A hard cap is the upper limit set in a blockchain’s code to maintain the maximum number of tokens in circulation. By setting a limit to the maximum number of tokens that can be in circulation or produced, a hard cap creates scarcity, which can drive up the token’s value. For example, in 2020, Yearn.Finance’s YFI token reached a value of $40,000 with a hard cap of 30,000 tokens, while the satirical MEMES token peaked at $1,700 in value, with its fixed supply of 28,000 tokens. Bitcoin, too, is programmed to create a maximum of 21 million tokens, as hard coded in the blockchain’s protocol.
When a blockchain developer is raising funds with an initial coin offering (ICO), the hard cap helps to set a limit to the maximum number of tokens they can sell in exchange for funding. While a hard cap is the absolute maximum supply of the cryptocurrency they can sell, a soft cap refers to the minimum funding required for a project to proceed with development. The developer needs to balance the amount of funding they need for development, and can do so by setting a soft cap.
To impose a hard cap, strict and consistent demand and supply principles need to be applied to safeguard the project’s value. This is because the price of each token decreases with an increase in supply, and increases with a decrease in supply. The hard cap also affects the project’s road map, which needs to be carefully monitored to ensure the limit on the supply of tokens isn’t breached if the funds being raised exceed the original goal.
Can the Hard Cap Be Altered?
The hard cap is a parameter in the blockchain’s code, monitored by the blockchain’s community as well as various crypto analytics websites. To bypass the limit, the cryptocurrency has to change its parameters, which may result in the creation of a new digital asset. Other things that can alter the hard cap include errors or bugs in the code, such as the 184M bug, which extended the 21 million limit of Bitcoin before it was fixed; alteration by developers (in exceptional cases); or manipulation of the hard cap for malicious intent, such as extra minting (or production of more tokens) to create illegal profits.
For an official alteration to the hard cap, developers have to initiate the change and amend the code to enforce it. As a decentralized entity, such change requires the endorsement of the community and their agreement to the update, before switching to the new rule set. Otherwise, the blockchain may reach a difficult fork, where all the nodes in the community have to accept the changes — or be removed from it.
How Is a Hard Cap Maintained?
Although it can be enticing for miners to subvert the hard cap and produce more tokens to improve their income in the short run, there are reasons why they don’t do so. First of all, cryptocurrencies like Bitcoin are notoriously hard to expand and require massive resources to produce. The halving process (approximately every four years) also makes the production of additional bitcoins complicated and extremely challenging to carry out.
Miners’ lack of control over blockchain rules also makes it difficult for them to produce new tokens for themselves. As they work on creating new blocks and processing transactions, thousands of nodes in the network will verify them, ensuring they contain valid transactions, and that the quantity generated is within the limit.
Additionally, attractive incentives for the miners and community governance help to ensure the hard cap is maintained. A hard cap is also important to a cryptocurrency’s value proposition as a scarce resource. In the long run, the decrease in value that comes from an increase in supply can hurt miners’ earnings.