Why We Need a Treasury Function in Cryptocurrencies
Tokenised utilities leverage blockchain networks and decentralised applications so as to offer services built using the capabilities of these networks. In order to interact with such services, users must use cryptographic tokens that represent certain rights of access to the network.
by Dr. Shaun Conway, Founder & President, ixo Foundation
It’s essential that tokens mediate the flow of value from the users to the providers of the utility. This flow may further extend to third-parties such as service providers that are necessary to the functioning of, or add value to, the network. It’s important therefore, that there is sufficient liquidity, ensuring that users can acquire tokens to use utilities, and so that providers can exchange the tokens they receive for general-purpose currencies.
Funding a network
Tokenisation is an ideal solution for utilities that deliver value through network effects, as well as for globally distributed digital services that operate transnationally. Bootstrapping such a system is often difficult, and requires significant funding.
ICOs are a controversial mechanism for launching a new tokenised utility — crowdfunding in exchange for digital tokens to provide capital to the project, whilst generating demand and user interest. Such token sales generate liquidity by selling a utility before it has actually been devised.
Creating liquidity beyond the immediate capacity of the utility provider to translate this liquidity into utility changes the purpose of a token offering: if the full number of tokens sold at a point in time can immediately be used to access the utility, then the liquidity is created for the purpose of offering the utility. If, however, more tokens are sold than can be used at the time where they are released, then the liquidity creates a form of debt where the tokens could potentially be considered a debt instrument — a form of security.
The dangers of excessive liquidity
It’s therefore dangerous, when launching a new utility, to create excessive liquidity. The proportion of tokens bought by a crowd that has no intention to use the utility (whether it doesn’t exist, or simply isn’t needed yet) in the immediate future represents pure speculation — raising expectations of financial returns that a utility provider is not in a position to deliver, unless the token has been offered as a securitised investment.
When a token-based utility does launch, it operates at a relatively low level of liquidity. It’s still a long-tail offering until the network becomes more mainstream and establishes a marketplace. Demand for the utility increases when a growing number of users find it useful. Through the network effect driven by this increasing amount of users, the value of the utility can also rise.
When a new tokenised utility starts off, it operates at a relatively low level of liquidity. This is still a long-tail offering, until the utility becomes more mainstream and establishes a marketplace. Demand for the utility increases when growing numbers of users find it useful. The number of users grows and can also compound the value of the utility, through network effects. Each degree of network growth, compounding with utility, has an exponential power effect on the value of the utility.
A treasury function
Optimising the ratio of a utility token’s price to its supply requires carefully managed liquidity — a treasury function. As of yet, there’s been very little literature published on the use of treasuries in the context of cryptographic utility tokens. However, as the distinction between different classes of utility versus security tokens becomes more palpable, there is no doubt that it will become a more relevant topic of discussion, research and experimentation.
Treasury functionality is relevant to any entity that issues a controlled-supply token.
Whether this control is exercised through a centralised treasury function, or whether we see decentralised treasury mechanisms being effectively deployed, the token issuer must take some responsibility for creating a market around their utility.
The alternative is that the market is manipulated to a degree by external market-makers, such as centralised exchanges or whales (holders of huge amounts of tokens), who will influence the market for their own speculative purposes. This externalises risk and contributes to the destabilising of market practices, such as shorting, or ‘pump and dump’ schemes.
There’s been talk of market-making smart contracts, which are a promising mechanism for establishing a decentralised and autonomous treasury function during the early stages of building liquidity for a utility token. This works by algorithmically determining the prices at which a smart contract sells and buys tokens, without the involvement of counterparties. Think of it as an autonomous token-dispensing machine that sells tokens and offers refunds for unused ones. The sale price is a ceiling, and the refund is a floor limit. Of course, holders are not obligated to use this mechanism, and can freely choose to make their own independent trades within the marketplace.
If a token supply contract is well-designed and effectively prices the token (taking into account the intrinsic value of the utility and market demand), it can provide the perfect levels of liquidity while the utility’s marketplace becomes established.
Beyond this long-tail phase, once the utility gains traction with a growing user base (and high demand for use), liquidity should no longer be an issue. At this point, the free market should determine the token price of the digital utility, much in the same way as is done with energy or communications.
About the Author
Dr Shaun Conway, is the founder and President of the ixo Foundation. He has forged his career in the medical domain, acting not only as a practitioner, but as an advisor to various organisations around the world. Shaun has made it his mission to increase access to better healthcare, a goal which he is currently exploring through the use of blockchain tech.