Written by: SAM ANDREW
Compilation: TechFlow TechFlow
The accumulation of token value is crucial. Valuable tokens guarantee the security of its blockchain. Validators need financial incentives to participate honestly. They need to be rewarded with tangible value. If there is no incentive, they will stop validating. The absence of validators can compromise the security of the blockchain.
There are currently over 2500 tokens. The types of tokens are beyond the scope of L1. Blockchain tokens are tokens used to secure the blockchain network. Bitcoin (BTC), Ethereum (ETH), SOL, AVAX, and NEAR are examples of native blockchain tokens. Protocols and applications that run on the blockchain have their own tokens. In cryptocurrencies, the creation and accumulation of value is becoming increasingly important. Native blockchain tokens have a clear purpose for their tokens, they have value. This is not the case for protocol and application-related tokens. And, as in the case of all tokens, the accumulation and distribution of value becomes muddled.
This article outlines four pathways for tokens to create value, detailing their drawbacks and how they relate to different types of tokens.
Tokens can gain value in four ways:
Practicality
productive assets
store of value asset
Governance
Practicality
Assets have utility value if labor or material is expended in an endeavour. Commodities and currencies are examples of utility. They are often referred to as consumable or convertible assets. For example, a car consumes gasoline when driving, and euros are used when going on vacation in Europe. They are useful and valuable because they provide a means to an end, such as transportation and vacation in the examples.
Tokens have utility value. Tokens are used on the blockchain as a means of exchange. Users purchase block space using the native token of the blockchain. Validators are paid in native tokens to ensure transactions are correctly entered on-chain.
L1 blockchains require native tokens. Native tokens ensure decentralization and coordination between different parties. It prevents the blockchain from being subject to a central authority. Imagine if Ethereum’s interactions were conducted in USD, the decentralized permissionless model would collapse. A central actor, the US government, will control Ethereum. This central role can review transactions and reorganize blocks. This would defeat one of the purposes of blockchain.
Native tokens are critical to designing decentralized permissionless networks. But this is not the case for all token-based projects. Outside of L1, generally no validators are paid. Projects have various demand points to create some form of utility for their tokens. For example, their native token needs to be used to transact with their protocol. It is a misconception that token holders are incentivized to "stake". The so-called "staking" has nothing to do with validating transactions, but rather to prevent token sales. This artificially increases the token price.
Token boo has created a reflective model. The more people interact with the protocol, the greater the demand to buy. The more tokens are locked, the more. But once the buying demand dwindles, there is nothing left to support the price of the token. Prices will crash.
The artificial utility makes sense. Entrepreneurs, developers, and communities creating these useful protocols designed token economics to get paid, and rightfully so. They develop useful technologies. However, the artificial “utility” of creating tokens for entrepreneurial rewards creates suboptimal token economic models. Balancing token economic design between developer compensation and long-term sustainability is necessary for the continued growth of the industry.
The “utility” of the token may also be a disguise. Tokens cannot directly represent an equity-like interest in the protocol, or they may encounter regulatory challenges. Tokens can provide non-essential utility functionality to the protocol and be traded as synthetic equity.
There are various tokens in the cryptocurrency market. L1 tokens have a clear and necessary utility. The utility of other tokens may be ambiguous.
productive assets
Productive assets generate returns. Real estate, company stocks, and bonds are all productive assets. They are also called capital assets. They produce something of value. They are purchased based on expectations of future returns or contractual obligations. Bonds are contractually obligated to pay the holder a disclosed interest rate. Real estate owners are rewarded through rental income. Equity owners have an interest in the company's cash flows. Their returns come from reinvesting cash flow into the business or distributing it to shareholders.
Tokens have the characteristics of productive assets. They produce something of value that people are willing to pay for. They generate revenue and generate costs. The difference between the two is profit. L1 tokens typically redistribute earned profits by burning tokens. Burning a token removes it from circulation.
Outside of L1, the accumulation and distribution of profits is ambiguous. This may be due to regulatory uncertainty. If a token distributes profits to its holders, it may be considered a security.
The market is grappling with the accumulation of token value. Some argue that protocols that do not charge fees or accumulate token value are worthless. Others see their no fees as a way to bolster their market share and avoid potential regulatory challenges. Reinvesting funds into business development is more return on capital than return to token holders.
Many Web3 protocols are compared to Amazon. Amazon lost money for decades trying to cement its dominance. It only occasionally distributes capital to shareholders in the form of negligible buybacks. This analogy is only accurate to a certain extent. Yes, Protocol may be consolidating its market share and reinvesting like Amazon. However, Amazon has always had a choice in how it allocates its capital. It evaluates the pros and cons of reinvesting the money in the business versus returning it to shareholders. Those alternatives are less clear-cut for the protocol, at least not yet.
