What is hard cap in cryptocurrency?
The cryptocurrency industry has brought of new terminology, and it continues to do so as it grows. Some terms are similar to the ones you might know from traditional finance. For example, Initial Coin Offering (ICO) is a crypto version of Initial Public Offering (IPO). However, ICO, an official name for the project’s token sale, has plenty of its terms. One example is a hard cap. Anyone intending to participate actively in the crypto market must learn these terms and know their meaning.
This guide will focus specifically on hard caps. It will explain what it is, why it matters, how it differs from the soft cap, and more. It will even offer alternatives to a hard cap, as there are several that exist.
What is a hard cap in crypto?
In the crypto industry, the hard cap represents the maximum amount of tokens that can be sold. When you sell tokens during an Initial Coin Offering (ICO), you have to limit this number for various reasons. ICO itself is a fundraising event where projects get to offer their cryptocurrencies to interested investors. The idea is for the project to distribute its crypto and raise enough to reach its financial goals.
The financial goals, on the other hand, can differ depending on what the project intends to achieve. ICOs offer a specific token price, and the token price is not volatile during the sale. Only after the tokens are sold and released into circulation does their price start to change depending on market conditions.
ICOs also show the full token supply and set aside an amount meant for token distribution. These coins or tokens will be offered in a token sale. That maximum amount is the hard cap. Typically, projects do not offer the entire token supply. They typically keep a certain amount for team members, advisors, treasury, and more. The token distribution details should be clearly stated in the project’s token economics (tokenomics).
The tokens are sold out if the hard cap is reached during the fundraising event. The ICO has achieved its investment goals, and developers will stop accepting investors’ funds.
Hard cap vs. soft cap
Another term that appears during ICOs is a soft cap. While the hard cap defines the maximum amount of tokens intended to be sold, the soft cap is the minimum. You could say that the soft cap is the minimum investment goal that the project wants to achieve. ICOs that fail to reach even a soft cap are mostly considered unsuccessful.
Ideally, the projects want to reach the hard cap, as that marks massive interest. However, finishing the fundraising event anywhere between the soft and hard caps makes the ICO successful.
What factors affect setting up a hard cap?
Setting up a hard cap is not as easy as it seems. Of curse, anyone can just pick a figure and call it a hard cap. However, projects need to determine exactly what amount to set. It needs to be realistic and possible to achieve, but also high enough to give them enough money for development. As a result, there are numerous factors that projects must consider in order to select the right amount, such as:
1. Project expenses/funding needs
The first factor is the project’s estimated expenses. The projects need to have at least a rough idea how much money they need to finish development. That includes paying the team, marketing, legal compliance, operational expenses, and more. Anything that might require money during development must be predicted, and included in the calculation. Then, the team must consider whether it is reasonable for them to expect such an amount.
2. Market analysis and demand
Another thing that an ICO project has to consider is market conditions, market analysis, and demand. Demand might depend on the project’s idea, and how attractive it is. However, market conditions also matter, as investors are more likely to buy tokens during bull markets. Only a fraction of investors invests during bear markets in comparison to bull runs. Analyzing the competitive landscape and general interest in the field that project focuses on also help. Based on that information, the project can determine more precisely how much it might expect to sell.
3. Token utility and token economics
Token utility is a clear and logical factor. Investors care about what they can do the token that they are investing in. A token that doesn’t have any use cases — lacks utility. As such, it has nothing to offer to investors, and they have no reason to want to buy it. Meanwhile, if the token plays important roles in the project’s ecosystem, that gives it token utility and token valuation.
Speaking of token valuation, it also matters how much each token is worth. You can sell a lot more tokens if their price is low per unit. However, you will also receive more money in exchange for the cryptos. Similarly, token economics tells investors about token allocation. They will know how much is up for sale, how much will be kept by team members, and other details. Transparency in this aspect is very important, as the entire token supply must be accounted for.
4. Token regulation
Another important aspect to consider when setting up a hard cap is token regulation. Compliance is extremely important in the crypto industry, to the point where many ended up in trouble for skipping it. The project’s team needs to consider the existing regulations and whether their project complies with them. That way, they can avoid common pitfalls and prevent their project from being sued by the authorities. As for how this plays into setting up a hard cap, the answer is simple. Among the restrictions and limitations, there might be a limitation on fundraising amounts. Consider this the project’s own risk management, and include it in token allocation plans.
5. Community considerations
Furthermore, the project should also take into consideration the expectations and interests of potential investors. The community is a massive factor, without which token sales have no point. Therefore, factors like investor appetite, community size and support, and alike, can influence the outcome of the token sale.
