the total market value of all outstanding equity shares in a company, reflecting the market’s opinion of the total value of that firm – including shares owned by company insiders (leaving aside some marginal added nuance around the exercise of warrants and options).
Initial token sales, meanwhile, are obviously comparable to stock-based IPOs. Stock IPOs on average sell about 20% of equity to the public. Jupiter’s initial 13.5% public distribution is well below that average, potentially exaggerating FDV by constraining supply. But it’s far from the worst offender – some initial token sales have offered as little as 5% of total supply, creating a drastically distorted picture of overall demand and momentum.
Comparing Jupiter’s “FDV” to equity market cap valuations further highlights how the metric might mislead. Does it really seem reasonable that Jupiter, a service that nobody outside of crypto has heard of, much less used, should have a market value in the same ballpark as Levi Straus, The New York Times, and Hasbro Toys?
How FDV Misleads
FDV is a distorting metric because of the constrained supply of tokens on the open market. Generally, less than 20% of a token’s total supply is offered in a public sale, with the remainder either procedurally “locked” and impossible to sell for a certain period of time, or held by large investors who won’t or can’t sell for similar reasons.
This is a problem because the price determined on public markets is then applied to all of these illiquid tokens to calculate FDV – but if those illiquid tokens were on the open market, the price of the token would be proportionally lower. From this perspective, FDV is inherently misleading as an index of the market value of a project like Jupiter. And high proportions of a network’s tokens can remain off the market for years after such an initial sale, continuing to limit true price discovery – and keeping FDV misleading.
This is even true when comparing the FDVs of different crypto projects, since variations in the share of tokens offered publicly in turn distort FDV to different degrees. For example, a project that offered 50% of its total token supply in an initial sale might end up with a vastly lower FDV than a project that only offered 5%, even if the former project had more users or a better product, simply because of greater floating token supply.
A Ticking Time Bomb?
And FDV is more than just a potentially misleading headline metric: it may also inherently create systemic financial risk.
This dangerous dynamic was on terrifying display not so long ago in the collapse of FTX. At the heart of the FTX scam was the use of so-called “Samcoins” including MAPS, OXY, and most of all, FTT, as nominal collateral for the lending of customer funds from FTX to Alameda – loans that brought down Sam Bankman-Fried’s empire because they took “fully-diluted value” a little too seriously.
Of course, a court has since concluded those loans were criminally fraudulent. But they would have blown up FTX regardless of their legality, because the distorting nature of the FDV metric made them appear on paper to be worth vastly more than they could ever have brought in an open-market sale. When Binance announced it would liquidate its large FTT holdings, the token’s price tanked – and suddenly, both FTX and Alameda were functionally insolvent.
What makes this dynamic truly scary is that FDV exaggerates harmful incentives for the team behind a token. A token’s founders are motivated to get FDV as high as possible for numerous reasons, and constrained public supply gives them more leverage to do that. Meanwhile, the tokens making up that FDV – including those that are technically locked or otherwise nominally illiquid – could be used in non-transparent, off-chain ways. The role FTT and OXY played in FTX’s collapse could easily be filled by any other low-float, high-FDV token in a future blowup.
Speaking to Laura Shin, pseudonymous Jupiter founder Meow admitted the pricing of JUP in the launch liquidity pool was “a bit too high.” Meow’s explanation was that previous launches had been priced too low, angering the community when bots successfully profited from scalping the sale. That’s a completely reasonable claim, and reflects the challenge of pricing initial offerings of all kinds: because there is no existing market, such opening prices are almost inevitably ‘incorrect.’
But the reliance on FDV as a proxy for a project’s success creates sector-wide motivation for pricing distortions in initial sales, because small changes in the price of a small slice of a project are amplified across the entire token supply when calculated as FDV. Furthermore, those initial prices have some degree of “stickiness,” meaning an initial inflated FDV can distort perceptions and markets long-term.
To be clear, there are similar flaws in calculated equity market caps, particularly in private venture capital markets. The prices of small private investment stakes are, much like public token offering prices, extended to calculate a startup’s entire value.
But this parallel shows exactly why crypto should be nervous about FDV as a metric: traditional startups have demonstrated just how rapidly these implied valuations can collapse. Most infamously, WeWork reached a “fully diluted valuation” of $48 billion in 2019. But as soon as the company attempted to enter the public market – that is, as soon as it exposed more of its equity to price discovery – that headline value began to crumble. By the end of 2023, WeWork had filed for bankruptcy – sending its “FDV” straight to zero.
David Z. Morris has been writing about cryptocurrency since 2013, publishing some of the first serious mainstream coverage in outlets including Fortune, The Atlantic, and Slate. He is the former lead columnist for CoinDesk, where he was part of the team that exposed Do Kwon and Sam Bankman-Fried, and created the Crypto Crooks documentary series. He is currently building Dark Markets, a newsletter focused on financial crime and elite corruption. He also provides communications services to privacy, identity, and cybersecurity projects: potential conflicts of interest will be identified in his columns for Unchained.
