The Fundamental Assumption of Cryptosystems
There is one statement everyone in this space believes but doesn’t want to say out loud: that token holders purchase tokens believing they will increase in price. It’s what Robin Hanson calls an Elephant in the Brain, a motive that is true but stigmatized — to the point where we develop explanations to hide it. If necessary, to deceive ourselves. But the elephant always remains standing there.
In the crypto space, especially among builders and token engineers, profit motive is an unsightly subject to talk about. We’re supposed to be changing the world, after all. Talking about profit motive or valuation in certain communities — much less your profit motive — will relegate you as someone with lesser intentions. It’s noble to claim you’re not thinking about the price (crypto’s favorite virtue signal), but it’s in the back of all of our minds.
We don’t talk about this motive enough. If we did, teams would be building their product with this primary token holder incentive in mind. There is no better way to exemplify a user-first mentality. In an ideal world where teams take ownership, increasing token price would be a forcing function for evaluating milestones and product features. Instead, teams flout any accountability for the financial valuation of their token. With bonding curves and other mechanisms I’ll explore in a future post, this doesn’t entirely need to be the case. It turns out this sector of monetary design is relatively unexplored. But to explain why an intervention in thinking is necessary, it’s important to first correct a base misconception: that tokens are equity.
As a token holder, you have no claim to company assets. You are not entitled to a slice of that network’s success. Consider how Aragon currently has a market cap of $30 million, while holding $80 million worth of ETH from their token sale. Remember that the next time you find yourself thinking of tokens as equity. Tokens don’t come with rights; they come with promises.
(Furthermore, the perception that because a founding team holds some portion of the tokens generated, they have “skin in the game” to drive future success, is simply false. They’ve already received their cash and are the ones ‘printing money’ in the first place. The “skin in the game” mentality doesn’t apply if the cost of acquiring your stake was zero.)
The implicit promise a team will always give is that the price of their token will increase. Accordingly, we’ve known that token fundraisers have been broken for a while now. Teams have all the leverage and token holders have none. Mechanisms like Vitalik’s DAICO seek to mitigate this by enabling token holders to have additional controls over the flow of funding.
Ultimately, changes to token sales don’t address the root cause, which is the disconnect between token value and price. The value of a token is the subjective value it entitles you to as a network participant. The price of a token is how much it trades for on the market. Raising the value doesn’t necessarily raise the price, and this leads to problems because teams and their token holders aren’t aligned on what the definition of success is.
This misalignment can be seen in the criteria for DAICO assessment. While Vitalik writes that token holders will slow or shut down funding based on poor development progress, token holders are just as likely to seek reparations if their token price doesn’t increase or show signs of moving. However, new features and milestones, along with success metrics such as daily active users, can be achieved without increasing the price of the token. Since token price is an indicator of success for token holders (it’s their skin in the game), we’re left with a one-sided incentive system.
Profit motive is a reality we must acknowledge, work with and design for. If a token’s price falls to zero, then as token engineers we have undoubtedly failed (perhaps even if the price falls below its initial auction). The problem is that the current discipline of token engineering focuses on building the platform (the noble pursuit) with little, if any, accountability to token price. It assumes a robust platform must result in an increase in pricing.
This is the fundamental assumption of tokenized cryptosystems: that as the value of the network increases, it reflects ascending equilibria for the price of its token.
In reality, the feedback loop between token value and price remains to be seen. The token holders for the the few working systems we see today — including Ethereum itself — will surely tell you their current token price does not reflect its value. The bridge from technology to financially-productive assets is not an efficient market.
One case study for this fundamental assumption on the micro-level can be examined through token-curated registries. For TCRs, the primary assumption is that the token price will increase given its ‘usefulness’ — or, the token’s power to curate a list that others perceive as valuable. The core incentive for curators to participate in the system is that it will increase the price of their tokens.
AdChain, a mainnet-live TCR, is a list of quality websites to advertise on. Its token is now trading under its initial auction price, despite adding popular sites such as Bloomberg and rejecting the applications for low-quality ones. That is to say, despite the platform taking empirical steps to fulfill its purpose, its token is worth less now than when it was only an idea. This is after more than half a year of development. Similarly, Augur’s token price has only gone downhill since the release to mainnet — after three years of development.
There are two perspectives for these previous performances that give me hope, while also building apprehension.
- n isn’t large enough to tell for certain how any of this works. Whether your n is the # of years or users, the crux of this argument is that we have yet to reach a stable equilibrium to properly assess these systems. The value of n is not tied a falsifiable hypothesis, and I suspect n will only ever come into being if these systems ever ‘succeed’.
- The price of Ether is tied to and will affect token price. It does, I agree. And the more I think about it, the less it makes sense for a token’s value and price to be predicated on the stability of ETH.
We don’t have enough evidence that our fundamental assumption of cryptosystems stands. There are pricing mechanisms and applications of monetary theory that force this, that I’m looking to explore and write more about. But at this point in time, I don’t have much faith in projects that tokenize or sell tokens. It’s foolish to build on an unset foundation — especially using the funds of others.
These views do not reflect those my employer, Consensys AG. Thanks to Alex Min and Kacper Wikieł for sparking this reflection.
