Anyone who has been around cryptocurrencies long enough has probably heard of the term 'hard cap.' It usually refers to a limit on the number of tokens a project puts into circulation. For instance, Bitcoin has a hard cap of 21 million coins. Once all these coins enter circulation, no new coins can be produced. This scarcity will drive the price of BTC in the future.
However, circulation supply is not the only context wherein the term 'hard cap' is used. It can also be used to describe the economics of an ICO, IEO, IDO or any other crypto fundraising campaign.
In this context, it also has a counterpart known as a 'soft cap.' Tag along as we explain both these concepts, how they work, and their pros and cons.
What is a hard cap in terms of crypto fundraising?
When it comes to an ICO, IDO, IEO or any other form of crypto fundraising, a hard cap is the maximum amount of funds a project is looking to collect through the sale of its tokens.
Once this hard cap is reached, no more tokens will be available for purchase. Projects choose a hard cap amount based on their development costs and other needs.
What is a soft cap?
A soft cap is the minimum amount of funding a project is looking to raise through its ICO, IDO or IEO. It is a purely theoretical number because it is not strictly enforced.
Some devs will make do with the funds received, even if they do not meet the soft cap. However, in many cases, if the project cannot reach the soft cap, the team will abandon the project and return the funds to investors.
Pros and cons of setting hard and soft caps
The development team will often provide reasons for the hard/soft cap it has set. These reasons give investors a fair understanding of the team's experience and provide insights into what they are trying to accomplish with the funds.
If the team sets a very high or low cap or they proceed without one, it could be a red flag and prompt additional research into the project. It is also a red flag if the project cannot reach its soft cap, indicating that investors do not believe in the future potential of the platform.
A capped ICO also creates scarcity, which props up the token's price, a win-win for project devs and investors. Without a cap, a large number of tokens will go into circulation, and investors may be tempted to sell a part of their holdings prematurely.
This can dent the coin's valuation and slow the project's growth. A cap can also keep whales at bay. It will limit the coins on offer and ensure a handful of investors do not end up with a large amounts of tokens.
Brave is an excellent example of a crypto project that launched its token using a capped ICO. The blockchain browser set a hard cap of $35 million, which it was able to collect within just half a second. Once this amount was reached, the ICO was closed, and the devs went to work with the funds they collected.
However, there are some disadvantages of a capped ICO. If the project sets the cap too low, the development team could receive fewer funds than required. In this case, they would have to hold additional funding rounds to collect the funds needed to complete the project.
Conclusion
Hard and soft caps tell you a lot about a project, its team and its vision. If the capped amount of the project is realistic compared to the team's goals, it is generally a good sign for investors. However, a project without a cap could indicate a lack of planning or, perhaps, something more sinister, such as a rug pull.
Also read: Explained: NFT stocks and how they work
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