On Tech, Business, Society.

Tag: token models

Picking Apart the State of Blockchain, And Have We Earned It?

Cutting to the chase, here’s what I’m seeing in blockchain and crypto markets. I started writing these thoughts last week, before signs of the current market downturns became visible.

Meme Coins Will Not Yield Anything Except Speculative Fever

I understand the power of community sentiment and excitement as levers that can lift demand, but the intent of a cryptocurrency is not just about the cliché statement: “number goes up”. A bonafide cryptocurrency must serve a purpose and have multiple utilitarian use cases. Meme coins are an interesting phenomenon, but they offer little utility outside of speculative trading. Cryptocurrency markets are already irrational to start with. If you add uncertainty on top of uncertainty, you get irrationality at a multiplied level. The meme coins mania will not end well. Cryptocurrency is not a game or a joke.

SEC and Regulators Still Too Slow

There are the two types of regulators: the slow ones, and the negative ones. As the leading body amongst Western regulators, the SEC continues to be slow and overwhelmed in terms of bringing significant change. A ray of hope was recently uttered by SEC Chairman Gensler when he hinted that a new regulatory entity might be needed in order to properly deal with crypto-regulation. In my opinion, a focused (new) U.S. regulatory body will be necessary if we want to see real innovation in the form of benign regulation. Otherwise, we will get a continuation of hit-and-miss positions, incomplete guidance, overlapping regulatory frameworks, more wild-west behavior and overall risk for all involved. No new regulation is as bad as some incomplete regulation.

China Needs To Blockxit

Let’s be straight: China does what is good for China. Corollary: China doesn’t care about the impact of its actions on the rest of the world. True for technology, economy, trade, healthcare, politics and cryptocurrency. When the Chinese government says they are banning cryptocurrency, miners, crypto-banks, ICOs, or whatever the next thing is, these directives are oriented towards its own people. However, these communications missives muddy the water because of global interdependence implications. For example, I’m looking forward to the day when Chinese miners aren’t the majority anymore. Like the boy who cried wolf too many times, China’s roars on cryptocurrency are often like thunderstorms that don’t bring rain, or a bark without the bite. Each time China tries to whack the next mole, the crypto industry goes “ouch”, feels some pain, but things quickly rebound thereafter, by discounting these actions, and the whole market gets stronger overall.

Exchanges Crave Volumes, Not Validation of Projects

Most exchanges are challenged about managing their vertiginous growth. Volumes are their drug, and they need increasing fee revenues to continue funding their operations. In addition, they are fighting like hell to differentiate themselves from what appears to be a commoditized business. However, exchanges are not the ultimate quality validators for projects, despite what they might lead you to believe. At the end of the day, they just want volumes and will list token projects that are making headlines. Just look no further to how quickly many of the top exchanges tripped over each other to list the top meme coins, caving-in to “popular” demand.

No Price Discrimination

The reality is: some projects are under-valued, while many others are over-valued. But here’s the key question: how do you rationally evaluate tokens? Transaction levels, number of users and fee volumes (if applicable) are still the true North of activity; assuming there is a real raison d’être for a token. Many token-based projects have “apparent” success if you judge by their market caps, a number that has become a vanity metric more than anything more indicative of real value. Many crypto market caps need to be discounted, as there is little correlation to their fundamental metrics.

Governance Tokens Are Overrated

At the heart of most governance tokens, you will see a common legal rider that “the token has no economic value…holders have no claim on financial rights…governance token is used to oversee the xyz ecosystem”. That said, the dichotomy is that, no sooner are these tokens declared to be governance tokens, and supposedly distributed to “voters”, that you see that same token being listed on exchanges (central or decentralized), and very quickly these “no economic value tokens” start to earn exponential economic benefits to their holders. Incidentally, many of these “governance-first” projects end-up with very low voting turnouts (1-3% is not uncommon), and most of them don’t even have a utility role that is critical to operations.

