Why Your Token Price Crashes – Part 1: Design Errors That Kill Your Market

A Founder’s Guide to Avoiding Economic Suicide in Web3

By Diego Martin, VP of Sales & Investment at Yellow Capital

In DeFi and Web3, it’s easy to get excited about innovation, but a token’s price isn’t just driven by market sentiment. It’s a mix of supply, demand, utility, and governance. If any of these pillars are weak or poorly designed, the consequences can be brutal.

In this article, I’ll walk you through three major tokenomics mistakes I’ve seen – ambiguous utility, unbalanced distribution, and overly complex models that can crash your token price.

1. Ambiguous or Insufficient Utility

A big mistake I’ve seen is failing to define clear utility for your token. Without a strong reason for people to acquire or hold the token beyond speculation, its value quickly disconnects from real demand, and when the hype fades, so does the price.

• Failure Mechanism: Tokens driven by speculation are vulnerable to “pump-and-dump” cycles – say hi to price volatility.
• Impact on Price: The price spikes during hype but crashes when interest fades.
• Impact on Perception: The project becomes “dead,” and trust erodes quickly.
• Impact on Treasury Health: With low demand for the token, the project struggles to generate revenue, which can quickly deplete the treasury.

Real Project Examples: Think of the ICO boom in 2017 – many projects launched tokens with no real utility other than to raise funds. Similarly, early GameFi tokens, where rewards were generated faster than the in-game usage, led to hyperinflation and rapid devaluation. 

What I Recommend: From the start, make sure the token has a clear, essential role in the ecosystem. Take $ETH or $YELLOW as examples. $ETH is used not just as a store of value, but to pay gas fees, making it vital for the Ethereum network’s operations. Similarly, $YELLOW ensures users, builders, and validators interact seamlessly across chains. Using Yellow-powered apps (yApps), every party must lock the $YELLOW token. If they act maliciously, they lose the deposit. So, if your token drives platform functionality, staking, or governance, you’ve laid a solid foundation. And don’t forget to create token sinks – burning, staking, or requiring tokens for specific services will help keep demand strong.

2. Unbalanced Token Distribution & Centralization Risk

A common flaw is having too many tokens concentrated in the hands of insiders, like the founding team or early investors. This centralization creates a risk of massive sell-offs and supply shocks, especially when tokens unlock after vesting periods.

• Failure Mechanism: If too many tokens are controlled by insiders, the price suffers when they sell their holdings in large volumes.
• Impact on Price: These sell-offs create a sharp price drop, especially when the market is already fragile.
• Impact on Perception: The project becomes viewed as an “insider game,” losing community trust.
• Impact on Treasury Health: Once the price drops, liquidity and further fundraising options become limited.

Real Project Examples: Take Solana – in its early days, it faced criticism for token distribution, where a large portion of tokens went to the foundation and early investors. Once these tokens unlocked, they flooded the market and led to a major price drop. The market was already fragile after the initial hype, and the large sell-off made the token’s value plummet, damaging confidence in the project. 

What I Recommend: A fair and equitable token distribution strategy is crucial. Insiders should have clear, gradual vesting schedules to align their incentives with the long-term success of the project. To avoid massive sell-offs and supply shocks, you should try to have over 98% of occasions that are bigger than 5% at once. And don’t forget that transparency around unlock schedules is key to maintaining trust with the community.

3. Overly Complex Token Models

Finally, I’ve seen projects complicate their tokenomics models far beyond what’s necessary. When the system becomes too complex – whether through multiple interconnected tokens, complicated reward systems, or unclear mechanics – it often leads to confusion and disengagement from users.

• Failure Mechanism: When users can’t understand how the token works, they disengage.
• Impact on Price: Lower engagement leads to stagnation or a decline in price, as demand dries up.
• Impact on Perception: The project becomes opaque, damaging the community’s trust.
• Impact on Treasury Health: Without user engagement, revenue generation falters, putting a strain on finances.

Real Project Examples: Many projects have failed due to overly complex token mechanics, like confusing reward systems or excessive governance. For example, Terra has faced problems due to its complex tokenomics. Its dual token system – LUNA and UST (a stablecoin), which included staking rewards for LUNA holders and algorithms mechanisms to maintain the peg of UST to the US dollar. These interconnected systems proved to be fragile and, as a result, led to more than $60 billion affected. 

What I Recommend: Keep things simple. Design your tokenomics so they’re intuitive and accessible. If complexity is necessary, make sure it’s abstracted away from the user. Clear documentation and easy-to-understand tutorials can also help mitigate this issue.

I’ve seen firsthand how these fundamental designs can ruin a project. Whether it’s unclear utility, poor distribution, or overly complex token models, these issues can destroy a token’s value. By addressing them early, you’ll build a token ecosystem that’s resilient and sustainable in the long run. 

Stay tuned – in the next part of this series, I’ll dive into other tokenomics pitfalls like unsustainable emissions and ineffective governance, and share strategies to avoid them.