Understanding Cardano’s Net Change Limit: Balancing Ecosystem Growth and Monetary Stability

Cardano’s Net Change Limit (NCL) caps how much ada enters circulation through treasury withdrawals, balancing growth and stability

Following up on our previous analysis of Cardano’s Treasury Mechanism, this post explores the concept of the Net Change Limit (NCL) and examines different approaches to implementing this critical governance parameter.

TL;DR

• •The Net Change Limit (NCL) is a constitutional parameter that, in our interpretation, caps how much ada can enter circulation through treasury withdrawals over a period of time (usually annually).
• •Our analysis indicates treasury withdrawals have a negative effect on ada price, though the impact varies depending on withdrawal size and market conditions.
• •Compared to other cryptocurrencies, Cardano’s treasury structure is most similar to Polkadot, which also uses a treasury-based funding model.
• •We recommend setting the NCL at the replenishment rate (which we have calculated at ± 15% of 315 million ada annually), emphasizing that this is a ceiling, not a spending target—DReps should approve budgets based on merit, not availability.
• •Broader market factors appear to explain a significant portion of Cardano’s price movements, though supply dynamics also play a role.
• •Implementing predictable withdrawal schedules and transparent communication can help mitigate potential negative price impacts.

What is the Net Change Limit?

The Net Change Limit (NCL) is a constitutional parameter within the Cardano ecosystem that, in our interpretation, defines the maximum allowable increase in the circulating supply of ada tokens through treasury withdrawals over a specified period—for example, on an annual basis (12 months). Unlike the protocol-defined staking rewards (which follow a predictable inflation schedule of approximately 2.6% annually), the NCL specifically governs treasury withdrawals.

This distinction is crucial: while staking rewards follow a predetermined parametric system, treasury withdrawals introduce a new variable that requires careful governance. The NCL safeguards against excessive dilution of token value by placing an upper bound on how much ada can enter circulation through treasury spending.

Why the NCL Matters

Treasury withdrawals can have a statistically significant impact on the ada price, albeit modest compared to broader market factors. While regular staking rewards appear to be “priced in” by the market, treasury withdrawals can create additional price pressure, especially if they are large, unpredictable, or concentrated.

The NCL addresses this challenge by providing:

1. •Predictability: A clear upper limit on treasury-driven inflation.
2. •Stability: Protection against excessive dilution of token value.
3. •Sustainability: A framework for responsible treasury management.
4. •Transparency: Clear expectations for all ecosystem participants.

Lessons from Bitcoin, Ethereum, and Polkadot

Before diving into Cardano-specific approaches, it’s valuable to examine how other major cryptocurrencies handle supply changes and their impact on price.

Bitcoin: Predictable Supply and Halving Events

Bitcoin implements a fixed supply cap of 21 million coins with a predetermined issuance schedule that includes “halving” events approximately every four years. These halvings reduce the block reward by 50%, systematically decreasing the rate of new Bitcoin creation.

Our analysis of Bitcoin’s historical data reveals several important insights:

• •No negative correlation between supply and price: Despite continuous supply growth, Bitcoin has experienced substantial price appreciation over its lifetime.
• •Halving events and market cycles: While halvings correlate with bull markets, the price impact is not immediate and involves complex market dynamics beyond simple supply reduction.
• •Stock-to-Flow relationship: The Stock-to-Flow (S2F) model, which measures scarcity as the ratio of existing supply to annual new issuance, shows a strong correlation with Bitcoin’s price (correlation coefficient of 0.93). However, our analysis indicates that this model tends to overestimate the direct impact of halvings.
• •Psychological factors: The narrative around Bitcoin’s scarcity model appears to be as important as the actual supply changes themselves.

Bitcoin Supply vs Price: Despite continuous supply growth, Bitcoin’s price has appreciated significantly over time, suggesting that the market prices in predictable supply increases.

Bitcoin Stock-to-Flow vs Price: The logarithmic relationship between Bitcoin’s Stock-to-Flow ratio and price shows a strong correlation, supporting the scarcity narrative but potentially overestimating the direct impact of halvings.

The key takeaway from Bitcoin is that predictable, transparent monetary policy creates market confidence, and regular supply increases appear to be priced in by the market when they follow a clear schedule.

