Hot Air or Piece of Moon?

In this article I touch upon what makes a compelling token proposition and what to be wary of.

Does it uniquely solve a ‘hair on fire’ problem?

Provide a solution to a niggling problem and there will be some takers, although the financial rewards are not likely to be earth-shattering. Address a very significant ‘pain point’ that is encountered by many and you may have a winner on your hands. This is otherwise known as solving a ‘hair on fire problem’ — something that needs addressing to avoid the onset of further very unpleasant consequences.

By way of example, facilitating peer to peer gambling may help improve participants’ odds by removing the middleman, but is this a real problem or simply an annoyance? On the other hand, enabling individuals to access and share their health records may prove to be life-saving.

If a token forms an essential part of solving a ‘hair on fire’ problem, then it’s at least worth digging deeper.

Is a token really needed?

A question frequently asked is whether Blockchain technology provides unique, or improved, problem resolution and whether a token is vital to its delivery. There is no doubt that some Blockchain merits are unique; this is particularly true in respect of the creation of an immutable record of transactions and in reducing or eliminating trust hurdles using mathematical proofs.

Blockchain may, indeed, give rise to a better way of undertaking a set of tasks, be it in respect of security, efficiency, delegation of authority or some other aspect. However, is a token really required to achieve this? After all, you don’t need a unique token to access software services that might achieve a similar outcome.

I guess the answer lies in the utility proposed for the token. A few do lend themselves to apparently valid use cases that would warrant holding them. Often, though, the token appears to have minimal purpose; a sceptic might say little more than window-dressing. In such cases tokens are used fleetingly, to facilitate a further transaction. For example, tokens required to access a platform where the tokens purchased can be exchanged for goods or services. The provider of the goods or services then needs to decide what to do with the tokens received in payment. Given that most tokens have no use outside of the platform on which they operate, chances are that they will be sold on an exchange for another currency that has greater acceptance in the real economy.

Another way of putting this is that many such tokens will simply be recirculated and possibly rather rapidly. The technical term awarded to this phenomenon is ‘velocity’.

Token holders versus equity owners

A key difference between a shareholder and a token holder is that the former has a claim on the issuer’s assets in addition to well defined rights. With very few exceptions, token holders have no claims and no rights. This is an important distinction. A company can operate a very successful and very profitable business and its shareholders will benefit through dividend payments and increases in share price. Token holders’ fortunes are specifically tied to the performance of their token economy.

Presently, speculation has the greatest influence on token market price, given that many tokens are tied to projects without a functioning product. However, over time token mechanics will be the single largest determinant of price. Owning tokens in a company that is hugely successful does not mean that the tokens will prove to be a good investment. This is a common misconception. Tokens are not shares and are unlikely to perform in the same manner. Where there is little or no reason to hold onto tokens for anything other than a very short period (possibly just a few minutes), then token velocity is likely to be very high. The higher the velocity, the less price sensitive the token.

So, it is quite feasible to own tokens in a company that is hugely successful in implementing its business model, generates significant profits for its shareholders, witnesses an exponential use in its tokens but has a stagnant token price. Increased demand for tokens, even with limited supply, will not necessarily translate into higher token price.

Summary

There is much discussion on this topic and there are some interesting thoughts being expressed as to how to structure token mechanics or token monetary policy, to operate in the best interests of token holders.

It is likely that too few founders have sufficiently considered the operation and effect of their token mechanics and this may well be to the detriment of their token holders. The crypto craze and the opportunity to make outsize and rapid gains has made critical scrutiny of tokens thin on the ground. This is changing. Some say most tokens are worthless. That may or may not turn out to be true. What is certainly true is that prospective token buyers need to do their homework, look carefully at the token mechanics and be prepared to ask founders tough questions.

Disclaimer: This article expresses my personal views on the subject matter and is not intended as investment advice of any kind or a recommendation to buy or sell any cryptocurrency.


Hot Air or Piece of Moon? was originally published in Data Driven Investor on Medium, where people are continuing the conversation by highlighting and responding to this story.