Why the intrinsic value of almost all ICO/airdrop token today is zero
I know this is not a popular heading, but I firmly believe it is true and that basic logic overwhelmingly supports this view. Of course we know that with religion and greed, logic usually takes a back seat. Crypto currently has large overlaps with both. I also thought Consensus2018 a good time to publish this. So while you enjoy the visions of grandeur spelt out there, read this for a reality check.
Before I make my case I need to clearly point out that I am specifically talking about token that:
(A) do not have their own blockchain complete with a proof mechanism (ie run on a chain such as ethereum)
(B) are not themselves the main product of the start up that ICOs or airdrops them (ie typically are used as a payment method for the future products, but are not the product)
(C) have tried to (unsuccessfully in my view) avoid being classified as a security by explicitly not including any kind of equity or debt like rights for their owners or (worse) taken these away after the ICO like Monaco or TenX have done
This encompasses c 95% or more of all ERC20 token today.
Finally, by intrinsic value I mean the logically deduced fundamental value of a token based on either its features or its unique use that cannot be achieved easily by other means.
What would constitute intrinsic value in a token?
In order to have any actual value that is not exactly the same value a piece of gravel would hold if I were to pick it up and sell it to you and then you‘d sell it to some other “greater fool“, a token needs to fulfill one of the following criteria:
(1) be a security WITH security rights
If a start up were to issue its token as debt or equity (even if it were just lower ranking debt than their higher tranches), then the holders of these token would have rights governed by a regulated prospectus that could not simply be altered without their consent. Monaco and TenX for example had planned to pay something similar to dividends to their token holders but cancelled their respective plans more than six months after the ICO. Ridiculous that token holders would not bulk at this. But of course they had no method to do so as they have no rights whatsoever. If a token had such rights attached (like Lykke, by the way does), it would have an intrinsic value.
(2) a (future) product that indisputably necessitates the token
If a start up were to offer a product, such as storing data on their own centralized or decentralized blockchain or offering an improved technological way to build smart contracts on their own chain, then it would make sense to reason that their token is an integral part of the product. In this case, if the start up is successful there is certainly a case to be made for intrinsic value. I have no idea how to make this case in the absence of a separate blockchain by the way. Perhaps if it is something like Dcorp or Augur that requires a voting mechanism (as the main part of their product, NOT as some vague option) for which a token is the best or most efficient solution and where the outcome of these votes are the main product or at least a big part of it. Decentralized exchange protocols might be such a case as well. Importantly this needs to be a true necessity for the token that cannot be achieved more easily or more user friendly without one.
(3) Solving the scalability issue
Again, I have no idea if this can technologically function as a token on a different blockchain (ie ERC20) without its own blockchain, but crypto kitties and ICO congestion have clearly shown that there is going to be a need for more scalable backbones of the decentralized internet than the current Ethereum configuration.
So how does the typical ICO/airdrop stack up against these criteria?
I am well aware that I may have forgotten a good case for intrinsic value (so if you know one, please comment), but it will be hard without the words “network effect“ (only potentially valid for complete blockchains, not for ERC20 token; unless of course you mean a network of ever greater fools), “payment method“ or “scarcity“ (if you cannot grasp why ICOs are not scarce, well then don‘t bother to read the rest, you won‘t agree with me).
So I will go with my list above. Remember that I am explicitly not talking about the token with their own native blockchain. The typical value proposition of an ICO looks like this:
We will revolutionize the world by bringing XYZ to the blockchain (or the blockchain to XYZ). To use our services in the future, users will need to purchase XYZ token to pay for them. You now have the unique opportunity (after we have held pre sales and pre icos and private rounds) to buy this token before we market our product.
The only concrete use of these token is people having to convert fiat, btc or eth into the token to pay for the services. Let me directly dispell this myth. Any start up that will truly be successful will not be stupid enough to limit their target audience to people (let alone companies, who would have a massive custody issue) who have crypto or can transact in it. If they do, someone else will offer the same exact service (someone like Blockchainfoundry perhaps?) to them, charge them in USD, EUR, BTC or their own token (ie let them choose) and maybe even charge them directly for the service, but not make them buy their token as well (or alternatively make their token supply so vast that even if it is bought in the background, like at DENT for now, its price will always be low enough for the model to work — again not great for token holders).
I think these business models are great and holding equity in such a firm (if not valued at 500x their intrinsic value) would be fantastic. However, the token are not equity. Moreover, they have no rights that cannot be taken away. This brings me to my next point.
When I read about why XYZ token is such a great investment, the arguments are typically just the same as for purchasing equity in the business. Leaving aside the “soon moon” side to the arguments they go something like this:
XYZ will revolutionize the XYZ industry. They will have billions of users, they will have thousands of clients, they will have amazing intellectual property, they have the best developers and most activity on github and they will replace the current leaders in their industry and become a hugely valuable business.
All of the above can be true no doubt. On the side, please consider that most VCs need 10–15 investments to have one that actually thrives. But let’s assume you found the one that will. Well, guess who will profit from it? Their equity holders. The people that actually own the company, their IP, the development team and their client relationships. These people, by the way have rights that cannot be simply taken away from them.
What you are buying when you buy their token however is none of the above. Intent on benefiting from the above and having been sold on all of the above (a key point), you are instead invested in a security without any rights, worse than such a thing as a “tracking stock” which companies very rarely issue to track parts of their business but which have no rights. The development team can sell out the business to anyone without giving token holders a cent, they can take away rights from them and they can decide that it is better for their business to accept USD or BTC next to their own token for payment.
Congratulations — you have bought (or been airdropped) hot air. Of course this is not to say that you cannot profit from trading said hot air and by selling it on an exchange practicably scamming the next holder (the greater fool) into the above value proposition. You can even orchestrate a pump and dump if you have enough followers or the founders can start orchestrating public takeovers where your useless token will be bought out for a premium to be paid in some other useless token (you ll never get USD or BTC for it) but you should realize that when the dust settles, the most positive way you can think of your investment is:
You bought an option on the founders deciding to at some point voluntarily give you equity-like rights in a company that has a 1/100 chance or less to then warrant a 100m USD+ equity valuation. Nothing more and nothing less.
That kind of an option should (and will) trade close to zero and not at 100s of millions of USD in market cap as even if the above happens (and I’d assume for every 1 grateful and ethically sound founding team that voluntarily decides to reward their early financiers (token holders) by giving them equity instead of letting them think about what a mistake they made, there will be 49 of the latter kind), the token holders will certainly not get the majority of equity value, but rather a small slice of it (for all the token).
Regardless of what your greed tells you, I am sorry to break it to you but this is the reality of the situation. Enjoy trading the hot air token while it lasts. I wish you luck.
If you enjoyed reading this, please clap and/or find me on twitter at https://www.twitter.com/dke82.
Lastly, the all important disclaimer: this is my personal opinion, not my professional advice. Most of all this is not investment advice in any way. Crypto assets can fluctuate widely in value and all of your capital can be lost. I have a 50/50 chance of being right. Any negative views expressed are solely aimed at the token in question or rather at their current state, never at the development teams behind them for which I have utmost respect (if they are sincere). I am a blockchain enthusiast.