Ethereum: Dynamic Supply Model

Unlike Bitcoin’s fixed approach, Ethereum has implemented significant changes to its monetary policy over time, most notably with EIP-1559 in August 2021, which fundamentally altered its supply dynamics. EIP-1559 introduced a fee-burning mechanism, reducing ETH issuance and potentially making Ethereum deflationary. Our regression analysis shows:

• •Weak negative correlation: A correlation of -0.12 between Ethereum’s issuance rate and price, suggesting that while there is some relationship, it explains only a small portion of price movements.
• •Stock-to-Flow dynamics: Ethereum’s Stock-to-Flow ratio shows a weaker correlation with price (correlation coefficient of 0.61) than Bitcoin. This suggests that while scarcity plays a role in Ethereum’s value proposition, other factors such as utility and network activity have greater influence.
• •Dynamic supply model: Post-EIP-1559, Ethereum can experience periods of deflation during high network activity, creating a potential positive feedback loop.
• •Successful policy evolution: The market responded positively to Ethereum’s monetary policy changes when well-communicated and aligned with network usage.

Ethereum Supply vs Price: The implementation of EIP-1559 created a more dynamic supply model where periods of high activity can lead to supply contraction.

The key insight from Ethereum is that monetary policy can evolve successfully over time when changes are transparent and well-designed, and mechanisms that tie supply changes to network activity can create positive alignment between value and usage.

Polkadot: Treasury-Based Ecosystem Funding

Polkadot offers particularly valuable insights for Cardano as it also employs a treasury-based funding model, making it the closest analog to Cardano’s monetary system among major cryptocurrencies.

Our analysis of Polkadot’s historical data suggests several notable patterns:

• •Negative relationship between supply and price: Unlike Bitcoin and Ethereum, Polkadot appears to show a more pronounced negative relationship between circulating supply and price.
• •Higher price sensitivity: Our models suggest that Polkadot may be more sensitive to treasury withdrawals than Cardano, with larger percentage price impacts observed for comparable withdrawal sizes.
• •Explanatory power of supply variables: Adding supply-related variables to our models substantially improved their ability to explain price movements, suggesting that supply dynamics play a significant role in Polkadot’s price formation.
• •Treasury management implications: The data suggests that treasury management practices may have more substantial market impacts in Polkadot’s ecosystem than other cryptocurrencies.

These findings provide evidence that treasury-based blockchains may experience different price sensitivity to supply changes than pure mining/staking-based systems like Bitcoin and Ethereum, with variation between different treasury-based cryptocurrencies.

The key insight from Polkadot is that treasury management requires careful calibration with meaningful guardrails against excessive withdrawals. This has direct implications for Cardano’s NCL discussion, suggesting that constitutional limits on treasury withdrawals could play an essential role in maintaining price stability.

Treasury Inflow Analysis: Current State

Before discussing potential NCL approaches, it’s essential to understand the current state of Cardano’s treasury inflows and withdrawals. Our detailed analysis of on-chain data reveals several key insights:

• •Treasury Inflows: The treasury receives approximately 4.32 million ada per epoch (25.92 million ada per month, 315.32 million ada annually, last 12 months). These inflows come primarily from the allocation of ada, newly released from the reserves, with approximately 32% of monetary expansion directed to the treasury.
• •Treasury Withdrawals: The treasury has already experienced withdrawals to fund the Project Catalyst. These withdrawals are highly variable, with a few very large withdrawals (the largest being 96.56 million ada in a single epoch).
• •Treasury Balance: The current treasury balance stands at approximately 1.69 billion ada. Annual inflows represent 19.05% of this balance.

These findings provide an empirical foundation for discussing potential NCL approaches, highlighting the dynamic nature of treasury flows and the importance of considering inflows and withdrawals when setting policy.

Cardano’s Supply-Price Relationship

Our analysis of Cardano’s historical data reveals several significant findings:

• •Negative relationship between supply and price: Our models suggest a statistically significant negative relationship between circulating supply and price, indicating that increases in circulating supply tend to create downward price pressure. The supply component represented by rewards, being largely predictable, has a less negative impact than the more uncertain elements, such as withdrawals.
• •Market correlation: Ada price shows a strong positive correlation with ETH price, suggesting that broader market trends significantly influence Cardano’s price movements.
• •Supply change explanatory power: Supply variables in our price models improved significantly the explanatory power, suggesting that supply dynamics are an important factor in ada price formation.
• •Withdrawal impact assessment: Our models suggest that while treasury withdrawals affect price, the impact varies by size. Small withdrawals appear to have minimal impact, while larger withdrawals can create more significant price pressure.
• •Relative stability: Compared to Polkadot, Cardano appears to demonstrate greater stability in the face of treasury movements, possibly due to its larger market capitalization and broader adoption.

Cardano Supply vs Price: The relationship between circulating supply and price shows that while there is a negative correlation, the market can absorb supply increases within certain thresholds.

