Dead Exchange Walking: Why current token exchanges are dead, they just don’t know it yet
Crypto markets are down and they show no real sign of picking up anytime soon. While there are several HODLers who believe that the markets will eventually come back up from this current funk, the reality is there is no logical reason why it should — at least for the vast majority of utility tokens minted via ICOs towards the end of last year. In fact, even if they somehow did marginally recover, there is a hard upper ceiling on their price and no real reason why there should be any volatility in their pricing.
Which draws us to our headline that there should be no opportunities to exercise arbitrage in token prices in the long run. This, in turn, has serious ramifications for the crypto exchange business model itself.
In one of our previous articles we gave a very simple analogy about what tokens really are. They are a right to future use on a platform that is often yet to be built.
Consider an example where you want to build a casino, and you don’t want to or are unable to attract investor partners for your venture. So what you do instead is create a bunch of chips and sell them to the general public as a kind of pre-sale. The premise is that these chips can be then used to play in the casino once it is built.
Now consider the following scenarios:
Your business plans do not work out
Building any kind of new business is hard. Very hard. This is why most new ventures fail, even when the founding team sets off with the best intentions. Here you tried to setup a casino but underestimated the costs and licensing requirements, come up short, and ended up not being able to execute on your plan. Those who bought your chips are now holding a pile of worthless garbage.
This is the most common scenario for most crypto startups. They have sold their tokens but they are no where close to actually delivering a working product or platform. Nor is there any realistic scenario in which they will actually build something close to what they promised. This is due to various reasons such as poor team, poor execution, various external factors, or the whole ICO being a cash grab in the first place.
Nonetheless, the tokens these crypto ventures sold to the public are now worthless, and the current state of the market is reflecting their true value.
2. Your business plans work out as expected
Now lets consider the scenario where you actually pull things off and build a casino. Great news for those who bought your chips, now they can actually use them. But what are they actually worth? They are worth what the casino will accept them for. Logically, under no scenario can they be worth more than what they can be used for in the casino. Their maximum value is the utility they can derive on the platform.
If you sold your chips at a discount to the potential future value, and you actually ended up building something that works which will accept these chips, then yes your early backers can make an upside.
But once such a platform becomes operational, the value of these chips (tokens) should have no reason to fluctuate. It can potentially go down if the platform does not do well or shows signs of failing, but even if the platform does do well, the chips should not command a higher value. Even if your casino expands and you build a chain of casinos which will accept the chips, the value of the chips is not going to exceed what the casino will accept them for. And the casino will never accept them for more than what their initial promised face value is.
You see even in the best case scenario where the platform exceeds all expectations, the upside for those who invested in ICO token sales is limited. A growth in the platforms business does not translate to an increase in value for the tokens. A token is not a share in the business so its success does not rub off on the tokens price.
If there was a secondary market place where you could trade these chips with others, then again the opportunities for arbitrage should be limited or non existent.
Either the casino is a flop and the chips are worthless, or the casino is doing well and you can potentially cash the chips for their face value. But nothing more.
The only purpose for any secondary market would be to give potential token holders to cash their tokens at a discount to the actual expected value. There are a few market places where you can trade your groupons that you don’t plan to use. Absolutely all the time they are sold at a discount to what they were purchased for.
So if you bought a bunch of utility tokens and are holding on to them expecting great returns in the years to come, I am sorry but your optimism is misplaced. 2017 was a year of irrational exuberance in the crypto markets and token prices ended up having no correlation with what they are really worth. Now the dust is settling down, we are not in bear market, we are now in a more clear market where people are recognising that unlike investing in shares which go up in value as the business performs better, investing in tokens is not really an investment as there is no long term upside.
This is obviously not applicable for currencies like Bitcoin as its value definitely improves with acceptance, but Bitcoin has its own devils which can be reviewed separately.
For now there are 2 sets of grim news:
The first is for token HODLers, your optimism is misplaced. For the vast majority of utility tokens, there is no upswing coming.
The second is for token exchanges. Without drastic re-tooling to become securities compliant platforms, they will face distinct challenges ahead. Sooner or later crypto investors will understand that there should be no real opportunities for arbitrage in token prices and that there is no long term upside in most utility token investment.
I continue to believe in Blockchain as a technology, but the real investment, the real opportunities for arbitrage, always lies in actual shares in businesses and ventures. Unlike tokens, a share in a business increases in value and presents arbitrage opportunities if the market value does not reflect the true potential of the business. This is why we believe security tokens and security token exchanges are the only real game in town for the long run. This is why our mission is to allow every day investors to participate in asset backed security tokens where values will be grounded in reality.