Elastic Supply Tokens Explained

TL;DR
Elastic supply tokens have a changing circulating supply. The idea is that instead of price volatility, what changes is the token supply through events called rebases. 
Imagine if the Bitcoin protocol could adjust how much bitcoin is in user wallets to achieve a target price. You have 1 BTC today. You wake up tomorrow, and now you have 2 BTC, but they’re each worth half of what they were yesterday. That’s how a rebase mechanism works.

IntroductionDecentralized Finance (DeFi) has seen an explosion of new types of financial products on the blockchain. We’ve already discussed yield farming, tokenized Bitcoin on Ethereum, Uniswap, and flash loans. One other segment of the crypto space that has been interesting to watch is elastic supply tokens, or rebase tokens.
The unique mechanism behind them allows for a lot of experimentation. Let’s see how these tokens work.

What is an elastic supply token?An elastic supply (or rebase) token works in a way that the circulating supply expands or contracts due to changes in token price. This increase or decrease in supply works with a mechanism called rebasing. When a rebase occurs, the supply of the token is increased or decreased algorithmically, based on the current price of each token.
In some ways, elastic supply tokens can be paralleled with stablecoins. They aim to achieve a target price, and these rebase mechanics facilitate that. However, the key difference is that rebasing tokens aim to achieve it with a changing (elastic) supply. 
Wait, aren’t many cryptocurrencies operating with a changing supply? Yes, somewhat. Currently, 6.25 new BTC is minted with every block. After the 2024 halving, this is going to be reduced to 3.125 per block. It is a predictable rate, so we can estimate how much BTC will exist next year or after the next halving. 
Supply-elastic tokens work differently. As mentioned, the rebasing mechanism adjusts the token circulating supply periodically. Let’s say we have an elastic supply token that aims to achieve a value of 1 USD. If the price is above 1 USD, the rebase increases the current supply, reducing the value of each token. Conversely, if the price is below 1 USD, the rebase will decrease the supply, making each token worth more.
What does this mean from a practical standpoint? The amount of tokens in user wallets changes if a rebase occurs. Let’s say we have Rebase USD (rUSD), a hypothetical token that targets a price of 1 USD. You have 100 rUSD safely sitting in your hardware wallet. Let’s say the price goes below 1 USD. After the rebase occurs, you’ll have only 96 rUSD in your wallet, but at the same time, each will be worth proportionally more than before the rebase.
The idea is that your holdings proportional to the total supply haven’t changed with the rebase. If you had 1% of the supply before the rebase, you should still have 1% after it, even if the number of coins in your wallet has changed. In essence, you retain your share of the network no matter what the price is.

Rebasing token examplesAmpleforthAmpleforth is one of the first coins to work with an elastic supply. Ampleforth aims to be an uncollateralized synthetic commodity, where 1 AMPL targets a price of 1 USD. Rebases occur once every 24 hours.
The project had relatively little traction until the introduction of a liquidity mining campaign called Geyser. What’s particularly interesting about this scheme is its duration. It distributes tokens for participants over a 10-year period. Geyser is a prime example of how liquidity incentives can create significant traction for a DeFi project.
While technically a stablecoin, the AMPL price chart shows you how volatile elastic supply tokens get.

 
The AMPL price targets $1, but it can be quite volatile nevertheless.

Bear in mind that this price chart only shows the price of individual AMPL tokens, and doesn’t take into account the changes in supply. Even so, Ampleforth is highly volatile, making it a risky coin to play around with.
It might make more sense to chart elastic supply tokens in terms of market capitalization. Since the price of individual units doesn’t matter as much, the market cap can be a more accurate barometer of the network’s growth and traction.
AMPL market cap on a logarithmic scale.

Yam FinanceYam Finance is one of the other elastic supply token projects that has gained some traction. The Yam protocol’s overall design is sort of a mashup between Ampleforth’s elastic supply, Synthetix’s staking system, and yearn.finance’s fair launch. YAMs also aims to achieve a price target of 1 USD.
YAM is a completely community-owned experiment, as all tokens were distributed through liquidity mining. There was no premine, no founder allocation – the playing field to acquire these tokens was even for everyone through a yield farming scheme.
As a completely new and unknown project, Yam had achieved 600 million dollars of value locked in its staking pools in less than two days. What may have attracted a lot of liquidity is how YAM farming was specifically targeting the holders of some of the most popular DeFi coins. These were COMP, LEND, LINK, MKR, SNX, ETH, YFI, and ETH-AMPL Uniswap LP tokens.
However, due to a bug in the rebasing mechanism, much more supply was minted as planned. The project was ultimately relaunched and migrated to a new token contract thanks to a community-funded audit and joint effort. The future of Yam is completely in the hands of YAM holders now.

The risks of elastic supply tokensElastic supply tokens are highly risky and very dangerous investments. You should only invest in them if you completely understand what you’re doing. Remember, looking at price charts isn’t going to be all that helpful, since the amount of tokens you hold will change after rebases occur. 
Sure, this can amplify your gains to the upside, but it can also amplify your losses. If rebases occur while the token price is going down, you not only lose money from the token price going down, you’ll also own less and less tokens after each rebase! 
Since they’re quite tricky to understand, investing in rebasing tokens will likely result in a loss for most traders. Only invest in elastic supply tokens if you can fully grasp the mechanisms behind them. Otherwise, you’re not in control of your investment and won’t be able to make informed decisions.

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Closing thoughtsElastic supply tokens are one of the innovations to watch in DeFi. As we’ve seen, these are coins and tokens that can algorithmically adjust their supply to try and achieve a target price.
Are elastic supply tokens only an interesting experiment, or will they gain significant traction and carve out their niche? That’s difficult to say, but there are certainly new DeFi protocol designs in development that attempt to take this idea further.