These findings suggest that while treasury withdrawals do have a negative effect on price, the market can absorb withdrawals with manageable impact if they are properly planned and communicated. This gives the treasury reasonable flexibility to fund ecosystem development while being mindful of potential market effects.

These insights provide an empirical foundation for developing a responsible NCL policy, balancing the need for ecosystem funding with price stability concerns.

Three Approaches to Setting the NCL

There is no universally “correct” value for the NCL. Instead, the optimal approach depends on the ecosystem’s goals, market conditions, and long-term vision. Here, we explore three distinct approaches:

1. Zero NCL: Maximum Conservation

The most conservative approach would set the NCL to zero, preventing treasury withdrawals. This would effectively lock the current treasury balance indefinitely.

Potential benefits:

• •Eliminates treasury-driven inflation.
• •Preserves treasury value for potential future use.
• •Provides a simple, easily communicated policy.

Significant limitations:

• •Prevents ecosystem funding for development, research, and growth initiatives.
• •Creates opportunity costs as treasury funds remain unutilized.
• •May hamper Cardano’s ability to innovate and compete with other platforms.

While a zero NCL would prevent any treasury-driven inflation, it would also mean foregoing the potential value that could be created through strategic ecosystem investments. The opportunity cost of not utilizing treasury funds for ecosystem development could lead to reduced adoption, functionality, and competitiveness in the long run.

2. Historical Replenishment Rate: Sustainable Balance

This approach sets the NCL based on the treasury’s historical net change rate, creating an adaptive mechanism that aligns withdrawals with the ecosystem’s demonstrated ability to sustain treasury growth.

Based on our analysis, setting the NCL at approximately ± 15% of 315 million ada annually would maintain treasury sustainability, as this matches the current annual inflow rate. This approach would effectively allow the treasury to spend what it receives, creating a balanced system where withdrawals don’t exceed inflows. This approach would:

Potential benefits:

• •Ensure long-term treasury sustainability by balancing outflows with inflows.
• •Provide meaningful ecosystem funding (approximately 26 million ada monthly)
• •Create a natural ceiling that decreases over time per the protocol’s monetary policy.
• •Base decisions on actual on-chain treasury flows.

Potential limitations:

• •May not optimally address future needs or opportunities.
• •Requires periodic adjustment as the inflow rate decreases.
• •Adds additional inflation (albeit modest at 0.9% of circulating supply) on top of the staking rewards.

This approach acknowledges the decreasing nature of Cardano’s monetary expansion and creates a sustainable withdrawal policy that naturally aligns with the protocol’s design.

3. Growth-Oriented NCL: Accelerated Development

A more aggressive approach would establish a higher NCL to prioritize ecosystem growth and development, potentially drawing down the treasury more rapidly to fund ambitious initiatives.

For example, setting the NCL at 400-500 million ada annually would:

• •Exceed the current inflow rate of 315 million ada annually.
• •Represent approximately 1.1-1.4% of the circulating supply (compared to the current inflow of 0.9%).
• •Draw down the treasury balance over time (at 500 million ada annually, the treasury would be depleted by approximately 185 million ADA annually).

Potential benefits:

• •Accelerates ecosystem development and adoption.
• •Funds more ambitious projects and initiatives.
• •Potentially creates greater long-term value through increased utility and adoption.

Potential limitations:

• •Creates greater inflationary pressure in the short term.
• •Risks of depleting the treasury more rapidly.
• •May create more significant price volatility.

This approach prioritizes long-term ecosystem value over short-term price stability, betting that the value created through funded initiatives will ultimately outweigh the dilutive effects of increased supply.

Mitigating Treasury Withdrawal Impacts

Regardless of which NCL approach is chosen, several strategies can help mitigate the potential negative price impacts of treasury withdrawals:

• •Predictable scheduling: Distribute withdrawals evenly throughout the year rather than in large, concentrated events.
• •Transparent communication: Provide clear, advanced communication about withdrawal schedules to allow the market to price in these events.
• •Strategic timing: Coordinate larger withdrawals during bull market periods to minimize negative price impacts.
• •Vesting mechanisms: Implement vesting or loan designs that encourage recipients to hold ADA longer, reducing immediate sell pressure.
• •Responsible selling practices: Encourage grant recipients to sell in smaller chunks over time rather than dumping large amounts on the market at once.

