Tokens for ecosystem investing

In this post, I’m going to examine how tokens can differ from traditional financial instruments, in particular how they might allow for new kinds of “ecosystem” investments.

When someone founds a business, they generally expect the business to make money. Typically this involves buying goods or services from suppliers, hiring and paying staff, and selling goods or services to customers, turning a profit in the process.

As an investor, I can buy shares in a business that I think is going to be successful. Over time, these shares may rise in value as the business succeeds, or fall in value if it fails (there are various other reasons why prices might rise and fall, but the health of the business is the fundamental driver).

This works pretty well for businesses that operate in established markets. There’s no doubt that the market exists, so investors just have to decide if they think that the new business can out-compete the incumbents. Even most technology startups fall into this category: any time someone calls something a “disruptive” innovation, they’re acknowledging the existence of an existing market order that will be disrupted.

Platforms and predation

As described above, when I think that a company will be successful, I can buy shares in that company and be rewarded when those shares appreciate in value. But what if I don’t want to buy into a single company, but something more like an ecosystem?

Say we have a new software platform, perhaps a fantastic new system for creating worlds in VR, let’s call it SuperDuperWorldBuilder, or SDWB for short. SDWB provides tools for creating worlds, a scripting language, a library of objects and interactions. Let’s imagine for a moment that SDWB’s creators have nailed it: it’s the best VR experience anyone has ever seen. All that the platform needs is content, and here the problems begin.

As a business, SDWB needs content creators to build virtual worlds on its platform. Content creators need to be paid. But SDWB’s revenues are thin, at least in the early days. Even if SDWB grows, there is a constant conflict between SDWB and the content creators — SDWB wants to capture the largest share that it can, consistent with providing the content creators enough revenue to survive.

This pattern is familiar — Google and Facebook have this relationship to most of the web, particularly news publications. Google wants to capture as much advertising revenue as possible, and wants to pay publishers as little as possible for the content that the advertising sits on top of. Facebook likewise needs content for its users to share with each other, but has little interest in funnelling revenue towards those publishers if it could capture the revenue stream itself.

For both Google and Facebook, this conflict was not fatal. Publishers continued to publish, even when their digital divisions made losses, because they understood the importance of building digital audiences and had enough existing revenue and money in the bank to finance this. In the case of an entirely new ecosystem, the predatory relationship between the platform and the content creators has a good chance of killing the platform before it begins.

Enter the token

Tokens are (maybe?) a new form of financial instrument, issued on blockchains. I should point out that there are multiple definitions of “token”, and even more suggestions as to their correct — or incorrect — use. I’m going to consider one use-case that I think is both interesting and useful.

In the SDWB example above, investors are clearly incentivised to invest in the platform, and then to encourage the platform to squeeze the content creators as much as possible in order to maximise revenues. If SDWB, the content creators, and the end users together constitute an ecosystem, SDWB’s incentive is to be the apex predator in that ecosystem. Tokens can provide an alternative to this, by allowing investment in ecosystems rather than specific businesses.

How it works is fairly simple: tokens are used by SDWB’s customers — the end users — to purchase subscriptions, and/or to purchase access to specific virtual worlds, or items in those worlds. The rewards are split between SDWB and the content creators (and there are many ways to do this). The tokens trade on an open market, and content creators compete to create the best virtual worlds in order to gain the most tokens, which they can then trade for other things (including fiat currency in their countries of operation). Whereas a purchase of shares in SDWB is a bet on the success of SDWB, a purchase of tokens is a bet on the success of the entire SDWB ecosystem. An increase in the value of the tokens rewards SDWB and the content creators equally. For token investors, funding an ecosystem makes sense because even if SDWB never makes huge profits, the ecosystem as a whole might do so. Betting on the whole ecosystem might be a good way to spread risk.

Funding ecosystem development

If buying equity in a business is a good way of funding a predatory model, is buying tokens a good way to fund an ecosystem-nurturing model? Well, it depends.

Some token sales look like thinly-veiled equity issuances. The language used — shares, market caps, dividends — is the language of equity. Many equity-like tokens are simply inferior to straight-up equity — they come with no voting rights, and often have broad disclaimers which guarantee token-holders no rights in the business that issued the tokens. A bet on a single firm is also very risky, because the single business is also a single point of failure — and startup failure rates are somewhere over 90%.

In contrast, ecosystem tokens are designed to be used. They circulate between the participants in the ecosystem, with the tokens rising in value as the demand for tokens increases. As individual tokens become more valuable, a single token should buy more services from the ecosystem, with the participants making higher revenues from the increased volume of transactions. As such, early token-holders could expect to gain from the appreciation of the value of their tokens without rising token prices killing the ecosystem.

There are also all manner of other token schemes, which I can’t cover here. But, contrasted with equity-like tokens, ecosystem tokens seem to me like a genuinely useful financial innovation, and one which should become part of regular finance in the future.

So, how do token issuers create ecosystems? My suggestion is that token sales should not just fund a single business, but should fund the ecosystem of other businesses around them too. In the case of SDWB, that means funding content creators as well as the core platform, and possibly several other ancillary services too. The token issuer has to play a dual role — they’re probably the one setting up the core platform, but they also have to play a role as an ecosystem catalyst.

What this looks like in practice may vary. In some cases, it may end up looking quite like Slack’s venture fund. In other cases, it may look like Bountysource. There’s no best practice right now, but if ICOs disrupt traditional VCs, a new role as ecosystem curators may beckon.

Conclusion

All of this is fairly speculative, and is much more optimstic in outlook than my normal take on things. Put simply, I think we have enough critiques of the ICO market right now, and I’m more interested in trying to rescue the good and useful ideas that have bubbled (pun intended) to the surface. For these things to become practical at scale, much more regulatory compliance work will be needed, and maybe even regulatory changes. Many more people will end up getting it wrong than those who get it right, but the ones that get it right deserve our support and encouragement.

It should go without saying that none of the above constitutes investment advice, or a recommendation of any particular token, ICO or investment scheme.