Utility Tokens and the Real World

Picture this, Starbucks announces an ICO of 1 billion new “StarCash” tokens. Each StarCash token lets you buy one Grande Americano that costs $3.53. The ICO price is set at $3.00 per StarCash token. Let’s say you missed out on the ICO, how much should you pay for StarCash in the secondary market ?

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Probably about $3.50. Maybe you would want to pay slightly more for the convenience of holding StarCash in your digital wallet. You could send some to your family and friends if they needed to buy coffee. Some people would only buy StarCash at a slight discount, say up to $3.40, since their dollars are tied up in a utility token that can only be used to buy a product at a single retailer.

Utility tokens represent future access to a company’s product or service (https://strategiccoin.com/ico-101-utility-tokens-vs-security-tokens/). By creating utility tokens, a company can pre-sell rights to purchase its products or service. For example, Filecoin raised $257 million by selling tokens that will provide users with access to its decentralized cloud storage platform. Currency tokens, on the other hand, are created to serve as electronic stores of value and mediums of exchange. Bitcoin is the best example. One reason why definitions can get blurred is that utility tokens can have the same look and feel as currency tokens. It is easy for holders to think of utility tokens as currency tokens. Imagine if your Charles Schwab account held StarCash and electronically tradeable Delta skymiles along with your stocks and ETFs.

For any product or service that can be purchased with fiat currency, a utility token should never trade at a premium to the fiat currency price of the product or service it can purchase. This is the case even if there are limits on the creation of new tokens. If a cup of coffee costs $3.50 and one token buys one cup, then the token should not be worth more than $3.50. If it was, a customer would simply use dollars to buy the cup cheaper than by buying a token. The main reason for this is the ability to “arbitrage” between utility tokens and fiat currency. If the product or service can only be purchased with tokens and not with fiat currency, then the market should look to fiat currency prices for comparable products. For example, StarCash should trade with reference to a similar Dunkin’ Donuts product (medium Macchiato) that costs $3.39. Fortunately, we can look to the gift card market for real world examples of utility token economics.

CardCash is a website which operates a market for gift cards (https://www.cardcash.com/buy-gift-cards/). When I was researching this article, gift cards issued by 588 retailers were listed on the site with discounts to their face amount ranging from 1.5% to 46.9%. Not one gift card had an asking price that was higher than the face value of the card. Although the site appeared legitimate, we were surprised to see so many deep discounts to face value. To validate the service, we ordered a gift card from McDonald’s at an 8% discount. After we ordered our Big Mac with fries we proceeded to pay with our gift card. Although the cashier was unfamiliar with the gift card (she had never seen one before), when we swiped it — it worked!

As expected, gift cards issued by large retailers offering a wide assortment of products are listed at small discounts (eBay 1.5% discount, Safeway 2.1% discount). Gift cards issued by smaller retailers that offer a narrow assortment of consumables are listed at large discounts (bd’s Mongolian Grill 46.9% discount, Spaghetti Warehouse 45.6% discount). I asked a barista at my local Starbucks about Starbucks gift cards, but he said he had never seen one before. Starbucks has its own loyalty program that uses “stars” to track a customer’s progress towards earning a reward. By using Starbucks’ loyalty program, customers earn an effective 5.6% discount (one free Grande Americano worth $3.53 for $62.50 of spending) on Starbucks’ products. Use of gift cards does not add to a customer’s “stars.” A gift card would have to trade for more than an 8% discount to make a Starbucks customer prefer the gift card over their loyalty existing card. In fact, the Starbucks gift card was listed on CardCash at a 12.4% discount.

Some utility tokens have security token features. The Binance token (“BNB”) is nominally a utility token. Binance’s token current use (other than speculation and investment) is that it currently gives holders a discount on any Binance fees (https://www.binance.com/resources/ico/Binance_ WhitePaper_en.pdf). In the 2017 ICO, 200 million BNB were created, with 100 million sold to customers, 80 million allocated to the founding team, and 20 million allocated to Angel investors. However, the market price of the token is primarily reflective of the profitability of Binance. As Binance grows in trading volume, and lists additional coins for trading, demand for BNB will grow. The Binance fees than can be discounted with BNB include transaction fees, listing fees, and withdrawal fees. Each quarter, Binance will use 20% of its profits to buy back, and destroy BNB, until half of all BNB have been destroyed and 100 million total BNB are outstanding.

Although some utility tokens may offer features of security tokens such as BNB, pure utility tokens should not trade at a premium to the fiat currency price of the relevant products or services. If the only way to purchase a product or service is with a utility token, then those utility tokens should not trade at a material premium to comparable products or services that can be purchased with fiat currency. If token users and investors understand these basic principles they should make rational decisions about utility token prices.

Manager of Cherokee Acquisition, an investment banking firm focused on the accounts receivable ecosystem.

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