The hidden power of Utility Tokens
How protocol-focussed crypto projects will revolutionize platform markets for the better.
The rise of security tokens
In recent months security tokens are the hot topic in the cryptosphere. You can read statements like “security tokens will take center stage in 2019” on Nasdaq.com. And I think that this is true. Big amounts of money from institutional investors will flow into the crypto market as soon as security tokens evolve. So there is huge potential for security tokens — since they can be seen as an incremental innovation over the stock market.
We could understand security tokens as stocks vNext
Many financial experts expect security tokens to be THE NEXT BIG THING. We usually see a lot of potential in things we know from the past. And that’s ok.
Projects like Neufund or Polymath are heavily pushing to make security tokens (a.k.a. equity tokens) a reality:
Still — I think that utility tokens have some hidden power not many stakeholders are recognizing yet.
Our beloved utility tokens
At first sight utility tokens have some disadvantages:
- Utility tokens are no securities because they don’t guarantee a stake in a company. That makes them a rather vague investment.
- Utility tokens are something completely new. They are no currency, they are no equity. So, there is no established regulation around them — opening the door for fraud and scams.
On the other hand, there are some benefits of utility tokens that arise out of these disadvantages:
- Utility tokens are built around a community. Blockchain start-ups without a solid community will hardly be successful with issuing their utility token.
- This community doesn’t have any guarantees. That’s why they are usually very interested in what’s going on in the project, whether it makes progress and sense from a mid- to long-term market-perspective — since the utility token usually plays a crucial role in that market.
- Many people in these community have multiple roles apart from being an investor — they are usually also early adopters, key users, some kind of “miner”, “validator” or another form of stakeholder.
- That’s why many successful projects put a lot of effort into their community works. This usually helps to be very market-focussed — and paves the way to another “super-power”…
The dominance of platform economies
If you read recent literature about the most successful business models you’ll read a lot about platform economies, network effects and the like. Think of Amazon’s marketplace, Google’s ad platform, AirBnB’s platform and the like. These companies don’t sell products anymore, they create a platform ecosystem that connects buyers and sellers in an unprecedented and extremely convenient way.
It is incredibly hard to compete against these platforms once they dominate a market, because you’ll always have the chicken-and-egg-problem: you need a lot of potential buyers to attract the sellers to join your platform, and you need a critical mass of sellers (offerings) in order to attract buyers. That’s why these markets tend towards monopolies.
Nevertheless, these markets have one big problem: Not every stakeholder in these markets benefits from them to the same degree. Take the business of credit cards:
- the credit card company…earns all the money — check!
- the user of the credit card…can pay conveniently — check!
- the shop accepting the credit card…
a) must buy a card reader to accept the card
b) has to share parts of its revenue to the credit card company
c) cannot escape the system since customers expect them to accept these cards. — PROBLEM!
Speaking more generally: An unbalanced market usually looks like this:
- We as the users of a platform benefit a lot from it since it gives us access to a lot of resources we couldn’t reach before. It’s very convenient, standardized and usually even “for free” — at least at first sight.
- The platform provider usually strives for world dominance, earns all the money and doesn’t pay too much taxes because no country can put enough pressure on it.
- Most other stakeholders in the system usually start to suffer at some point in time, because the dominance of the platform owner gets overwhelming. Smaller players are forced to adapt to the rules of the platform provider. And those rules might be changed over time to redistribute profits…
This leads to my conclusion that most of the existing platform economies tend to be unbalanced — in favour of the owner of the platform, which is usually a single company.
If you want to participate in the profits of that platform economy, you are usually forced to buy shares of this company — without having too much of a say how this company should develop its platform. Worse: Your investment in the big player unintentionally increases the power of the platform owner und thus the imbalance of the system.
How utility tokens and crypto protocols might change the platform landscape
But the times they are changing: Markets get more and more interconnected. This alone gives a lot of room for innovation. And as we’ve seen above: platforms that are built by a single provider usually don’t find an equilibrium to benefit and motivate ALL stakeholders.
Utility Tokens are the new weapon to create a platform economy out of thin air and attack unbalanced markets.
By now you might wonder:
“How could utility tokens change these platform markets?”