Bitcoin and Ethereum Still The Only True Leaders

I’m not only referring to market cap leadership, although these 2 coins command close to 64% of the overall crypto market cap (as of June 22 2021). Rather, the fact that there are only 2 true leaders in a new emerging era is problematic when you contrast to the 5 Web2 leaders that comprise the FAANG analogy. Today, Facebook, Apple, Amazon, Netflix and Google have a combined market value of $6.7 Trillion, and if you add Microsoft, those 6 tech leaders add-up to $8.7 Trillion. Bitcoin is sitting at about $600B market cap and Ethereum close to $220B. What will be the FAANG of crypto? We are probably far from seeing that group emerge, although for fun, I have made-up the CUBBE gang: Coinbase, Uniswap, Binance, Bitcoin, Ethereum, as potential blockchain lighthouse leaders.

DeFi Is Underhyped, And Mostly Mysterious

Despite its kwarkiness and risk, DeFi is the tip of the iceberg when you think of the future of global finance. But DeFi’s impact won’t be so significant unless it reaches awareness and adoption levels that are orders of magnitudes over the current ones. For that to happen, the barriers to user adoption must be lowered even further. Democratizing liquidity provisioning might be a foundational core upon which other layers build on top of. But each successive layer must be solid first, so that the whole doesn’t come crashing when things start to shake or when the boundaries get tested.

Talking Heads Who Are Not Experts

The market is fickle with commentaries from talking heads who don’t see anything but price action and momentum plays. Every other TV financial commentator is now asked to talk about Bitcoin or cryptocurrency when their knowledge is actually superficial or opportunistic. Most of them are clueless and just spitballing stuff. The loudest or most articulate mouth isn’t the smartest nor the most insightful. Beware of so-called experts who aren’t really experts. Ask them to enumerate several cryptocurrency use cases, or to intelligently describe DeFi, and their knowledge will be as thin as a razor. Someone who invested in an NFT company or just bought an expensive NFT last month is not necessarily an expert on NFTs or their future.

Ethereum Killers Who Are Not

“Ethereum killers” will not kill Ethereum, but will make the market larger. So-called Ethereum killers are still gunning for it, touting this or that feature as their ace card. However, those claims aren’t going far, because each blockchain should stand on its own, by self-differentiating itself based on its peculiar features or achievements. The reality is that – as other emerging blockchains become successful, they make the market larger as a whole. Ethereum and Bitcoin are in a league of their own. Most other blockchains attempt to mimic Bitcoin/Ethereum key aspects, with some degree of variation. Claiming feature superiority is one thing, but acquiring a network effect level of users to validate market success is an entirely different ball of wax.

Working Together Doesn’t Exist

The blockchain is natively global. It knows no borders, and doesn’t like barriers. Just as global issues require global cooperation to solve our world problems, I wished there was more native cooperation between some blockchain standards to increase interoperability, and make the user experience more seamless. Take stablecoins for example. When sending them around, you often need to specify which blockchain network you want them settled on. Sometimes, it’s a choice of 6 different networks. The user shouldn’t need to worry about that. On the other hand, wrapping coins on Ethereum has proved to be another way to ingest standards instead of fighting them.

Wallets Are Still Archaic

On one extreme, there are innovative wallets that are optimized for DeFi (e.g Zapper or Zerion), and on the other side of the spectrum, there is a variety of straightforward wallets that are simply optimized for token swaps. Of course, there is MetaMask as the uber wallet for non-custodial transactions. But there isn’t an all-around wallet that combines ease of use, security, variety (e.g. voting/rights access), DeFi, NFTs and generalized Dapps entry. General-purpose wallets will be to blockchain what browsers were to the Web. We need to see an evolution of wallets that captures the imagination of millions of users. Just as browsers stitched together the hyper-connectivity of content, wallets are stitching together the hyper-connectivity of money.

