Tokens Are (Future) Accounts Receivable
They are a company’s future cash flow — oops — token flow
Overlooked in the breathless coverage of “The Year of the ICO” stands a fundamental question: What exactly do a company’s tokens represent? With $100M ICOs becoming frequent — if not yet exactly commonplace — one would think it would be plain exactly WHAT is being snapped up by so many eager ICO investors.
So let’s have a conversation and endeavor to produce some answers. Framing the discussion now underway, we are focused on “utility tokens” issued by startups via an initial coin offering. Lacking a common definition of utility token (and yes, I tried to find one) here is our context:
- Startup has an idea for a digital product, very often a service.
- Startup is funded (entirely or partially) through an ICO of a new utility token.
- Proceeds from the ICO are used to turn the idea into a plan, and the plan into a commercial product.
- Meanwhile, the utility token is traded on crypto-currency exchanges.
- The startup delivers a commercial product and becomes a going concern.
- Customers pay for the product in the utility token — they may have purchased these in the ICO and/or they purchase them on an exchange.
- The product may rely on an ecosystem for key functionality, in which case the ecosystem providers are paid in the utility token.
- The company’s revenue is in its own utility tokens.
The above business process gets us on the same page, vis-à-vis a working definition of utility token … so from here forward we will use the word “token” to mean “a utility token used in such a business process.” I am not suggesting this is the ONLY business process for utility tokens … refer to the numbered process for illustrative purposes … your mileage may vary.
Before diving into the mechanics, let’s make a couple of early observations about “our” tokens:
- Tokens are NOT equity — though they may very well be securities as defined in Howey, and THAT is a topic for a different post.
- A company’s tokens are “currency of the realm”: customers procure tokens to pay for the product(s), ecosystem providers are paid in tokens, and the company’s revenue is in tokens.
- It is challenging to envision a hybrid model where customers can choose to pay with fiat currency OR with the company’s tokens. That statement may well be proven wrong, though it is safe to say that a hybrid model would add complexity AND potentially destabilize the business process and the price of the token.
- Given that a company’s tokens are traded on exchanges, its price will move up and down. Even if contemporary volatility falls by an order of magnitude, the dynamics are “interesting” for all parties when compared to the relative stability of fiat currency.
- A company’s tokens are traded by two distinct groups: customers and traders, much like “commercials” and “speculators” on contemporary futures markets like the CBOE. Customers and traders have different motivations, and their interests will be aligned at times and at odds at times. Here again, the dynamics are “interesting” for all parties.
Let’s put all thoughts of ICOs in the rearview mirror, and think in terms of a company OPERATING on token economics. There are a few such token-based companies in operation, though the vast majority of token-based startups are in product development.
We’ve sketched a full enough picture of our tokens to understand the title atop this post: a company with our business model will see accounts receivable ENTIRELY in its own tokens. That raises some intriguing new elements for corporate finance.
First and foremost, the company will sell its received tokens on the open market. “Heresy!” you shout? Hardly. There are two imminently practical reasons for a token-based company to “re-cycle” its own tokens:
- Price stability. If the company holds onto its received tokens, the circulating supply is reduced and deflation is produced. That may produce undesirable knock-on effects: customers perceive that the token price will be lower still in the future, fomenting a wait-and-see attitude. This is one reason central bankers are so fearful of deflation.
- Payables. The company’s account payable will be in fiat currency. Think landlords, non-ecosystem suppliers, etcetera. One can visualize SOME payables in tokens, though the majority of payables will be in fiat currency. And while employee compensation will certainly have a token component, base salary will be in fiat currency (trust me on the latter, separate blog post).
In short, the corporate treasury will sell received tokens in the open market in exchange for fiat currency or perhaps Bitcoin.
Every rule has its exceptions, as does the paragraph above. Imagine that speculators push DOWN the price of the token. The company may choose to hold received tokens, to avoid selling its tokens into a weak market and further pushing down the price. That is certainly a new wrinkle for corporate finance — thinking and acting as central bankers.
Along those lines, imagine that the price of the token soars. While delightful for investors and speculators, a dramatically higher price DOES present a conundrum for customers. The company may chose to perform a secondary coin offering (SCO). Increasing the circulating supply would [a] lower the price of the token and [b] drop fiat or crypto-currency onto the balance sheet, for investment or future token buy-backs.
Bottom line: corporate finance takes on new responsibilities and activities when accounts receivable are in its own tokens.
An Imaginary Example
Illustrative examples help bring concepts down to earth. Using a REAL company, however, brings conscious and subconscious biases to play. Coming up with an IMAGINARY example can be fun … though something of a challenge when there are hundreds and hundreds of utility tokens with “real” ideas behind them.
We’ll call our imaginary new company Anti-Malware of Crowdsourcing, and take the liberty of shortening that to MoC (including the leading ‘A’ would, uhm, well, it wouldn’t be a marketing win). Of course, our new token is MOC.
MoC will deliver the best-of-breed threat protection package for FREE. What makes the package best-of-breed is superior rules and definitions: signatures for file scanning, rules for intrusion detections systems, IP addresses for web blocking, etcetera. MoC’s secret weapon: it crowdsources and PAYS for superior rules and definitions. Pays in its own MOC token, ‘natch. And you guessed it: customers will pay for their rules and definitions subscription in MOC tokens.
Damn if our imaginary company doesn’t hold water! I’ll start a pool to bet on when a whitepaper arrives.
Let’s apply our business process from the start of this post …
- MoC has the idea outlined above. The founders produce a presentation and a whitepaper.
- MoC is funded through the ICO of a MOC tokens. The proceeds are used to turn the idea into a plan, and the plan into a commercial product.
- Meanwhile, MOC is traded on crypto-currency exchanges. With such a greenfield idea, MOC rises 20-fold before the product is delivered.
- MoC launches their blockchain — initially for ecosystem providers only — to build the superior set of anti-malware rules and definitions. White hat hackers submit rules and definitions and are paid in MOC, proportional to the value of their submission. Tricky that vetting process; insert hand-waving miracle here.
- MoC delivers the product and becomes a going concern. Customers download the client software (Mac, Linux, and Windows) for free.
- Customers pay for the rules and definitions subscription in MOC tokens. They may have purchased these in the ICO and/or they purchase them on an exchange.
- Ecosystem providers continue submissions in exchange for MOC.
- MoC rakes in MOC tokens from customers as accounts receivable. Some of received tokens are paid to the white hat hacker ecosystem providers. Most of the received tokens are sold on the open market as explored earlier in the section on Corporate Finances.
Closing the Circle
The opening paragraph of this post asked :
Overlooked in the breathless coverage of “The Year of the ICO” stands a fundamental question: What exactly do a company’s tokens represent?
REMINDER: our context is UTILITY TOKENS as defined above.
We’ve made the case: a company’s tokens represent its accounts receivable. Given that the vast majority of startups issuing tokens do not yet have a product — indeed, most startups have not yet staffed product development — A COMPANY’S TOKENS REPRESENT FUTURE ACCOUNTS RECEIVABLE.
Disagree with our conclusion? Let’s have a constructive dialog! Please keep the context focused on utility tokens as defined here, so we don’t try to boil the ocean.
Next Question, Please: Valuation?
While we’ve closed the circle and answered the opening question, we have not addressed the closely related question: HOW MIGHT ONE VALUE THESE TOKENS? Ahh, yes, valuation … what differentiates an “investor” from a “speculator” … and the topic of our next post!