On the blockchain, there has been an explosion of new forms of financial products known as decentralized finance (DeFi). Elastic supply tokens are a relatively new and lesser-known idea in the DeFi space.
The supply of these tokens is algorithmically modified in smart contracts through a mechanism known as rebases. Elastic supply tokens are also known as rebase tokens because of this.
When tokens are priced above or below the target price, supply changes (rebases) occur, essentially expanding or contracting their supply.
Elastic Supply Token
Elastic supply tokens are assets whose supply is determined by their price and fluctuates accordingly.
The total token supply of an elastic supply project is basically adjustable. Rebases change the total token supply of a specific crypto project on a regular basis.
Let's assume you have one XYZ coin that is currently worth $1. You will have two XYZ coins tomorrow. Rebasing, on the other hand, has reduced the value of each coin to half of what it was yesterday ($0.5).
What are the benefits of using elastic supply tokens?
The basic idea behind this principle is that supply changes ensure that the value of these tokens remains constant.
Because of their ability to keep the value constant, elastic supply tokens are also compared to stablecoins. There are, however, some significant variations between the two.
Stablecoins are based on the fixed exchange rate theory, which holds the coin price stable by pegging it to another physical commodity.
Elastic supply tokens, on the other hand, use a time-varying token supply to achieve a target price.
Elastic supply tokens, unlike stablecoins, do not attempt to remove uncertainty. Instead, they want to minimize it to the point that the token's intended value is realized.
The overall supply of the project is balanced so that as the price rises, so does the supply. The value of each token decreases as the supply grows.
Similarly, when the price of a project is reduced, the overall supply of the project is reduced in order to raise the price. As you can see, the project's total token supply is guided by the same demand and supply logic.
Are there any risks associated with tokens with an elastic supply?
Investing in tokens with a fluctuating price can be dangerous. The odds of losing money are higher with elastic supply tokens. Sure, this will help you increase your profits, but it can also help you increase your losses. If rebases happen when the token price is falling, you will not only lose money, but you will also own less and less tokens after each rebase!
Another explanation why investing in elastic supply tokens may be risky is that they are an experimental asset, which means there is a higher probability that projects' smart contract code would contain bugs.
Final words
Despite their infancy, elastic supply token projects are gaining traction and can open up new use cases in the DeFi room. In the future, tokens with elastic values may be a viable alternative to stablecoins.