Do Not Sleep on Tokens
So far this year, 211 projects led by passionate innovators sold $3.5 billion of new tokens via Initial Coin Offerings (ICOs). In most cases, these passionate innovators promised to #disrupt based on vague white papers, cool logos and soon to be written code. It is not hard to see how most of these will end in tears, even the Wolf of Wall Street agrees. Despite the impending doom, a few of these could become the next Facebook or Amazon.
Beyond Bitcoin
Intelligent people can disagree about the right price of a bitcoin. But, Bitcoin has proved a network can store and distribute value without a central counter-party. Bitcoin achieves this with a decentralized network, tokens and a distributed ledger (See Bitcoin: Explain It To Me Like I’m Five ). The potential use cases for this type of network goes well beyond Bitcoin’s original goal of creating peer-to-peer electronic cash.
Most describe the potential as a paradigm shift in networking architecture that results in value accruing at the protocol layer instead of the application layer (see Fat Protocols). While correct, I don’t believe diving that deeply into the technical weeds facilitates a broad understanding. Decentralized networks with a distributed ledger are more simply just the latest in a long list of advances in communication technology. A 15th century Monk did not need a Ph.D. in metallurgy to understand it was time to learn new skills.
Advances in communication technology led to significant creative destruction whenever they changed who could create networks and act as their gatekeeper. The printing press gave Martin Luther the power to #disruptThePope because M.L. was able to quickly and cheaply communicate with a large group of followers. Before the printing press, M.L. would have had to interview and hire a bunch disciples as well as build a network of brick and mortar churches.
The notable difference in this round of creative destruction is decentralized networks with a distributed ledger eliminates the need for a gatekeeper. Tokens hold the value of the network on a distributed ledger and the rules that govern user interactions (i.e., the network protocols) decide who get what. While that may be only slightly more intuitive than Fat Protocols, it still does not explain why the world needs tokens. Hopefully, an example of a quasi-imaginary social network will drive home the point.
Snapface
Today, equity investors fund most development of emerging technologies. Passionate innovators create start-up companies, sell some of the equity to finance their disrupting and keep the rest for themselves. Although most fail, the few successful start-ups provide investors with a high return which attract an abundant supply of capital. Let’s see how this works with a quasi-imaginary social network, Snapface.
Snapface’s passionate innovator wanted to build a network of users by storing their content and sharing it with other users. Investors loved the idea and bought Snapface stock. Snapface used their investors capital to build a website and started adding users. As more users joined, the network gained in value (see Metcalfe’s Law). As the gatekeeper, Snapface monetized this value by selling advertising. As more user joined, advertising revenue, profits, Snapface’s stock price and the value of the network all rose; encouraging more user to join.
Once Snapface’s user base was sufficiently large, the value of their network became so great that not even the deepest-pocket competitors could challenge their market position (think Google+) and they could swallow hole any competitor who challenged them with innovation.
Snapface’s passionate innovator is happy, investors are happy, but users are getting a raw deal. Neither Snapface’s passionate innovator nor the investors created the value of the network, the users did.
dAppface
Another yet to be famous passionate innovator wants to #disruptSnapface. But, if Google could not take down Snapface, how can she. She can build a decentralized social network and offer users the opportunity to participate in the value they create. But, how can she fund the development this decentralized social network with no gatekeeper to collect advertising revenue and reward equity investors? The current answer is with tokens. This is how, in theory, it should go:
- Our passionate innovator publishes the dAppface white paper, writes the code and launches an ICO for 220,000,000 facecoins. She keeps 20,000,000 for her troubles and sells 200,000,000 to the public at $0.05 each.
- The $10,000,000 raised goes to the dAppface project which hires developers who will write new features and maintain dAppface.
- The protocol requires users to own one facecoin to join dAppface.
- Facecoin immediately trades to $0.10 and assuming half the public ICO went to users and half to investors. The value of dAppface is $22,000,000 with 100 million users.
- If users double to 200 million, Metcalfe’s Law predicts dAppface will be worth $88,000,000 and a facecoin price of $0.40.
- dAppface’s passionate innovator has paper profits of $8,000,000 and the initial users’ tokens rose 700%.
This is a fictional idealized ICO example, and I do not touch on a number of significant technical and governance issues facing all decentralized projects.
The Future of Tokens
Many of the most profitable companies today are those that control the most valuable digital networks. The values of these networks make their market positions unassailable save a reinterpretation of anti-trust laws or the continued development of decentralized networks. These companies earn too much money to expect the former to happen and the latter to not happen.
It is early day in the evolution of decentralized networks and digital tokens as an asset class. Many important issues need resolving before tokens are investible and irrational expectations has created more fluff then substance. But, regardless of how you may view them today, do not sleep on tokens and do not allow the impending bursting of irrational expectations to blind you from the long term opportunity.
From Fortune Magazine November 2001:
So yes, there is a chance that someday Amazon will grow up to be a company with real profits. But it will never be the high-growth, wildly profitable, super-efficient company of Internet lore. The only place that company lives is in the history books, and in the powerful imagination of Jeff Bezos.
