There will be three key phases in the evolution of the crypto-token cycle before we get to a point where there will be accepted ways of valuing and funding utility tokens. The first phase will be the Infrastructure development phase where economics will be largely centralized; followed by the Dissemination and cross-pollination phase, where new technologies are applied to the traditional economy; and finally, the Decentralized dissemination phase, where utility tokens will come into their own.
This post will step you through how each of the phases will unfold and which aspects of the phase will capture a majority of the economics. To begin, it’s necessary to briefly look at what happened over the past year, the pump priming that has started the engine which will drive the material changes in the way we interact and do business on the internet.
Phase 0 — House Money
As we’ve already seen, the emergence of the crypto-token cycle was fueled by the rising crypto-currency prices. The early investors that saw their holdings shoot up were willing to back any Initial Coin Offering (ICO) that had the right investor relations positioning, regardless of the actual application or economics surrounding the tokens. We saw this unfold in the second half of 2017 and early 2018, before the crescendo that led to a 70–90% drawdown in most of the major crypto-currencies.
This was an important phase to create the foundation of the crypto-economy. A lot of the early investors and miners walked away with cash when they sold to the new-comers. Some developers and scammers were able to syphon funds out of the major crypto-currencies to building companies or projects that could hold some promise. I imagine that this phase will play out in a similar way to the 99/01 tech bubble where there were a handful of really important businesses created that were able to stand the test of time. However, a majority of the ICOs that were created will likely fold as treasury management, combined with a lack of product, will lead to a complete washout of the sector.
Phase 1 — Infrastructure Development
Importantly, the first phase also allowed the first infrastructure to be developed. This is the equivalent to the early investors in the railroads in the US. A lot of the railroads eventually folded. However, they created the backbone of the infrastructure that allowed goods and people to move around the country relatively easily. The rail infrastructure enabled the economic engine to kick itself into overdrive.
In a similar manner, the most important companies for crypto-tokens that are going to be created as a result of the house money phase are going to be the infrastructure businesses: the crypto exchanges (spot and derivatives), the wallets, and the mining hardware providers amongst others.
One thing that these early businesses/applications in the crypto-economy have in common is that the economics are centralized. Some VCs were quick to the game, realizing that they could take an equity position in the companies and then encourage them to pursue an ICO noting that it doesn’t mess with the cap-table so it’s a no-lose situation for them.
This phase will continue with other crypto-specific infrastructure that has centralized economics building out, as incumbent fund managers begin to invest in crypto-currencies. It’s likely that we’ll see crypto-custodians, crypto-service providers (free-lancer platforms), and crypto-administrators amongst others. The way to benefit from this wave is going to be to invest in the equity of the centralized crypto-service providers that will be created to fill the void and legitimize the industry to standards that will be accepted by the incumbents (or likely surpass them).
Phase 2 — Dissemination and Cross-Pollination
In the second phase, it’s likely that some of the features and technology that was created as a result of the crypto boom will be applied to aspects of the “old economy.” One of the killer applications of this will be security tokens. Security tokens will become more mainstream and largely replace the position that equity held in the “old economy”.
Currently, in a majority of jurisdictions, security tokens are subject to the same rules and regulations as equity investments. So, there’s limited reason to implement a security token over traditional equity (apart from the fact that you might be able to benefit from the House Money effect mentioned previously).
However, as custodial structures and regulations evolve to catch up with the new evolutions, it’s likely that security tokens will hold a significant amount of benefits over equities, such as; 24/7 markets, fractional ownership, rapid settlement (including the reduction of middle-men), reduction in direct capital costs (capital tables automatically maintained), automated compliance and additional abilities created by smart contracts.
During this phase of the market development, security tokens will capture a majority of the economics. In much the same way that equities are valued today, similar valuation frameworks will be able to be applied to security tokens. It’s likely that there will be a premium placed on security tokens over and above similar equities, because of the additional security and smart contract features that are able to be applied.
Phase 3 — Decentralized Dissemination
Eventually, we’ll get to the utopian paradise that underpins the internet’s raison d’être, a decentralized meritocratic platform for interacting with others. During this phase, it’s likely that we’ll start to see a wide range of decentralized protocols that will emerge, which will change the way that we’re able to communicate on the internet.
As I’ve mentioned previously, the protocols that we use today were developed in non-profits and academic institutions. The protocols have been sufficient and while there has been a small amount of development, there hasn’t been the same level of economic incentives to create something new and meaningful. Crypto-economics will turn the table and encourage the development of new utilities and ways of communicating.
It’s likely that the current valuation approaches that rely on Total Addressable Markets and the velocity theory of money approach (MV = PQ, see the INET valuation example) will need to develop further. From these concepts, it’s likely that we’ll see other valuation methods emerge. I’m unsure what tools and methods will evolve but I’m confident that they’ll add to the current frameworks that have been developed and intermingle with the tools used in traditional finance (DCFs etc).
During this phase, the market will begin to reach maturity with a wide understanding of the various layers of protocols. In this phase, it’s likely that the economics will be truly decentralized. The holders of the winning protocol tokens will likely be the beneficiaries. To be a winner in this phase, it will be beneficial to understand the competing protocols and be willing to be an early investor in the protocols that could potentially be the winners, through taking positions in utility tokens.
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