Are Token Buybacks Problematic?

Of the many loathsome events in 2022, one of the worst was the recurring collapse of cryptocurrency exchanges. One identifiable pattern in these collapses is the astonishing amount of buybacks exchanges executed on their own native token. So, are token buybacks problematic, and what impact did they have, if any, on the market activity of 2022?

What are token buybacks?

Token buybacks occur when the company that issued those tokens repurchases them on the open market. All buybacks lead to a company reaquiring cash immediately. This practice is not exclusive to the cryptocurrency market; TradFi companies buy back their own shares on the stock market all the time. 

There are several reasons why a company would buy back its tokens. Namely, to reduce the supply of sellable tokens in the market, which raises the price of remaining tokens in circulation. It can also signal to investors that the company is confident in its product and its team’s ability to execute the roadmap.

While buybacks can be good for a company and its investors, they can easily raise questions about why reacquiring cash on a short-term basis is necessary. Investors need to look into several factors including circulating supply, fully-diluted circluating supply, trading volume, and volume by market cap to get a sense of where the impetus for a buyback is coming from.

Considerations of token buybacks

While there are certainly good reasons companies have to repurchase tokens, they can also be red flags to investors. A few pros and cons to consider when a company buys back its own tokens include the following.

Pros:

1. Increased demand: the token price increases as the number of available tokens decrease, as long as the project is viable and there is a capped token supply. 

2. Improved market stability: as a project evolves, the company may realize it has issued too many tokens into circulation and must reduce the supply to meet demand.

3. Increased token holder confidence: a company’s willingness to decrease its market share tells investors that the company is confident in the project, which boosts investor confidence in the project. 

Cons:

1. Reduced liquidity: token buybacks could signal a company has less capital than it thought may not be as financially sound as once thought. 

2. Short-term focus: buying back tokens can be a short-term fix to a long-term problem. Token buybacks can be perceived as an emergency brake, raising doubts about the project. 

3. Diverted funds: a company that repurchases its own tokens is not investing in research, development, marketing, or new hires which could raise red flags. 

DYOR for buybacks

The answers to questions about buybacks can usually be found in a crypto company’s tokenomics. Some questions investors should ask themselves include the following.

1. Is the company’s balance sheet readily accessible to investors?

2. How many tokens are being repurchased?

3. Where is the cash from repurchasement being invested?

4. How will the amount of tokens affect the percentage of circulating supply and fully diluted supply?

5. Has the team been completing roadmap milestones over the past year? If not, why not? 

6. Does the C-suite team have a consistent track record of launching projects and completing milestones? If not, why?

7. Does the token have a market cap of at least $100 million (a threshold used by most investors).

8. How volaile has the trading volume been over the last 6 to 12 months? 

9. What other companies are under the crypto’s corporate umbrella? Do they have native tokens on their balance sheet? If so, how many?

10. Is there a transparent throughline between the native token and the project behind it? If so, are you able to easily explain the correlation between the token’s valuation and the project?

Were token buybacks problematic in 2022?

Token buybacks in 2022 were by and large problematic because of what they were used for. 

Several exchanges went bankrupt in 2022 including Voyager, Celsius, Genesis, and the most high-profile of them all, FTX. For each of those exchanges, and several others projects such as Terra LUNA, answering the aforementioned questions would raise major doubts for many investors.

All of them were either buying back their own tokens in an attempt to stave off insolvency or were negatively impacted by another company that could not repay its loans. In either case, investors need to be aware of certain factors involved in these repurchases. Not all buybacks are bad and neither are an exchange’s native token, but they must be scrutinized carefully.