6. Project sustainability and long-term viability
Finally, projects need to think about what will happen in the long term, and have a plan for the future. This means that projects that wish to be sustainable and viable must find a balance. They have to balance the long-term road map and the amount raised. The best way to do this is to set up a realistic hard cap to provide themselves with enough resources.
What is the significance of a hard cap?
Hard caps play several major roles within each project, and here, we will discuss some of the most important ones. For example:
Investor protection and transparency
Transparency is extremely important in order for the project to gain the trust of its community. Meanwhile, ensuring investor protection is the only way to gain actual trust. The hard cap can do it by securing that the project will not raise excessive funds. The project is not supposed to profit from the ICO but rather to raise funds for development costs. Greed can be a powerful motivator, and it has led many traditional businesses to corruption. This is why crypto insists on transparency and investor and token security.
Funding limit
By using a hard cap, the project establishes a maximum amount on funds that it will raise. This shows investors that the team has a clear target and solid goals for the future. They know what they want to achieve and how much it is going to cost. This also allows the project to manage their financial expectations and budget accordingly.
Token value preservation
With a well-defined hard cap, a project can even preserve the value of its tokens. By limiting the supply available for sale, it creates scarcity, which encourages investors to buy. As such, a hard cap can increase demand, if the project defines it properly.
Project feasibility
Another significance of the hard cap is that it forces the project to consider itself carefully. The team behind the project will have limited funds, so they must consider the scope and feasibility of their plans. The project can’t end up in a situation where it will fail to deliver. In such a situation, investors would have every right to sue it and label it a scam. Everyone will dump their tokens to save what little money they can, and the project will fail. This is not an option for any serious project, so its team will have to think and plan carefully.
Challenges and criticisms of hard caps
Hard caps in ICOs have major significance, as we have seen previously. However, they also come with certain challenges, which has led to criticisms of the hard cap. Since investors and projects need to remember this, we will share some of the greatest challenges. For example:
Missed opportunities — Setting a hard cap could limit the project’s potential to raise additional funds. If the demand is greater than expected, the project could miss an opportunity to raise more money;
Unrealistic funding allocation — Sometimes, projects might set a hard cap without properly assessing how big it needs to be. As a result, they might raise too little money in order to cover all the expenses that development will require;
Exclusion of potential investors — A strict hard cap could prevent potential investors to participate. This is typically a problem when it comes to investors who intended to invest large amounts. As such, investors may feel excluded and give up on working with the project entirely. This is how projects could lose the involvement of institutions and wealthy investors;
Artificial scarcity — Some projects were criticized in the past for setting their hard cap too low. This was seen as a way of creating artificial scarcity, in order to drive the prices up. This could lead to speculative behavior among investors, which will surely damage the project in the long term;
Negative impact on token distribution — A hard cap could also lead to disproportionate token distribution. If the demand exceeds the available supply, that is. As a result, a few investors could come to own most of the tokens. This leads to a concentration of power and influence within that project’s ecosystem;
No flexibility — After a hard cap is set, it is difficult to make modifications during the fundraising period. In cases of unexpected circumstances or the need for additional funding, a low hard cap may limit the project.
Are there alternatives to hard caps?
Due to their risks and limitations, hard caps have several alternatives. For example, soft caps and flexible fundraising models. If a project only has a soft cap, that means that there technically is no ceiling. Investors can buy as much as they want. Alternatively, more flexible models where the upper limit can be modified can also be a solid solution.
Apart from that, it is also possible to use hybrid models that combine hard and soft caps. Even dynamic token supply models can adjust supply as per need.
The future of hard cap in crypto
Despite being here for over 14 years now, the crypto industry is still considered young. As such, it is still evolving and trying to find what works and what does not. Even hard caps could end up being removed if a better solution is found. Of course, they could remain as easily if there is no better alternative. In the end, the future of hard cap depends on a lot of factors. Regulations, the evolution of different models and solutions, and shifts in investor preferences are only some of them. In other words, there is no clear answer, as no one knows what the future may bring.
FAQs
What is a hard cap in crypto?
A hard cap is a term for the maximum amount of toneks that the project plans to sell. Simultaneously, it also marks the maximum amount of money that the project hopes to raise.
What is hard cap vs. soft cap?
While the hard cap marks the maximum amount that the project wants to raise, soft cap marks the minimum. Projects that are so uninteresting that they do not even reach their soft cap are generally unsuccessful. This shows that the community has no interest, or that the project did not do its marketing well enough.
