Polkadot (CCC:DOT-USD) is now the eighth-largest cryptocurrency according to CoinMarketCap. Its market capitalization was $45 billion at $45.88 on Nov. 10. DOT is likely to keep rising as it has in the past several months based on its recent parachain crowd loan auctions.
I described what these auctions were all about last week in my previous article. The key takeaway you should have about these auctions and the associated crowdfunded loans with Polkadot parachains is very simple.
The net effect will be to reduce the supply of DOT crypto tokens in the trading supply for the next two years. Here is how this will work.
Crowdfunded Polkadot Loans
The various parachains are required to post a lot number of Polkadot tokens in order to lease space on its blockchain platform. They have to do this in order to build out their parachain apps. But Polkadot wants them to post these DOT tokens in order to ensure that, based on an auction of the space, the best and most well-funded parachains get the space.
The parachains are able to post these tokens by raising the capital through crowdfunded loans from DOT holders. They promise various interest rates and rewards in return. But the money has to be “lent,” or staked, for two years.
So, if you follow what is happening here, the net effect is the same as what a company does when it buys back stock. The total supply of DOT tokens will be lower.
As anyone who has taken an Economics 101 course can attest, the supply and demand curve determines the price of an asset. So, with a lower supply of DOT crypto tokens, the price will rise, all other things (i.e., demand) being the same or higher.
The Acala Auctions
As an example, one of the parachains that is raising crowd loans is the Acala project. It is probably one of the most well-known parachains. I wrote about this project and two others, including the Moonbeam project and the Astar project.
Acala now has a website that shows its daily crowd loans. As of Nov. 10, 12.3 billion DOT tokens had been loaned, and the project had $572 million total value locked (TVL). Additionally, Acala has a separate site that shows how easy it is to provide one of these DOT loans.
Given that Polkadot has a total market value of $45 billion, the TVL works out to 1.27% of the total market cap just for this one parachain.
There are many such parachains throughout the platform. I roughly estimate that at least 10% of the market value of the total DOT token supply could be tied up in auction-related loans.
Velocity and Multiplier Effects in Polkadot
By the way, this doesn’t just mean Polkadot could rise by 10%. Given what economists call the “velocity of money,” the effect could be significantly leveraged. Depending on how many DOT transactions occur and the speed or velocity, there could be a multiplier effect.
The same thing is evident if you squeeze the opening of a hose. With just a 10% reduction in the opening (i.e., a supply disruption), the speed or velocity of the exiting water is more than 10% faster.
The same effect will occur with the price of DOT tokens. I think we could see a four or five times multiplier, and Polkadot could rise another 50% as a result.
The effect of the new parachain auctions at Polkadot could be quite significant. Don’t be surprised if the total cumulative effect is another leg up for the cryptocurrency.
And don’t forget the self-reinforcing effect of a crypto price, which is often seen in crypto markets. Once a crypto asset starts rising, it can overdo it. The initial reasons for the rise get overtaken by the rise itself. The crypto starts to rise simply because it is rising, and investors understand the reasons for the uplift.
Therefore, look for DOT to rise more as the effects of a reduced supply take hold. This could start to happen well before the results of the ongoing Polkadot blockchain spectrum auctions are finalized.
On the date of publication, Mark R. Hake did not own a position in any security mentioned in the article, either directly or indirectly. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.