Avalanche ($AVAX) Reviewed; Does It Rock? Will It Roll?

Disclaimer: Not financial advice. As always, please do your own research.

With the successful launch of Avalanche subnets like DeFi Kingdoms and Crabada, there has been increased discussion around the tokenomics and value accrual mechanisms of the Avalanche native token, AVAX. So, let’s dive in and see if Avalanche is worth the hype.

First, let’s get some housekeeping basics out of the way:

* AVAX is the native token of the Avalanche blockchain and is used to secure the network through staking, pay for fees, and provide a basic unit of account between the multiple subnetworks created on the Avalanche platform.

* As of May 2022, there are about 404 million AVAX outstanding (280M circulating, rest are subject to lock-ups).

* The maximum number of AVAX that can ever be minted is 720m

* The Avalanche network burns transactions fees, and has already burned 1.8m AVAX (i.e. lowering the theoretical “cap” to ~718m, which will continue to decline)

* Visit the Avalanche website or Avalanche stats page for more.

Suppose that the valuation of a blockchain token is fundamentally based on the expected future cash flow of the native token normalized for the available stock (supply). The higher the future cash flow and the lower the supply, the higher the valuation.

Cashflow is relatively straightforward: the more applications there are on Avalanche and the more people there are that use those applications, the greater the cashflow.

Since the mainnet launched in late 2020, Avalanche has been one of the fastest growing ecosystems in blockchain, and historical growth points to Avalanche continuing to be a dominant force in the industry. As of writing:

* Over 3 million unique wallets on the C-Chain and 600k+ monthly actives

* 400+ dapps

* 4th in TVL (total value locked) with over $5B

* Averaging about 800,000–1 million transactions per day (on par with Ethereum), having grown from ~15,000 in summer of 2021

* Among the fastest growing developer bases, and growing faster than Ethereum did at a similar point in time (source: Electric Capital Dev Report)

That said, mechanisms that drive a decreasing supply are more nuanced. Let’s break down the two key drivers:

* Fee burning

* AVAX locked in validating / staking

Avalanche Fee Burning

Avalanche burns all gas fees, lowering the effective supply. C-Chain has burned nearly 1.8 million AVAX since the mainnet launch in 2021.

The overall rate of fee burn has grown exponentially over the last 6 months, which reflects the increasing usage of the blockchain. Avalanche continues to set record highs in monthly transactions across the network, surpassing 30M transactions in the last two months (for reference, there are now more monthly transactions on Avalanche than the entire first year of its existence).

Crucially, while the network is processing more transactions than ever, users are experiencing consistently lower fees on the C-Chain. This is a product of Avalanche’s horizontal scaling approach, which uses novel Subnet technology to isolate high traffic dapp activity from impacting other Avalanche projects and users.The two pilot Subnets are for DeFi Kingdoms and Crabada. Crabada originally used the C-Chain, and then migrated to their own Subnet to create dedicated infrastructure for their users to have the optimal experience.

This reduced the load on C-Chain, thereby reducing gas costs for every application on the network — and yes, it also reduced AVAX fee burning via the C-Chain in the short-term. Three important points here:

1. Even though the C-Chain load temporarily dropped, Avalanche is still one of, if not the, best proof-of-stake protocol out there right now in terms of reliability and speed. So, it won’t be long before the C-Chain gets used up quickly again.

2. Subnets are fundamentally tied to Avalanche (more on this in the next section) + can decide to use AVAX as their gas token, which will continue to drive fee burning via AVAX.

3. Avalanche is a multichain system that is tied together by AVAX, and comparing only C-Chain metrics against other single chain metrics leaves out a large piece of the story.

Don’t forget that this method of scaling Avalanche was part of the design from day one.

Singular, monolithic blockchains cannot scale infinitely and we will need multiple blockchains to run the Web 3.0 infrastructure of the future. The Avalanche architecture is designed to allow for horizontal scaling (i.e. Subnets), while continuously forcing new validators to decentralize and further secure the Avalanche Primary Network.

With that said, let’s talk about what validating & staking mean in the context of Subnets, and how that will impact AVAX supply.

Validating & Staking:

As mentioned, validating a subnet requires validating the C-Chain. What’s less well-known, however, is that there is a limit to how many Subnets each validator can secure because of hardware constraints.

While hardware will continue to improve over time, enabling validators to handle more Subnets, it almost certainly will not outpace the demand for validators to secure Subnets. Any validator must stake a minimum of 2,000 AVAX per validator (up to a 3 million AVAX maximum). As more subnets launch, whether they use AVAX for the gas token or not, more AVAX will be staked. Staking AVAX is a measurable metric for the minimum security of the subnet. This is especially useful if the subnet is new.

This maximum cap means that you cannot simply run a single node with a highly concentrated stake. Further, delegators can be up to 5X the stake. This means that you cannot run a validator with 2,000 AVAX and yet have 1 million AVAX delegated to you. On the network side, while there’s no limit to how many validators each subnet can have, there is a limit to how many subnets each validator can launch. Each validator can realistically run C-Chain + a few other subnets at most. This means that, as new subnets are launched and validator demand grows, new nodes will need to be spun up to meet that demand. These new validators will continue to lock up a minimum of 2,000 AVAX (while also further securing the C-Chain).

Effectively, Avalanche creates opportunities for both block space demand on the C-Chain, as well as validator space demand, which creates an economy for validators to build reputations (and pricing power) as high-quality, value-adding partners to Subnets.

As more subnets deploy, AVAX will be tied down for staking, for gas in those subnets that use it as their native token, and in liquidity pools for subnet tokens that want cross-chain transfers & other liquidity needs. Even if the subnet uses own native tokens for gas, running an AVAX node will still be the only way to capture value generated by the activity of the Subnet. At the time of writing, 65% of the total supply of AVAX is staked. As more Subnets launch, that percentage should continue to rise.

An analogue to Web2 would be the App Store, which has about 2 million apps available for download. Let’s make conservative assumptions and say that:

1. Web 3.0 produces the same amount of applications as are currently on the App Store

2. 5% of those applications choose to build on a subnet (i.e. there are 100,000 subnets)

3. Each of those subnets are validated by (only) 5 validators

4. Each validator can validate 5 subnets

This results in 100,000 Avalanche validators staking a minimum of 200,000,000 AVAX*; remember that AVAX is hard capped at 720,000,000.

*barring any reduction in the minimum staking requirement

Conclusion

If you combine the two factors driving AVAX scarcity described above (i.e. fee burning and validating / staking), you get a feedback loop that looks like this:

People use Avalanche C Chain because
it’s cheap, reliable, decentralized & secure →

Usage drives up C-Chain fees →

Apps migrate to subnets →

New validators lock up AVAX, lowering supply →

C-Chain utilization drops →

C-Chain gets cheaper ->

Repeat

There is still a lot of work to be done to bring the Avalanche vision to fruition, including building out cross-subnet communications; this and many other updates are in development.

With AVAX’s strong tokenomic foundation and assuming subnets become meaningfully adopted, this feedback loop represents a clear path to an AVAX supply shock that can drive significant value to token holders.