Finding the Right Balance

The optimal NCL approach for Cardano will depend on community priorities and the balance between competing objectives:

• •Price stability vs. ecosystem funding
• •Short-term value preservation vs. long-term growth
• •Treasury conservation vs. ecosystem development

A moderate approach based on the historical replenishment rate could provide a reasonable balance, ensuring treasury sustainability while funding ecosystem development. However, the ultimate decision rests with the Cardano community through its governance processes.

Market Correlation between Ethereum and Cardano: The strong relationship (R2 = 0.416) indicates that broader market factors significantly influence Cardano’s price beyond its own supply dynamics.

Our Recommendation: Replenishment Rate NCL with Merit-Based Spending

Based on our analysis, we recommend setting the NCL at the treasury replenishment rate of approximately ± 15% of 315 million ada annually. This approach provides several key advantages:

1. •Sustainability: It ensures the treasury remains stable over time, neither depleting nor unnecessarily accumulating funds.
2. •Flexibility: It provides sufficient headroom for funding important ecosystem initiatives.
3. •Alignment: It naturally adjusts with Cardano’s monetary policy as the protocol evolves.

However, it’s crucial to emphasize that setting the NCL at this level does not mean all available funds should be spent. The NCL represents a maximum ceiling, not a spending target. Delegated Representatives (DReps) should exercise their governance rights to:

• •Vote on budgets based on merit and potential return on investment.
• •Fund only initiatives that demonstrate clear value to the ecosystem.
• •Maintain fiscal discipline even when funds are available.
• •Consider the long-term sustainability of the treasury.

In other words, the NCL should be viewed as a constitutional guardrail that prevents excessive treasury withdrawals, not as a spending goal. DReps should approve budgets because they have merit, not simply because funds are available within the limit.

This balanced approach allows the Cardano ecosystem to fund valuable initiatives while maintaining fiscal discipline and ensuring the long-term sustainability of the treasury.

Limitations of Our Analysis

While our research provides valuable insights into Cardano’s treasury dynamics and their potential impacts on price, several limitations should be acknowledged:

• •Data constraints: Our analysis is limited by the available historical data. As Cardano’s governance system evolves, new patterns may emerge that differ from historical observations.
• •Market complexity: Cryptocurrency markets are influenced by numerous factors beyond supply dynamics, including technological developments, regulatory changes, market sentiment, and broader economic conditions. These factors can sometimes overshadow the effects we’ve identified.
• •Model assumptions: Our statistical models make certain assumptions about the relationships between variables that may not fully capture the complexity of real-world interactions.
• •External validity: While we can compare Cardano and other cryptocurrencies like Bitcoin, Ethereum, and Polkadot, each ecosystem has unique characteristics that may limit direct comparisons.
• •Evolving ecosystem: Cardano is a rapidly evolving ecosystem. As adoption grows and use cases expand, the relationship between supply dynamics and price may change.
• •Behavioral factors: Our models cannot fully account for the psychological and behavioral aspects of market participants, which can sometimes lead to outcomes that deviate from statistical predictions.

We view this analysis as an ongoing effort to understand Cardano’s monetary dynamics. As more data becomes available and the ecosystem evolves, we plan to refine our models and update our findings.

Conclusion

The Net Change Limit represents a critical monetary policy tool for the Cardano ecosystem as it transitions into the Chang era with community-managed treasury systems. By carefully calibrating this parameter, the community can balance ecosystem funding needs with price stability concerns. Our analysis of on-chain data provides an empirical foundation for this decision, revealing the complex dynamics of treasury flows and their impact on price.

While treasury withdrawals appear to create downward price pressure, the market seems able to absorb withdrawals with manageable impact when adequately planned. The treasury currently receives inflows of approximately 315 million ada annually, suggesting that an NCL within ± 15% of this range would maintain treasury sustainability while providing meaningful ecosystem funding.

The lessons from Bitcoin, Ethereum, and Polkadot provide valuable context. While Bitcoin’s strong Stock-to-Flow correlation highlights the importance of scarcity in its value proposition, Ethereum and Cardano demonstrate that utility and ecosystem development play increasingly important roles in more advanced blockchain platforms. Most notably, Polkadot’s experience with treasury withdrawals suggests that treasury-based systems require prudent management of withdrawal patterns.

With proper planning, communication, and implementation, the Cardano ecosystem can utilize treasury funds effectively while maintaining monetary stability. Our analysis suggests that smaller, more frequent withdrawals likely have less market impact than large, concentrated ones, and transparent communication helps markets absorb supply changes more efficiently. As the ecosystem evolves, an adaptive NCL framework that can adjust based on changing market conditions, ecosystem needs, and empirical data would help ensure Cardano’s longevity and success as a leading blockchain platform.