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Huge Problem: Confidential 1
Huge Problem: Confidential 1
There are a lot of variables that that impact the valuation of a token. The primary ones are:
1) Why is a decentralized protocol superior to a centralized alternative?
2) Why is a particular protocol superior to decentralized alternatives?
3) Total addressable market - if the protocol fulfills its vision, how much commerce can it power?
4) How strong are the network effects?
5) Quality of team
6) Progress - how far along is it?
7) Token velocity - will people hold onto the asset, or will they sell it immediately?
Velocity is probably the least discussed of these, and the hardest to understand. In this post, I’ll dive
into velocity and provide some examples. I’ll conclude by reviewing how teams can engineer lower
velocity into their protocols.
Ticket fraud (literally reprinting and selling the same ticket multiple times) for live events is a h
uge
problem. There’s a reasonable case to be made that tickets for live events should be issued on
blockchains. If venues come to accept blockchain-issued tickets, this solution should stomp out 100%
of fraud. You can’t double spend blockchain-based assets.
Issuing tickets on blockchains can bring other benefits (e.g. disallow resale, profit shares on resale
back to venue, capping resale amounts, etc.)
I love this use case for blockchains. This use case unlocks a lot of value: no fraud, reduced scalping,
reduced fees to middlemen like Ticketmaster/Stubhub.
But I don’t own, or plan to own, any cryptoassets that are trying to solve this problem. Why not?
Because these tokens will have a high velocity.
There is no reason that I, as a full time crypto investor, want to actually want to h
old Aventus,
Ticketchain, or Blocktix tokens. But I think that in time, many people will want to u se these tokens. I’ll
use Aventus as an example below, but I don’t mean to pick on Aventus in particular. Everything below
is generally true of Ticketchain, Blocktix, and many other cryptoassets as well.
Consumers generally want to pay a price denominated in USD (or maybe in the future, ETH or BTC)
and get their tickets. They may purchase Aventus tokens as part of the process to acquire
blockchain-issued tickets, but Aventus will just that: a small and temporary step in the process.
Consumers will generally not hold Aventus tokens for more than a few minutes at a time because they
have no incentive to.
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Venue hosts won’t care to hold these cryptoassets either. Venue hosts care about generating profits
denominated in the currency of their choice, likely USD, or eventually BTC or ETH. After consumers
trade Aventus tokens for concert tickets, venue hosts will trade Aventus tokens for their preferred
currency.
This process is shown below. In this example, I’m assuming that all parties prefer USD as their reserve
currency. This diagram would still hold true with another reserve currency such as BTC or ETH.
This creates an interesting dynamic in which the people who get paid in Aventus tokens don’t actually
want to hold Aventus tokens. The moment they receive Aventus tokens, they will sell them… to
someone else who wants to buy different concert tickets, or a market maker (who will sell them to
someone who wants to buy concert tickets).
Even if Aventus becomes the global standard for ticket issuance, no one will want to hold Aventus
tickets. BTC, ETH, and/or USD denominated trading volume for Aventus tokens may skyrocket as
Aventus becomes the global ticketing standard, but the price won’t actually go up much. Everyone who
buys into Aventus will sell their Aventus immediately.
The only people who will profit from the success of rise in trading volume of Aventus tokens will be
market makers who provide liquidity for those entering and exiting the Aventus market. This is not a
bad thing. As asset pairs increase in volume and become highly liquid, bid-ask spreads will collapse to
near 0%, which is good for consumers and venue hosts. Market makers may take a few basis points, or
even a few dozen basis points, but not more than that. These fees are certain to be lower than credit
card fees.
To be clear, in this proposed future venue hosts still win by cutting out scalpers, and consumers win
because of increased fraud protection. But coin holders don’t really win since the price of the coin won’t
go up enough to justify the risk of investment.
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The analysis above doesn’t imply that Aventus should be worth near $0. This analysis assumes no
speculation, which will never be true. Also, if volumes increase, it’s natural that some people will buy
and hold the asset simply because increases in volume typically correlate with increases in price in
crypto land. Insiders will also hold shares. However, this limited number of market participants will not
be sufficient to counteract the market forces of high velocity, especially in the absence of massive
speculative value.
Quantifying Velocity
Velocity can be measured over any time span. For standardization purposes, we’ll measure it annually.
We can say that an asset has a velocity of 0 if, over the course of one year, no one buys or sells the
asset. The lack of liquidity would cause the asset to trade at a discount to “intrinsic” value. Assets need
some velocity to achieve intrinsic value. This is known as the l iquidity premium.
Let’s say Bitcoin has an average network value of $1B over the course of a year. Bitcoin would have a
velocity of 1 if $1B worth of Bitcoin trades over that period.
In the last 24 hours, there were about $1.5B of Bitcoins traded on exchanges. This excludes OTC
volumes, which could be significant. The network value of Bitcoin is about $70B. This implies an
annualized velocity of $1.5B * 365 / $70B = 7.8x (ignoring OTC).
