Hard Cap and Soft Cap are two very influential concepts in the future of a new token or digital currency. Estimating an accurate amount for these two criteria can make the Initial Coin Offering (ICO) very successful and draw investors’ attention to it; But on the other side, these two criteria can destroy a token in the very initial phase of the launch! In this article, we will examine these two concepts and their importance from the point of view of developers and users of digital currencies.
What is hard cap? A concept with two different definitions!
All digital currencies and tokens are offered to investors in the first stage of their creation through a process called Initial Coin Offering or ICO. The purpose of the initial coin offering is to attract capital from digital currency developers to continue its development. At this stage, every investor can buy the amount of coin he wants and wait for its price to grow. But as expected, not all available coins will be available to investors at this stage!
Read more: What is an ICO?
This is where the term hard cap comes into play. In simple words, Hard Cap is the maximum amount of capital that developers are expected to raise during the initial launch stage. This figure is often determined by the standard of a traditional currency (such as the dollar).
For example, imagine that a development team has developed a token or digital currency and is looking to raise some capital to keep it alive. This team secures a certain figure as the hard cap and capital ceiling and starts the initial offering. As soon as the total investment reaches this limit, the initial supply is over and it will no longer be possible to buy coins in this way.
Of course, in some sources, the concept of Hard Cap is mistakenly equated with Maximum supply. However, these two terms are different from each other. The maximum supply indicates the maximum number of tokens available. For example, the maximum supply of Bitcoin is 21 million units; But this number does not indicate the maximum amount of its initial supply.
Who is responsible for setting the Hard Cap?
The determination of the hard cap is entirely the responsibility of the new token developer team. Due to the fact that this criterion is set before the initial offering of the token, the blockchain community will not have a role in selecting and monitoring the amount determined by the development team. Of course, determining the hard cap strongly affects the real value of a token and digital currency. In the next parts of the article, we have examined this issue in detail.
Is it possible to change the hard cap?
Hard Cap is basically a parameter among blockchain network codes. This parameter is monitored by the blockchain community and cryptocurrency analysis websites. To bypass the limit and change this cap, developers will need to make changes to their parameters that may lead to the creation of an entirely new digital currency. In addition, the existence of some technical problems in the codes can also change the maximum ceiling of initial capital collection.
In any case, the official and legal change of the hard cap will require changing and modifying its codes; As a result, in a decentralized institution such as blockchain, most of the community must agree to this change and, if necessary, propose new reforms before the final implementation of the changes. Otherwise, the blockchain network may encounter a fork, the result of which will be the approval of all community nodes or their removal.
The exact determination of the hard cap can play a very effective role in the future of a digital currency. On the other side, smart investors can also make accurate decisions about buying or not buying a new digital currency through this established criterion. In the following sections, we have discussed the importance of this criterion. But before examining the importance of the hard cap, it might be better to take a look at its opposite, or the soft cap.
Soft cap: minimum capital for the survival of a digital currency
The opposite side of hard cap comes to another concept called soft cap. Of course, if you are fully acquainted with the nature of Hard Cap, the role of Soft Cap will also be clear. In short, soft cap is the minimum amount of capital that the developers of a digital currency or token intend to collect during the initial offering stage. If this capital is not collected, the coin offering will fail and the money paid by the investors will be returned to their account.
The soft cap is generally determined with two goals. The first goal is to estimate the success of the project by the developers. In this way, if a digital currency is not able to attract the attention of investors and obtain the necessary funds to continue its activity in its initial stage, there will be no hope for its success.
The second reason for determining the soft cap is also related to attracting investors’ trust. A soft cap can prevent a blind investment on a project with an uncertain future. In other words, investors are confident that if the invested project fails in the initial stage, their capital will be fully returned and there is no risk in this regard. According to the definition of these two terms, we can conclude that the amount determined for Hard Cap will always be higher than Soft Cap.
The importance of determining hard cap and soft cap
As mentioned, Hard Cap and Soft Cap criteria can play a decisive role in the future of a token or digital currency. Determining the exact floor and ceiling in the initial supply phase will strongly affect the real value or the so-called Tokenomic of a digital currency. In the future, the same issue can affect the token’s market cap.
If the development team is not able to properly estimate these two parameters, the following risks will be waiting for them:
Impossibility of collecting initial funds: If the development team of a token does not have an accurate estimate of its development and infrastructure costs, it may set the amount of soft cap lower than required. As a result, the project may face challenges to continue its activity despite the initial collected capital reaching this figure.
Shortage of token supply (Low Hard Cap): This situation may arise when the development team fails to anticipate the demand for the token. In this situation, despite the demand for investment, the collected capital will reach the hard cap and the initial supply will be stopped.
Failure to meet the minimum criteria despite raising sufficient funds: This is related to the case where the developers set a high level for the soft cap. In this situation, the initial funds needed for further development of the token may be collected; But failure to achieve the minimum set amount made the project fail and the funds were returned to the investors.
Depreciation of the token from the perspective of investors: In some cases, the development team may consider the capital ceiling too high and after the initial purchases, the demand for it subsides. In such a situation, other investors consider the high supply of the token to be equivalent to its low value and are not interested in investing in it.
Of course, note that the determination of hard cap and soft cap is not mandatory for initial offerings. In the crypto world, initial offerings with these parameters are known as capped and offerings that do not have a minimum and maximum amount of supply are known as uncapped.
Comparison of Capped and Uncapped IPOs
As mentioned, IPOs are not the same in terms of determining the capital ceiling and floor. In fact, some projects prefer not to set a figure as hard and soft cap and continue their work with any collected funds. The purpose of this IPO is to obtain maximum profit without setting a limit for the hard cap; But not setting the cap can make investors pessimistic. Because if there is not enough reception, investors will lose their allocated funds and in case of high supply, their purchased token will be worth less.
As a result, things like the possibility of collecting capital without restrictions, the possibility of more participation and the possibility of obtaining unlimited funds are among the advantages of Uncap’s initial offering, and the possibility of reducing the desire of investors to buy tokens is included in its disadvantages. Therefore, investing in capped IPOs brings more certainty.
Limitation is not always bad!
In this article, we introduced the terms hard cap, soft cap and also the difference of initial supply based on these parameters. Determining Hard Cap and Soft Cap can significantly increase the real value of a token or digital currency in addition to attracting investors’ trust. However, inaccuracy in determining these parameters can equally destroy the future of a token. As an investor, how important is the existence of a cap in the initial offering to you? Share your opinions and experiences with us and other Valex users.
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