ICOs By Another Name

ICOs are still happening, but they aren’t called ICOs in order to stay under US regulatory radars. They typically start via a private offering of tokens at a favorable price to accredited investors. Then, a small percentage of tokens is offered (typically to non-US investors) at attractive prices with a cap on the allowed amount (in the $500-$1,000 range) in order to fake the decentralization of ownership, which is a factor along the decentralization spectrum. All these have some lock-up periods that are not excessive. Then, the network is launched, and the token is gradually released into circulation, and finds itself trading on DEXes first, then it gets picked-up by exchanges, depending on the number of headlines generated.

I do not see how the industry can positively move forward while logging garbage tokens with it. Some large market cap tokens in the top 20 will be a train wreck when it is revealed that the Emperor had no clothes. Some other under-valued tokens that represent real token usage, transactions, a circular economy, and active users will emerge and earn their rightful place along the valuation spectrum.

Irrational exuberance and bubbles are good propellers of activity. But bubbles don’t discriminate between good and bad activity.

No matter where we are in the overall market cap spectrum, we need to ask again this fundamental question that Vitalik Buterin once asked in December 2017 when the crypto market hit its first half Trillion mark: “Have we earned it”? Now, this question needs to be applied to each and every token and organization behind it, not just to the market as a whole.

The Elusive Value-to-Usage Linkage in Cryptocurrency Market Valuations

We continue being obsessed in wanting to draw rational relationships between the price of crypto-tokens and the value behind them. There is no shortage of research and analytical viewpoints from analysts, entrepreneurs, developers, pundits or investors attempting to draw definitive relationships that are reliable and widely applicable. Just Google “crypto tokens valuation metrics”, and you will see the variety of what has been written so far on this topic.

My own last attempt was from September 2019, as I enumerated 9 different variables for measuring the health of cryptocurrencies and tokens. But I didn’t profess to have cracked the code on a magical formula or found the magical equation that would become the telling star for these valuations. 

As I lamented in 2017 in The Darkness Side And Long Honeymoons Of Token Sales, we are in dire need for fundamental metrics that could be equated to how public companies’ stock prices are routinely valued:

In public companies, analysts and investors use metrics such as revenues, net income, EBITDA (earnings before interest, taxes, depreciation and amortization), EPS (earnings per share), P/E ratio (price to earnings ratio), and sales growth in order to correlate market capitalization justifications.

For ICOs and token-based projects, what are the equivalent performance metrics?

Some time at the end of 2017, there was hope that a turning point might occur, as the number of token users started to increase to the point where it might have surpassed the number of token speculators. That is when I wrote The Other Flippening: Token Users vs. Token Traders.The hope was that usage activity would eventually prevail as the driving force in token valuations. It was believed that the number of actual token users and the sheer usage inertia behind them would overrule the speculators’ sentiment who were thus far dictating the particular value trajectory of a given token. Fast forward to today, 3 years later. I believe we find ourselves caught in the same dilemma. 

Two promising blockchain metrics have struggled to become real prognosticators of token value that we could have banked on, because they failed the test of times. 

First, take gas fees on the Ethereum network, as an example. As the network became more popular (a good thing), it also became slower (a bad thing), resulting in increased gas fees to run the variety of smart contracts. The interpretation of the increased gas fees became a point of contention: on one hand, increased gas fees count as part of “network revenue” (a good thing), but on the other hand, it also meant that each given transaction became too expensive to run on the Ethereum network (a bad thing), and that forced some use cases to consider either moving to Ethereum side chains or other chains (a bad thing for Ethereum). 

What did the Ethereum token price do during this period? First it went up, then it went back down, but it was very hard to establish a real correlation via any type of equation or quantitative measure that could be followed reliably.

Second, take DeFi, a sector that has been described to be “on fire”, and on an aggressive growth trajectory. As recently as July 2020, it was commonly accepted that the DeFi Total Value Locked (TVL) was a good indicator for the valuation of the DeFi market. As TVL continued to grow, so did the total market cap of the top DeFi tokens, until that correlation broke-down shortly thereafter. At the time I wrote my last piece on DeFi in early September 2020, (For DeFi to Grow, CeFi Must Embrace It), the total DeFi market cap was hovering at $16B. Today, it is about $12B despite a TVL continued climb from $9B to $11B today. 