By non-crypto standards, this is an extraordinary velocity. Equities as a whole are w
orth about $70T
and trade about $70T annually. Amazingly, Litecoin has an even higher velocity than Bitcoin.
(Note, this rudimentary analysis implies that crypto prices will continue to rise as institutional capital
converts from fiat to crypto. In comparing crypto velocities to equity velocities, institutional capital tends
to hold equities on average longer than current crypto holders hold crypto. Given how large the
disparity is between equities and crypto velocities, it’s likely that crypto velocity will decrease as equity
capital transitions to crypto capital.)
It’s difficult to say what future velocities should or shouldn’t be. We can look to things like equities,
commodities, and retail, but cryptoassets are different. It’s difficult at this stage to confidently say what
normal velocity ranges should be.
There are a few ways a protocol can reduce the velocity of its associated asset:
1) The first mechanism to reduce velocity is to introduce a profit share. For example, A
ugur ($REP)
tokens pay out coin holders who report event outcomes to resolve prediction markets. $PAY holders
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get paid as consumers transact using TenX cards. A dividend-like mechanism reduces token velocity
because, as the market price of an asset decreases, its yield increases. If the yield becomes too high,
market participants seeking yield will hold the asset, lowering velocity.
Also, a dividend stream makes a token easier to using a traditional d
iscounted cash flow (DCF) model.
Side note: check out our recent Augur analysis and valuation.
2) The second way a protocol can reduce velocity of its asset is to give token holder influence over the
future of the protocol. This is typically handled via a one-token:one-vote mechanism. The theory is that
stakeholders in the ecosystem will be unwilling to sell their coins because they have a vested interest in
the future of the ecosystem and want to have some influence over the future direction of the protocol.
This sounds nice in theory, but I’m dubious of this claim in practice.
Token-based voting is appealing to many because it’s analogous to democracy. But voting on protocol
governance is unlike voting on elected officials in one important way. It’s easy to sell cryptoassets and
move wealth elsewhere. You can’t easily move in and out of a given democracy (possible, but high
switching costs). If you disagree with the future direction of a protocol, you always have the option to
leave that “democracy” at will for near $0 cost.
Moreover, for a protocol that becomes even moderately successful - let’s assume a terminal network
value of $200M - a token holder would have to hold $5-10M worth of tokens before her vote would
move the needle. Even then, the movement would be small. The ability of any given token holder
moving the needle decreases as network value increases.
3) A third mechanism to reduce velocity is to build staking functions into the protocol that literally lock
up the asset. This includes proof-of-stake based staking, although this alone shouldn’t reduce velocity
too much. But extended staking mechanisms can reduce velocity further. For example, N umeraire
requires data scientists to stake their NMR tokens for 30 days to compete for prize pools. This staking
by definition reduces velocity since the tokens are illiquid while staked. Moreover, in the case of
Numeraire specifically, the amount of NMR staked is a function of the data scientist’s conviction in
herself and amount of money the data scientist believes she can win.
4) A fourth mechanism is what I’ll call the “network utility expansion” mechanism. This applies to
decentralized cloud protocols such as Golem, STORJ, Sia, Filecoin, and Maidsafe.
Since token supply is fixed, each token can purchase a defined percentage of total capacity of a
network. Overtime, if a protocol is successful, the capacity of these networks will grow as more people
seek profits and rent out underutilized assets. Therefore, each token will be able to purchase a larger
absolute amount of total compute power / disk space. Although price per CPU cycle and KB are always
falling, markets have generally shown an appetite for ever increasing amounts of both. It’s therefore
likely that those who own access to these networks will hold their tokens, reducing velocity.
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5) A fifth mechanism is to become a cryptocurrency (this is a similar, but different lens on #4). This is
non trivial. If people start holding a currency so they can purchase goods and services at a later time,
velocity is by definition reduced.
Today Bitcoin is the reserve currency in crypto land. But other cryptocurrencies are emerging. For
example, let’s examine distributed VPNs like M ysterium and Mesh Labs (no website yet).
Mysterium is a distributed VPN. The basic problem Mysterium solves is one of trust. Centralized VPN
services are not safe. As a user, you have no idea what the centralized VPN is doing. You could setup
your own VPN on AWS, but this is not something most users can do. Mysterium aims to solve this
problem by decentralizing the VPN host across many computers. Tor has done this for years, but Tor
relies on altruistic hosts, which limits the number of hosts and reduces speed for the end user.
Mysterium is effectively “Tor with a token.”
The kinds of users who would act as hosts on the Mysterium Network are also the kinds of people who
would want to use Mysterium as they traverse the Internet. As Mysterium hosts accrue MYST tokens,
they’re unlikely to sell them since they’re going to use them again in the near future. This reduces
MYST velocity.
Conclusion
Velocity is one of the key levers that will impact long term, non-speculative value. Most app coins like
Aventus don’t provide a compelling reason for coin holders to hold the token long term. Absent
speculation, assets with high velocity will struggle to maintain long term price appreciation. Protocol
designers will be well served to incorporate mechanisms into their protocols that encourage holding, not
just usage.
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