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On my plane ride from Bali to Singapore I finally found the time to read John Pfeffer’s An (Institutional) Investor’s Take on Cryptoassets. The paper reaches two conclusions, that “store of value” case for BTC still has 60x potential upsides, and that “utility tokens” are already grossly overvalued.
Pfeffer argues that for ETH to be an attractive investment (annualized %20~30 return), it needs to be in the range of $1.8–3.8 billion.
The bearish argument against utility tokens goes like this:
- Utility tokens are open source projects, and nearly costless to fork.
- A community that extracts too much value from its users would invite others to fork it.
- In the long run (“equilibirum”), people would migrate to cheaper networks, and the value of tokens would approach the cost of computation and bandwidth.
There is a particularly interesting back of the envelope evaluation of what Ethereum’s “fair market value” might be:
We can then play with different assumptions for how fast the Ethereum network will grow vs the declining computing and energy costs. For example, let’s assume Ethereum network traffic grows from here at the same rate internet traffic grew from 1995 to 2005 (roughly 150% growth per year)18 and that the combined offsetting impact of declining computing costs is -20% per year (optimistic as this approximates only the effects of the average rate of decline in computing costs without a change in the consensus mechanism; implementation of proof-of-stake or other scaling solutions could represent a step change down in the computing costs of the network by orders of magnitude). The combined net effect would imply ‘Ethereum GDP’ (PQ) doubles each year. At this rate, Ethereum GDP would grow from $355 million to $363 billion in ten years, an over thousand-fold increase. If we assume an ETH velocity of 7, the network value of ETH would be $52 billion in 10 years, about 24% less than its current network value of approximately $68 billion. Of course, in order to provide an attractive return to investors buying ETH today, its current network value would have to be significantly lower than $52 billion (assuming investors would expect to make a 30–40% annual rate of return over that period, the current network value would need to be in the range of $1.8–3.8 billion).
If you believe that value of a utility network approaches hardware cost, utility tokens are bad businesses and bad investments.
I think this argument is wrong, because network economy does not boil down to computation cost.
Economy On Top Of Computation
In the Second Life world, you could buy land, build houses, and start all kinds of businesses. Second Life Entrepreneuriship was a thing. The size of the Second Life GDP reached US$567 million in 2009, and the value of its economy is the aggregate of the goods and services rendered, including computation.
In the case of Second Life, the share of the Economy in computation is a comparatively small. And it seems obvious that even if the computation was provided for free, say by a Philanthropist from Mars, the GDP would grow instead of shrink, because everything costs a little bit less.
What about Ethereum?
The official & advertised use case for ether is to pay for computation and storage on the “world computer”. It seems reasonable to argue that the value of the token network approaches raw computation cost.
But ether had become more than that. Like “storage of value”, ether gained a subjective/speculative value detached from computation cost. People are willing to receive ether for goods and services in both the real world, and virtual worlds. The total economy of Ethereum is what the miners make in fees plus ALL the goods and services rendered in all the worlds, real or virtual.
Even if the same Philanthropist from Mars decides to subsidize all computation costs, the GDP would grow, because it just became cheaper for everyone to use Ethereum.
Also imagine, what if we only keep payment, but turn off the smart contract platform tomorrow? Would the price of Ethereum crash to 0? No, because people and businesses are already willing to accept tokens for fees, salaries, investments, and Lambos. The offchain economy does not live & die with the computation platform.
A utility token that starts as an open computation platform will inevitably connect humans, and develop a secondary (and larger) services & goods economy.
The Subjective Value of Payment
Pfeffer accepts that Bitcoin is a “better gold”, and agrees that the worth of both gold and bitcoin is subjective.
But the value of utility tokens as a medium of exchange is also subjective. If more people participate in the token economy, the GDP grows. And since the supply is fixed, the price goes up.
For the sake of argument, let’s abdicate the “store of value” crown to BTC, and focus on being a “better fiat” that powers an economy.
The “utility” of a token lays the ground for the kind of economic activities that can grow on top of the network. The raison d’etre for a utility token needs to be compelling enough to attract enough users. Once the network hit a critical mass, subjective acceptance of the token’s value kicks in, and a secondary economy would start to develop and grow.
A humble “utility token” then become the currency of a larger economy beyond itself.
It is perhaps an advantage for an ecosystem to create outrageous complexity cough Solidity cough in order to spawn cottage industries of experts making livings off it. For my livelihood as an EVM expert, I am truly grateful : p
How Big Can A Token Economy Get?
In what ways are crypto economies better than fiat economy organized by national governments?
I think the most compelling reason is that crypto economies are borderless, open to all.
A TukTuk driver in Thailand making $300 USD a month would gladly, if given the opportunity, move to the United States and drive Uber for $3000 USD a month. A programmer in China making 1/5 the salary of his/her Western counterpart is on average just as competent.
More than 4 billion people live in non-free countries. The only reason that you and I in the first world make more money is that our countries are more efficiently organized. If we were so unlucky as to be born into a bananna republic run by a petty self-enriching dictator, there’s really not much we could do to improve our economic prospects.
Except to emigrate.
Soon (perhaps inevitably, now that BTC has shown us a proof of existence), anyone can choose to participate & compete in any borderless crypto economy, where the same rules apply to all, and the accumulated wealth cannot be arbitrarily confiscated. This is valuable to at least 4 billion people.
So if we think of a cryptocurrency more as a city-state economy that anyone can join, what might be a best-case scenario for a network that wins the “better fiat” game?
Perhaps a city like Hong Kong? Hong Kong’s M1 (cash plus bank deposits) is about 1.7 trillion USD. At 60B, ETH may still have 20~30x room to grow, IF it succeeds in developing a viable crypto economy.
Of course, ETH could still lose the lead.
Subjective Acceptance Is Hard To Fork
I think cryptoeconomies would become more and more fork resistant. Even in the extreme speculative environment of late 2017, forks tend to be less than 10% of the network value of the original coin.
As an economy gets bigger, the share of GDP for computation would become correspondingly smaller. Forking only duplicates the computation platform, but not the secondary economy.
As cryptoeconomies mature and consolidate, it will get harder to attract people to accept new currencies. For a new cryptocurrency to gain acceptance, it would need compelling features that serve unmet needs.
Regional Acceptance
Building a network of subjective acceptance is hard, and difficult to disrupt once it is built.
Uber may have been the first to make ride-sharing work at scale, it still lost to regional competitors like Grab in Southeast Asia or DiDi in China.
We would likely see the rise of regional crypto-economies too. Upstarts like QTUM are in the race to develop a stronger regional cryptoeconomy.
(Disclaimer: I work for QTUM ;)
Conclusion
Bullish on utility tokens, provided that they can attract a large number of users to participate in its cryptoeconomy.
Follow me on Twitter @hayeah and let me know how you think about token network’s value.
Check out my DApp, an Ethereum address book keymesh.io.
