Revisiting the “Taste Test”
Two years ago, we presented our vision for decentralized price discovery, a concept we called the “Taste Test.” We envisioned a system whereby the initial fair market price of a token was determined collectively, and some of the initial speculative volatility of token launches removed.
At the time we did not have the resources or time to make this a reality, but we’re excited to have been able to launch our taste test platform with ClarityDAO, a project focused on building accessible governance for all on Cardano. Now, we’re following up with a second project: REITCircles.
While other projects have used similar projects for token launches, we believe one of the key missing elements is crystal clear education on the mechanics of a taste test, and how the behavior of rational actors helps the system function. A Taste Test relies on many people understanding how the mechanism works, so it’s important to educate yourself.
With the upcoming launch of this platform, we thought it would be wise to provide a single resource for people to reference with regards to the Taste Test.
We’ve provided two sections, one that explains the concept abstractly, and one that uses an example, depending on what style works best for you.
Mechanics
The Taste Test is a process where a new project negotiates with the market to set the initial price for a token, and seed the initial liquidity in the market.
The project, such as REITCircles in this case, deposits some amount of their token (REIT) to start the taste test.
People can then deposit ADA to pair against that token. As the amount of ADA fluctuates, they can re-evaluate their decision, and either deposit more, or withdraw from the taste test completely.
To prevent last-minute price manipulation, you can withdraw up to the very end, but doing so in the last 24 hours will incur a 25% penalty. You will receive only 75% of the ADA you deposited.
At the end, both the REIT and the ADA get used to create a liquidity pool, and that ratio determines the initial price. The generated LP tokens (which act as a receipt of ownership for the pool) gets distributed among all of the participants.
The project provided half of the tokens in the pool (the REIT tokens in this case), while the community provided the other half (all of the ADA). So half of the LP tokens go to the project, and the other half get distributed in proportion to the users who deposited ADA.
Example
Now lets walk through an example, this time with a hypothetical token. Those who have followed for a long time know our favorite example token is RBERRY. 😊
Imagine a project contributes 100,000,000 RBERRY tokens to start the taste test.
Collectively, if users deposit 20,000 ADA, this sets the initial price of the token at 0.0002 ADA per RBERRY.
The project and the community would each receive LP tokens that were worth 10,000 ADA and 50,000,000 RBERRY.
The community portion would be split among all of the participants. So, if you deposited 1,000 ADA (5%), you would receive 5% of the community portion of the LP tokens, which would be worth 500 ADA and 2,500,000 RBERRY.
If, instead, 1,500,000 ADA was deposited, then the initial price would be 0.015 ADA per RBERRY. The community portion of the LP tokens would be worth 750,000 ADA and 50,000,000 RBERRY.
Why does this work?
We now explore why this mechanism is expected to arrive at an approximation of a fair market value for the token.
Lets assume that collectively, the market would normally value the RBERRY token at 0.015 ADA per RBERRY. Nobody knows this exact value, of course, but everyone has their own personal estimation for what that value is.
Imagine that, half way through the Taste Test, there is a total of 20,000 ADA deposited, with an implied price of 0.002 ADA per RBERRY. If a rational actor truly believes that the real market value of the token should be 0.015 ADA per RBERRY, then there is an easy opportunity to make money here: deposit some amount of ADA to receive these tokens at this price, and then wait for the normal market trading to settle at the real market value of 0.015 ADA per RBERRY.
A user who used 100 ADA to do this would net 7400 ADA, a tidy profit.
This creates an incentive for rational actors to deposit, which ultimately raises the price closer to the fair market value.
Similarly, imagine that 3,000,000 ADA has been raised so far, with an implied price of 0.03 ADA per RBERRY. A rational actor participating in the Taste Test is better off withdrawing, waiting for the price to settle back down to levels they feel are more reasonable, and buying then. Someone who had deposited 100 ADA, and who withdraws because they feel the price is oversubscribed, will avoid 50 ADA in losses.
That user can still buy when the pool launches, and so it’s important to understand that the taste test isn’t your only opportunity to receive the token. If the Taste Test does its job, much of the volatility is removed from the initial market, and you can still trade for the token once it is created.
Conclusion
We hope you learned something from this walk through of how the Taste Test platform works, and understand your options when and if you choose to participate.
In the coming days leading up to the launch of the REIT token, we will release an update video showing how you can use the platform and explaining all of this again.
