Many crypto projects issue their own tokens as rewards to attract new users and accelerate adoption. Play-to-earn games, blockchain loyalty programs, and decentralized applications do this. Projects such as these usually have rapid early growth, but quickly die down after the initial interest.

One reason for this development is the token velocity problem. It refers to the speed with which the tokens are moved through the system. Users don’t hold onto the tokens; they sell their rewards right away. In this article, we’ll explain this problem and how it causes crypto economies to collapse.

What Is Token Velocity in Crypto Economies?

Token velocity is a term used by crypto experts, such as those at CryptoManiaks, to describe the rate at which crypto tokens change hands within the crypto network. It can be understood as the relationship between transaction volume and the circulating supply of tokens.

It’s an important metric for blockchain economies because it depends on scarcity and, therefore, the value of crypto tokens. Productive token use includes staking, governance participation, or collateralization. All of these require the user to hold on to a token. If a user sells the tokens right away, they are not using them productively.

Velocity increases because users treat crypto tokens as income rather than long-term assets to hold. Selling rewards is easy, and even seamless, when using a modern crypto market, and users have the incentive to do so.

 Why Reward-Based Crypto Models Create High Velocity

Reward-driven crypto economies are especially vulnerable to this problem because they incentivize users to sell their rewards as soon as possible. Users join platforms to earn rewards and convert them into real financial value.

Another major factor is the fact that the tokens are emitted continuously. Many projects distribute new tokens daily or weekly, and users are entitled to them if they regularly log in or use the app. If the number of new tokens grows faster than demand, their value will inflate.

Tokens that don’t provide sufficient influence or government capability aren’t worth holding. Finally, easy access to exchanges is another factor leading users to sell rather than hold reward assets. Exchanges have built their whole model on providing ease of use for trading, and crypto reward holders are using it.

Case Studies: When Token Economies Collapse

One of the best examples of a token economy collapse is the blockchain game Axie Infinity and its reward token Smooth Love Potion (SLP). Players were rewarded SLP for engaging in battles and completing in-game tasks. At first, strong player demand supported the token’s value. However, as more players joined the system, the token began to lose its value.

Players ended up farming the tokens much faster than the game was able to produce them. Eventually, the players became pressured to sell, and the token’s value fell sharply.

Move-to-earn apps have experienced a similar problem. These apps reward users with tokens for walking, running, or completing daily exercise. Early adopters benefited from the system, but once more users joined, the app couldn’t provide enough coins.

Liquidity mining programs in decentralized finance also illustrate the velocity problem. DeFi protocols issue rewards to promote liquidity, but the participants sell the tokens as soon as they get them. It attracts capital to the decentralized network, but doesn’t create a lasting demand. Over time, the constant flow of new tokens will destabilize the whole ecosystem.

The Economic Feedback Loop Behind Token Collapse

 The collapse of token economies is predictable, as it follows a cycle. As the activity grows and the pool of participants grows due to early demand, users will start selling their rewards to realize profit right away. It creates steady pressure to sell to earn right away and keep up.

Token prices will start to fall due to this activity. This provides a further reason for users to sell their tokens, since they no longer seem valuable. Over time, new users will stop joining, and demand for the token will weaken further.

The feedback loop will eventually lead to a reduction in both the value and adoption, and, in the end, make the token worthless.

How to Reduce Velocity

Sustainable crypto economies are working to reduce crypto velocity and encourage users to hold their coins. One way to do it is to use what’s called utility sinks. Tokens may be required for certain actions, so users must hold on to them. For instance, they may be needed for upgrades, transaction fees, governance voting, or access to premium services.

Staking mechanisms can also be used to slow circulation. Users are expected to hold on to these so they can generate profits in the long run. This can stabilize prices, but only as long as users believe it’s more valuable to hold the asset.

Conclusion

 Many crypto rewards systems fail because the systems behind them are designed to fail as more users join in. Users move reward tokens as soon as they can, a phenomenon known as token velocity, which weakens their price.