For a protocol, the key to understanding today is how it creates value, how it captures this value, and how this value is distributed in the future. In this context, the Amazon analogy is appropriate. If the market believes in a protocol that creates and captures value and responsibly manages the capital created, the market will pay less attention to distribution issues. The path of distribution is even more important if a protocol actually fails to capture the value it creates or engages in irresponsible capital allocation.
The protocol's treasury is increasingly accumulating the economic value created. How the treasury handles the accumulated capital will become the primary issue. Does the treasury distribute capital to token holders? If yes, how is it allocated? Does it reinvest capital? Who makes these decisions? How to evaluate alternatives? Suddenly, the code of the incubation protocol now needs an organizational structure to decide what to do with the value created.
store of value asset
Store-of-value assets include art, collectibles, and gold. They are valuable because of their scarcity and social status. People believe they have value, so they have value. It's a meme effect. Gold didn’t suddenly become a store of value asset. It became gradually over centuries. When da Vinci painted the Mona Lisa, he had no intention of creating a store of value asset. It becomes over time. Satoshi Nakamoto aimed to develop a peer-to-peer electronic cash system that would allow online payments without trusting third parties. There is also no mention of a "store of value" in the Bitcoin white paper.
Assets cannot be set as a store of value. This is a nickname given over time due to certain attributes and social development. As a result, stores of value are irrelevant today for cryptoassets other than Bitcoin and Ethereum.
governance
Governance rights have economic value only if they involve assets with economic value . This economic value can be embodied in productive or commodity assets. Just as there is value in a vote on how a company or agreement allocates capital, there is value in a vote on how the Organization of the Petroleum Exporting Countries (OPEC) controls oil production.
In the world of cryptocurrencies, governance itself has no value. Governance needs to be coupled with things that have productive or utility value.
Summarize
Utility and productive assets are the two most important avenues for crypto assets. The protocol needs a utility component in order for someone to buy tokens for the first time. It needs a productive asset component for someone to continue to hold it. Bitcoin and Ethereum are in a class of their own. Both Bitcoin and Ethereum have utility and store-of-value properties. In addition, Ethereum also has the characteristics of productive assets.
I suspect that the value of the "practicability" aspect (besides the L1 protocol) will diminish over time.
Apart from the L1 blockchain, other applications/protocols may not require native tokens. The Liquid Staking Protocol can operate through its Liquidity Staking Derivatives and ETH or Stablecoins. It doesn't actually require a native token, nor does a decentralized exchange.
Native tokens are sometimes created for understandable means of profit. It's quasi-equity, but it's not actually equity. To comply with regulatory requirements, it's wrapped in a "utility" veneer.
Ironically, the "utility" aspect of a token can destroy value. The protocol awards tokens to users to facilitate their usefulness. For example, if a user needs to use tokens to interact with the protocol, then the tokens need to reach the user. Airdrops are the way to do this. The problem is that as more and more tokens are awarded, the future value of the protocol will gradually be divided into more and more tokens, reducing the value of each token.
Regulatory clarity may remove the need for token utility. Protocols can then eliminate unnecessary and costly issuance and reflexive token models. Users can simply use the blockchain-native L1 tokens or stablecoins built by the protocol to interact with the protocol. The result will be a huge improvement in user experience. Cryptocurrencies require a different token for almost everything. Interacting with each of the different L1s requires the use of the blockchain's native token. Another token may be required to use the app. All these tokens need to be owned in advance. If a user wants to use another blockchain, the asset needs to be bridged to the target chain, which is vulnerable to hacking. This is a nightmare for users.
Imagine if customers had to use a different currency to shop at each store. That would be an inefficient mess. This is the cryptocurrency experience.
There are 180 currencies in the world, but most global trade is conducted in dollars, renminbi and euros. So will the crypto economy. Most interactions will revolve around several utility assets. Behind the scenes, many different tokens may be used to facilitate interactions without the user knowing about it.
If tokens don’t need to be disguised as utility, they can be hidden quasi-equity for many.
Wait... isn't this recreating securities we already own?
Kind of like it, but better.
Tokens are a novel invention. They are easy to create, track, exchange and settle. They are far superior to traditional securities. Blockchains using tokens are more efficient and transparent than our outdated financial infrastructure.
I think tokens will represent blockchains, cryptographic protocols, and off-chain assets mapped on-chain. In addition to the L1 blockchain, the source of token value will be its productive properties. Most tokens will be considered productive assets. Therefore, their value depends on the quality of their product, the size of market demand, and network effects. Only a few cryptoassets will have the attributes of utility, productive, and store-of-value assets.
