While there seems to be little dispute about this, I’m surprised to see less concern and discourse about this amongst the community of investors. Instead of continuing to try to value assets that suffer from this problem, I think there are two more important questions we should turn our attention to:
I initially posed this question to myself thinking I would argue that certain tokens like Filecoin and BAT would prove to be exceptions (just because I like them) because of certain dynamics like…
- Attractive demand-side dynamics: Basically, that there are people who actually want to purchase these tokens for real money because the utility is valuable to them. (The number of projects that do not have this quality is appalling, but that is an article for another time)
- Natural dynamics that reduce velocity: Filecoin requires people to continue to fund storage using Filecoin over an extended period of time, and will lock up tokens in escrow. BAT might have natural dynamic where advertising dollars turn over in 30-day cycles, thereby reducing velocity naturally.
- Artificial incentives to lower velocity: There are a few questionable examples of this like PROPS and STEEM, where users are incentivized to hold tokens for reputation or for other reasons related to the usage of the platform.
… but I ended up concluding that two fundamental forces continue to pose a problem for velocity even for tokens with the above qualities. I’m inclined to believe that no single utility token is immune to the problem.
A. The Effect of Speculation on Velocity
If we assume that there is a healthy market for any speculation at all, we should assume that there will be an impact on velocity that adds volatility to the token price.
Looking at blue chip stocks (AAPL, IBM, etc), approximately 1% of all shares change hands once a day. (Average daily trading volume as a percentage of total shares). More speculative stocks (for example, ones that have IPO’d in the past few years like APRN or SFIX) have 5 — 10% of their shares change hands every day. If we use this as a comparison, this factor alone increases velocity by approximately 20–40 (5–10% token supply at 365 velocity).
One could argue that the gradual establishment and reduction in trading volume then increases value due to the decreasing velocity (to the order of 5–10X returns), but I repeat, are investors really willing to speculate on propensity to hold as opposed to fundamental value?
B. The Effect of Usage on Velocity
There also seems to be this idea circulating around that a large percentage of people HODLing the token will reduce velocity.
However, having more people HODL the token simply reduces the liquid token supply, but does not actually reduce the total number of transactions that occurs on the platform. It simply concentrates those transactions over a smaller liquid token base.
If we can just understand how weighted averages work, as long as total transactions continue to increase and the token base stays the same, velocity still increases by the same amount. The only exception would be if that lack of liquidity actually decreases the transaction volume, which then just means it’s impeding the growth of the network.
Therefore, increasing usage is directly correlated with increasing velocity (assuming a stable total token supply) which then decreases utility token value. And no, more HODL’ers is not a solution here.
Velocity will continue to be a problem for single utility tokens.
We need to change the underlying token model.
I will start by pointing to one model that I find very interesting — the Gnosis / SpankChain model— but I’m hoping this discussion will point me in the direction or more novel ideas.
For Gnosis / SpankChain, there are two tokens — a ‘mint’ token and a ‘utility’ token. The ‘utility’ token is used in the marketplace, is burned to pay for platform fees, is pegged to $1USD, and has a variable supply based on token usage in the previous period. The ‘mint’ token is staked and generates tokens to meet the target supply. More details on how this model works here.
Assuming a somewhat stable platform fee percentage and a steady state usage of that platform, over a long holding period, the tokens generated for ‘mint’ tokens is equivalent to the revenue associated with the platform fees plus the increase in token supply. The problem is that in high growth situations over short time periods, the change in token supply can affect returns significantly. For speculative venture-capital-like investment purposes, this should be acceptable because, nonetheless, returns are directly related to growth in platform usage with no confounding variables.
You can take a look at how this works in this Google Sheets model.
While imperfect, this two-token model gets us much closer to a cleaner, investable cryptoasset model where the ownership of the mint tokens correlates well with market value growth, without any confounding variables. It even has cash flows and yield you can calculate from it, so you can apply a standard DCF to come to a opinion on value. We would no longer need to rely on the PQ = MV model.
Ultimately, instead of trying to value single utility tokens, we should be looking for a token model that allows for investability where the value is directly correlated with network value with no confounding variables. These models will definitely resemble securities much more than a utility token — which is likely why a lot of these projects are running towards the default single token model — and we will have to contend with the SEC in the future, but that’s a discussion for another day.