One could justify this pull-back by citing traditional market behavioral dynamics that typically price underlying instruments ahead of expectations, but deflate themselves after the news has been made public, and that is a common psychological yin and yang in markets behavior. Perhaps that was the case. 

That said, keep in mind that the DeFi “TVL-to-market cap” relationship I cited above draws on “macro” metrics, based on the health of the entire segment, and that is a lot easier to quantify than trying to apply metrics to individual tokens based on their own intrinsics. Good luck in trying to translate the macro view at individual token correlation level.

In addition, DeFi had the peculiar artificial reality that for many of these tokens, their price was often driven by automated market maker algorithms that do not factor prior judgement in, or knowledge about usage metrics, and rather derive their core from a given demand / supply dynamic curve and the presence of a variable liquidity pool. Tight liquidity/float pools create artificial price points that need to be tested over time.

This leaves me to conclude that, in the absence of correlatable metrics, we are only left with vanity metrics, or perhaps just “input-type” of data points that could one day find their way into some set of correlative equations that will make sense. 

The other peculiar anomaly between traditional stocks and crypto markets is the fact that, in crypto markets, the same currency that has actual (user) utility is the one that investors/speculators partake in owning. This is in contrast to stocks that are just a unit of account, but cannot be used to purchase related products or services from the underlying issuer. 

You would think that this intrinsic singularity within crypto markets should give room for an even tighter correlation to emerge between usage and value, but this hasn’t happened yet, at least not in a way that we can start to build a body of support behind it. 

Of course, we still have hope that one day, the usage of highly popular cryptocurrencies (whether via user or developer traffic) would append and dictate the actual value trajectory of the underlying token, but that day is yet to be expected sometime in the future. 

Imagine if you were mandated to pay for charging your Tesla via a fraction of a Tesla stock. In essence, you would need to keep buying Tesla stock, (therefore creating demand for Tesla stock and contributing to its eventual rise) in order to pay for an electric charge (excluding from your own charging station for example). Of course, as the Tesla stock price goes up, your actual cost for charging would go down, and that would be a good thing. If for some reason, Tesla owners stopped driving their cars, the ensuing decrease in activity would result in less demand for Tesla stock/currency and its price would dwindle accordingly. But at least, there would be a real linkage between usage and demand, something that is natively intrinsic to crypto tokens. 

In the blockchain space, on-chain fees/revenues still hold a good promise for being a leading indicator of blockchain network value. Ethereum has a proposal for making the fees schedule more dynamic (EIP 1550 and Fee Structure), which promises to make payments more equitable, but also potentially more difficult to correlate. That is certainly a development area to watch.

My friend Evan Van Ness aptly called a number of chains “Zombie Chains”, based on the little number of transactions that actually pass through them. That is an example of negative metric correlation that is nonetheless logical and easy to understand or validate. 

We continue to be in the iterative stages of finding the holy grail of correlation metrics between crypto tokens value and usage. 

For this reason, I believe we are still in the stage of qualitative crypto tokens valuation, where the price of tokens is primarily driven by speculative perceptions, brand value, and creator promises. 

6 Blockchain-based Innovations…or Loopholes?

There is no shortage of innovation in the blockchain sector. Technological innovations were the starting points, led by developers. Now, we are seeing entrepreneurial innovations, led by creative entrepreneurs and financiers who are applying the technology in ways not thought of before.

In this post, I’m highlighting 6 applied innovations in blockchain or token models, many of which border on being loopholes that are currently flying under the regulatory radars.

