In our previous analysis we proposed the production cost correlation to token evaluation.
Why does a token need to exist?
To incentivize a provider to provide a service. In the case of Proof of Work, the service is mining (providing hashing power to secure the network). The provider takes an expense x and is paid for with value x + y, with y representing market value markup.
So we have proposed that in a;
- Proof of Work system, production cost is equal to, total energy cost for total hashing power / total tokens generated.
- Proof of Stake system, production cost is equal to, total hosting costs / total tokens generated.
We identify three actors
- Provider (Miner or Validator)
- Consumer (Participant in the eco system)
- Investor (Token purchaser)
Test case 1: Investor best interest
We establish the following metrics
- Production cost of token $1
- Investor price $0.1
This design has the best value for an investor, since providers won’t sell for less than $1 (why sell at a loss?), (assuming no outside factors to create sell off pressure and the system is in use), consumers will purchase tokens from investors and keep circulating to providers, providers won’t sell until profitable, and the price will gravitate upwards towards it production equilibrium of $1.
This design has a critical flaw. Why would providers join? A provider needs to provide their service at a loss until the price equilibrium is established. This risk could be mitigated by the originating entity (chain developer), but then it isn’t a decentralized solution and highly dependent on the originating entity. The speculative mining community could potentially carry this risk.
Consumers would be using the system actively, so fees could offset static (block) rewards.
- Discounted value for Consumers (high adoption)
- Best ROI value for Investors (high participation)
- No incentive for Providers (low adoption)
- Theoretical upwards buy pressure
- High risk for Provider adoption
Test case 2: Providers best interest
We establish the following metrics
- Production cost $1
- Investor price $10
Providers would have a profit margin of $9, (dependent on current provider profitability ratio’s), Consumers would be paying a high price for usage. Investors would lose return on investment. The price would decrease towards production cost until it is viable for Consumer costs. System has to provide static (block) rewards (Consumers won’t be using the system, fees won’t offset the equilibrium)
- High cost for Consumers (low adoption)
- Losses for Investors (low participation)
- High rewards for Providers (high adoption)
- Strong sell pressure
- High risk for Consumer adoption
Test case 2.1: Too high interest for providers
Above we propose that high Provider profit will create an influx of Providers. We need to quickly discuss the ratio of provider influx vs production increase. We have discussed that as the network grows, the production cost increases, and the profitability decreases. The ideal is that, new Providers are introduced into the system at the same ratio as sell pressure from Provider profit taking is occurring.
If the profit value is too high, you will have an influx of providers, they will each be taking profits as soon as possible (as each provider is selling to maximize current profits), this will create a strong downtrend on price until it reaches production equilibrium and then the profit seeking miners will leave the ecosystem.
- High influx of profit taking Providers
- Strong downtrend in price
Test case 3: Equilibrium
- Production cost $1
- Investor price $1
Provider participation is again limited as low profit margins. Investor participation is limited as very little reward incentive. Consumer participation (if designed correct) is neutral.
- Neutral cost for consumers (will only use service is valuable)
- Neutral for investors (low participation)
- Neutral for providers (low adoption)
- Price equilibrium
- Ecosystem needs a strong value proposition
Theory: Perfect storm
Provider participation increases at a ratio greater than the current production sell off pressure. If new nodes are introduced into the system faster than the sell pressure of production, price will increase.
The initial price would need to be at a level where an artificial influx of providers are not created, but value is still provided for providers.
We split providers into three categories
- Profit hunters (will gravitate to whichever system gives them the most profit, and leave when profit decreases)
- Speculative providers (will provide a service with speculation towards a future return on investment)
- Supporters (provide the service because they believe in the ethos)
We see the same rules in traditional technology exists in a blockchain driven world.
- The creators must fund the risk until adoption (and actively drive adoption)
- Providers will gravitate towards the most profitable solution and should be considered rogues in the system
- Community support allows for a stable equilibrium
Identifying the consumers
Till now we have discussed two entities, we have established the investors and the providers, but we have yet to flesh out the consumer. We consider the following consumers
- Purchaser wishes to purchase product xyz with cryptocurrency
Why would the purchaser need cryptocurrency?
- The product is only available for purchase in the currency
- The purchaser already owned the cryptocurrency
- The purchaser owns speculative value for future purchases
A following assumptions is made here, the purchaser speculates that there will be more value in the future, and thus purchases now for a future discounted value.
Is the chain being built for purchases?
- ICO participant speculates on discounted value
Why would the ICOer need cryptocurrency?
- The ICOer believes that ICO’s will be run on the system and purchases with speculative value
- The ICOer wishes to participate in an ICO that is only available in the currency
Is the chain being built for ICOs?
- Service consumer that wishes to use a service (Same as product purchasing)
We are starting to see, that a secondary metric comes into play, the value of the product itself.
Why is the chain being built? Will it integrate payment options? Will it have services on top of it? Will it host ICO’s? Will it be used as a DEX? Will it be used to build dApps?
Who are the consumers of these systems?
If we can align the consumer with the investor, we are essentially giving the consumer a discounted future value of service usage.
It becomes important to align the consumer with the investor and this should be considered in each ecosystem.
Let’s look at a few detailed use cases of consumers
The purchaser wishes to know if their purchase is authentic. What are they willing to pay for this knowledge? Would they be willing to pay more if the product was more expensive? Should fees be correlated to product value?
The supplier wishes to have stock value metrics for better stock management. What are they willing to pay for this? Does this require a different fee mechanism than the purchaser?
The manufacturer wishes to optimize their supply line based off of supplier sales. What are they willing to pay for this?
Payment processor (Service, Product, ICO)
The purchaser is willing to pay a fee for purchasing an item. Is this fee cheaper than traditional processing mechanisms? Is this purchase faster?
We look towards some of the solutions we have built
Crypto based salary payment scheduler
- Consumer wishes to pay their employees in Crypto, they are willing to pay a subscription and management fee. (fixed cost)
Decentralized SMS provider
- Senders pay to send an SMS. (fixed cost)
Crowd funded p2p insurance platform
- Consumers pay monthly fees. (fixed cost)
Enterprise Data share
- Consumers are willing to pay a subscription fee for data access. (fixed cost)
So when considering a tokens value we must consider
- What is the product and how does it benefit the consumer?
- Who are the consumers, and what are they willing to pay?
- Who are the providers, and for what value are they willing to provide?
A token will gravitate towards its production cost, so if the services provided at production cost are expensive, consumers will not use the system unless it is their only option to use the system.
Did you ask these questions the last time you participated in an ICO?