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Dead exchange walking: why token exchanges are dead, they just don’t know it yet

The crypto market is down, and it shows no real sign of picking up anytime soon. Some HODLers believe the market will eventually rise up from its funk, but 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 do recover marginally, there is a hard upper ceiling on their price and no real reason why there should be any pricing volatility.

Which draws us to our headline — there will 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 used a simple analogy to show what tokens really are. They are a right to future use on a platform that is often yet to be built.

Consider an example in which you want to build a casino and you don’t want to or are unable to attract investor partners for your venture. What you do instead is create a bunch of chips and sell them to the general public in a kind of pre-sale. The premise is that these chips can be used to play in the casino once it is built.

Now consider the following two scenarios:

Building any kind of new business is hard. Very hard. That’s why most new ventures fail, even when the founding team sets out with the best intentions. Here you tried to set up a casino but underestimated the costs and licensing requirements, came up short, and ended up being unable to execute on your plan. Those who bought your chips are now holding a pile of garbage.

This is the most common scenario for crypto startups. They have sold their tokens but they are nowhere close to delivering a working product or platform. Nor is there any realistic scenario in which they will build something close to what they promised. This may be due to reasons such as a poor team, poor execution, or external factors, or it could be that the whole ICO was only ever just a cash grab.

Regardless of the reason, the chips you sold to the public for your casino venture are now worthless, with the state of the market reflecting their true value.

In this scenario, you actually pull things off and build your casino. This is great news for those who bought your chips because now they can 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 ended up building something that works that will accept these chips, then, yes, your early backers could make an upside.

But once such a platform becomes operational, the value of the chips (or tokens, to bring the scenario back to the crypto world) should have no reason to fluctuate. It could go down if the platform performs poorly or shows signs of failing, but even if the platform does well, the chips are unlikely to command a higher value. Even if your casino expands and you build a chain of casinos that will accept the chips, the value of the chips will not exceed what the casino will accept them for. And the casino will never accept them for more than what their initial promised face value was.

Thus, even in the best-case scenario in which a platform exceeds all expectations, the upside for those who invested in ICO token sales is limited. Growth in a platform’s 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 token’s price.

Even if there was a secondary market place where you could trade your chips with others, the opportunities for arbitrage would be limited or non-existent.

Either the casino is a flop and the chips are worthless, or the casino does well and you can cash in your chips for their face value. But nothing more.

The only purpose of a secondary market would be to enable token holders to cash in their tokens at a discount to the actual expected value.

Market places exist where you can trade groupons you don’t plan to use. Every time, these groupons 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 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 often had no correlation with what they were really worth. Now the dust is settling and we are no longer in a bear market. We now have clearer air and people are recognising that, unlike investing in shares that go up in value as a business performs better, investing in tokens is not really an investment because there is no long-term upside.

This is not applicable to currencies like Bitcoin, the value of which does increase with acceptance. Bitcoin has its own devils — but that’s another story.

For now there are 2 bits of grim news:

The first, for token HODLers, is that their optimism is misplaced. For the vast majority of utility tokens, no upswing is coming.

The second is for token exchanges. Without drastic re-tooling to become securities-compliant platforms, they face distinct challenges ahead. Sooner or later, crypto investors will understand that there will be no real opportunities for arbitrage in token prices and that there is no long-term upside in most utility token investment.

We continue to believe in Blockchain as a technology, but real investments, real opportunities for arbitrage, always lie 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. That is why we believe security tokens and security token exchanges are the only real game in town in the long run. That is why our mission is to enable everyday investors to participate in asset-backed security tokens where values are grounded in reality.



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