1) Create Your Own Currency

Traditionally, only governments created sovereign currencies. With the blockchain, anyone can design a currency by giving it a special purpose. Using Ethereum, a developer can create a new currency (now called token) in a few lines of code. The good part is that this has fueled billions of capital to fund startups and projects who created trillions of tokens, but this has also simultaneously lowered the quality bar on what gets funded.

2) Say the Smart Contract Issued the Tokens

Since typical regulatory frameworks prohibit companies from raising money from the public without substantial disclosures and due filing processes, one loophole is to structure the public ICO such that- technically, it is the smart contract that is the issuing party. This means that token buyers aren’t sending their money to an entity, but rather to a piece of software that holds it, and returns the equivalent number of tokens. Regulators are still scratching their heads around how to subpoena or arrest a blockchain smart contract.

3) Foundation Controls the Tokens

A common practice is to create a non-profit “foundation” that actually administers the receipt and use of the tokens, but then commissions another entity to develop the technology. There could be a variety of relationships between the foundation and the developer entity, and sometimes the foundation is created before, and sometimes after the ICO. Foundations offer a layer of legal protection, but the fog hasn’t completely lifted on them, and there are no standards for foundation structuring.

4) Adopt a Virtual Jurisdiction

The virtuality of the online world is now taken to the legal level. Traditionally, companies are created within the jurisdictions they are typically conceived from. Of course, we’ve had Delaware-type entities and Cayman-based funds as the precedent for choosing remote jurisdictions. With the blockchain, the leading new alternative jurisdictions are Switzerland (Zug), Gibraltar, Malta, Cayman and a handful of others. All you need is a local lawyer in that jurisdiction to get this done.

5) Air Dropping, Not ICOing

As I’ve described in an earlier post (Utility vs. Security Tokens: Why Not Both?), companies are now air dropping tokens (e.g. 20% of total distribution), while keeping a significant percentage as reserves (e.g. 60-80%). Then, they wait until the token starts trading upwards (assuming there is some speculative hype or real usage that drive it). At that point, they start selling their reserve tokens into the public markets to fill their treasury. In essence, it’s like getting the effects of an ICO without raising money from anyone, and flying under the suspicious radars of regulators.

6) Trade-Driven Mining

This practice is being popularized by new exchanges (Binance, Huobi, KuCoin), and it is well described in this article by Mohamed Fouda (How Asian Exchanges And Investors Are Making Huge Profits Through Trade-Driven Mining). As the author explains, the exchange token is distributed to users based on their trading volume, in essence subsidizing the transaction fee. By distributing their native token, the exchanges also drive the demand and price up, and they make their profits from the token appreciation in the market. In addition, to further tighten the supply/demand equation (which drives the token price even more up), some of them (e.g. Binance, KuCoin) are buying back and burning a significant number of their tokens from up to 10-20% of their profits, each quarter. This is the most machiavellian scheme I have ever seen in this space.

In my opinion, all of the above schemes equate to legal, or financial engineering prowess, and are less about product innovation. You can implement any of the above and still fail if you haven’t been able to develop a real product with substantial traction.

In the case of the trade-driven mining example, the scheme looks like a perpetual bribe for usage, almost like loyalty points that appreciate in value, so it is very attractive to users. Luckily for these exchanges, they do have a product that works.

Generically, one could extrapolate that model into any usage-driven token reward for any product, blockchain or not. Wouldn’t be nice if Apple had given you a token for every product you bought from them, and let that token appreciate in relation to their stock price? If that was the case, you would have received a x22 bump on that token price since the first iPhone was introduced, 12 years ago. Even with a less extreme case of appreciation, let’s take United Airlines whose stock appreciated x3 in the past 5 years. Anyone would have loved a 3x bump on their MileagePlus points, no? If a new credible and safe airline appeared on the scene tomorrow, with a fly-based mining reward scheme that is linked to their token appreciation, I’m sure it will instantly get filled with travellers.

That said, the jury is still out on the longevity of these practices. Entrepreneurs are always 3 to 4 steps ahead of regulators.


Powered by WordPress & Theme by Anders Norén