Well — it’s their social power:
- the enthusiasm for fair markets,
- the incentivizing for all stake-holders and
- solid governance with transparent rules
I’ll make an example to guide you through my reasoning:
How Aventus protocol will “heal” the broken ticketing market
Project teams like that of Aventus look at a certain market, analyse its imbalance and seek for a token-based solution to create balance among all stakeholders. In Aventus’ case it’s the ticketing industry.
Most of us know the problem: You want to visit a concert of your favourite music band and have real trouble to get hold of tickets. Either you are the “early bird” and buy those tickets a year before the event — or you have to buy the tickets for a much higher price in the secondary market. Many players have tried to solve these problems. But the incentives in this market are too strong. So, the players stick to the status quo and the problems won’t get solved at their root. Aventus describes the problems in detail in their whitepaper and in this introductory video:
And here comes the first take-away: these teams seek to fix a central problem in their industry and redefine the rules of the game:
- It’s not about competition.
- It’s not about a better product.
- It’s also not about getting rich.
- It’s about fixing the market itself!
These new start-ups seem to have a completely different mindset and ambition than those we know from Silicon Valley. If you talk to them they are really determined to change the world for the better. Yes, being successful might also be a result of their work, but it is not their primary goal. Their primary goal is fixing the market.
Now: Fixing a market isn’t easy if you are just one small player. There are a lot of dynamics going on. But: Using utility tokens you can incentivize all players to behave in a certain way that is good for themselves and the market. In Aventus’ case we have a lot of different stakeholders and interests:
- artists want a fair distribution of their tickets to their fans
- fans want to get hold of a ticket at a fair price
- ticket vendors want to sell these tickets with a certain margin
- organizers of events want to be sure how many people will attend
- ticket re-sellers want to build-up a successful secondary market
If you look at possible use cases they are all about transparency of ticket transactions — from issuing tickets in a primary market, selling them to a fan, who might re-sell his ticket via a secondary market until someone really uses the ticket at the actual event. Blockchain and its smart contracts are obviously very well suited to increase transparency for these kinds of use cases.
Imagine you could see that someone tries to sell you a ticket for twice the price they paid: Would you buy it? I wouldn’t.
Imagine the reseller had to use a system that automatically cuts his profits if he doesn’t play to pre-defined rules: Would you like that? I would.
But transparency is only one part of the formula. Utility tokens can be used to define the new rules of the market. If you happen to define them in a way to motivate all stakeholders — you might be up to something big. To be honest: this is not easy. There is a whole field of economics science build around that problem of designing certain rules to create a desired behaviour of different stakeholders: it’s called mechanism design.
Nobel Prize winning economist Eric Maskin gives some great examples how mechanism design works in this video:
Back to our example: Aventus uses its token AVT in all its smart contracts that define the ticket transactions. These contracts just went live on Ethereum mainnet last week. Every stakeholder needs to use AVT (implicitly or explicitly) to be part of this game. The token is a small part of each transaction. You need to pay a small number of tokens as a usage fee of the platform like you would pay in fiat for traditional systems.
But there is a new aspect:
- If you play according to the rules, everything is fine.
- If you try to cheat, you’ll pay the bill.
This trick is usually done via “staking”. Providers (like in our case ticket sellers or event organizers) need to provide some tokens to the system before they get access to it. If the system recognizes that they are cheating it will take parts or all their staking tokens away. But it gets even better: these tokens are not given to the platform provider, but to the stakeholder who found out that someone was cheating. These stakeholders are usually called “validators”.
You see: the system is built in a way to strengthen the motivation for everybody to play according to the rules. If you get the rules right, you’ll create an ecosystem that is hard to beat.
Blockchain start-ups built around utility tokens are like modern institutions that re-create the rules of “their game”. Jurisdiction is built into the system; its execution is automated and very fast — compared to classical economies.
If enough people agree that these rules are great, the project might become successful and dominate the market. Experts speak of cryptoeconomic primitives, that are used to define those rules. Primitives like Token Curated Registries (TCRs) use the community and token-based incentives to rate the quality of the different players in the ecosystem. You may find this story by Jacob Horne helpful to dive deeper into this topic. Utility tokens can be understood as the fuel that drives these economic systems.
This leads us to our second take-away:
If you invest into a utility token, you don’t invest into that company.
You invest into that company’s vision of a future market and its ability to create it.
Initiating the platform
You might argue:
Wait! That still doesn’t solve the chicken-and-egg-problem you mentioned above! How do we get people incentivized to build a critical mass of users in the first place?
My answer is three-fold:
- Token Launch
- Airdrops & bounty programs
- Open Source
Phase 1 — the Token Launch
Issuing a utility token via a Token Launch seems easy: You try to convince as many people as possible with your idea to fix a certain problem in the market. You collect their funds — mainly based on your promises — et voilà: You have not only a lot of money, but also a big community of like-minded people that are very interested to make your project a success. That’s at least the theory.
Reality looks a bit different. Usually greed kicks in very fast and your community expects a little wonder. But nevertheless: It was never so easy to get a 7- to 8-digit crowd-funding as with a Token Launch. It is crucial to be honest about the roadmap (planning in years rather than in months or weeks) and set expectations accordingly.
If you do it right, you suddenly have 10.000 to 20.000 global supporters of your project with very diverse talents and backgrounds.
Phase 2 — Airdrops & Bounties
Most teams reserve some of their tokens to do token “airdrops” or bounty campaigns to motivate people and spread the news. In the past most of these campaigns just rewarded simple social media marketing tasks like a Retweet or a Facebook Like. Most of them also expect you to join their telegram chatroom to stay in touch. Some start-ups just even send a very small amount of their tokens to every Ethereum wallet to gain interest. These mechanisms help to get the critical mass of people getting curious about the project. They can be used to raise awareness for the Token Launch itself or (in my opinion even more interesting) they are used at a later stage to find those important early adopters of the ecosystem. These might be users, but also other participants you need.
Nowadays start-ups like Wysker get more and more creative and foster community engagement via treasure hunts or gamified launch events. It’s all about intensifying engagement, coupling the “token presents” to behaviour that is relevant for the ecosystem, like registering an account, installing an app and engaging with the system. I’d bet we’ll see more and more of these kick-starter incentives.
Phase 3 — Open Source
Finally — and this is interesting — many teams give away a big part of their source code, sometimes all of it.
You might argue: “Wait — isn’t that the heart of their start-up?”.
The answer is: Yes and no.
Remember: It’s not about the product, it’s about the ecosystem and the market!
What is the best way to let a market grow? Lower the entrance barrier. For everyone — including potential competitors.
If you have a look how those blockchain start-ups are organized, you’ll see many examples of a split:
- A “foundation” holds all or most of the money collected at the Token Launch and is responsible for the token and its ecosystem. The foundation usually has the responsibility for the lower-level open-source part and has the task to grow the community. This is the part where the utility token is used, and those ecosystem rules and incentive systems are defined.
- A commercial company builds products on top of it. It is a proof of concept that all those ideas are feasible.
If we look back to our example: There is the “Aventus Protocol Foundation” and “Artos, the company”. You can find some more background about the split of responsibilities in their story. But there are a lot of examples. Even some of the well-known projects like IOTA or Lisk work with a foundation as their basic construct.
Another nice example for growing a protocol and utility token-based ecosystem is the 0x protocol. Their utility token builds the foundation for a lot of decentralized token exchanges these days. Their list of partners is impressive! Time will tell if they manage to compete with the established centralized exchanges. I’m positive due to the reasons mentioned above.
Conclusion
I hope I made my point:
Yes Utility Tokens have the potential to disrupt markets.
And yes, Utility Tokens are a risky investment.
Holders of Utility Tokens should understand that they do not invest into a company but that company’s idea of a better market. A market that is driven by a balanced incentive system for all stakeholders. Success is totally dependent on the team behind the token, its vision, its ability to get their token economics right, its determination and endurance — apart from handling all other things that possibly could go wrong with any start-up.
On the other hand: Don’t we all dream of possibilities to make this world a better place? Fair market conditions and balanced ecosystems are an important substrate for humanity to thrive. Utility Tokens might be the new means to achieve exactly that.
Disclaimer: This article is not intended to be an investment advice of any sort. Do your own research and search for professional support if you intend to invest in one of the projects mentioned in this article.
Further reading: If you liked this story, you might also want to check out my earlier work about “Democratizing the digital markets” or my “Blockchain vNext series”.
You are also welcome to follow me on Twitter or get in touch via LinkedIn (and please tell me that you found me via Medium).
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