The power of tokens beyond ICOs

ICO

Many projects today launch their token sale to the crowd to raise funds. ICOs have proven themselver the "killer dapp", as they are opening a new gateway to finance, especially for decentralized projects and communities. Issued tokens are divided into two main categories: utility tokens and non-utility tokens.

It is no doubt that we are now in a bubble, call it token fever if you want. This bubble, however, is fueled by the bubble in all assets in the real economy and traditional financial world. Ultimately blockchain assets are the safest, as they are not tied to a particular regional/national economy, but rather are oriented on a global market for a global audience, and the sector is emerging just now. Utility tokens are pivotal to the working mechanism of one platform, as without them either the whole project would not make sense, or some core funcionalities/incentives mechanisms would not be possible. 

Current ICO models are aimed at augmenting short term price gains

The whole concept of creating tokens which are designed to maximize the amount of money which can be raised and to generate hype on the market allows for projects on paper to receive appropriate funding and get delivered, hence they are a very powerful tool. 

The true power of tokens lies in augmenting network effects

Yet we believe there is more, as tokens have a very powerful effect of "gluing" early contributors and stakeholders to the platform. And if the design of the token is such that the users have a long term in the success of the company, this will result in amplifying the network effects around the platform. 

We believe the true value of tokens goes far beyond raising money through a crowdsale, as tokens are a powerful tool for creating a loyal community of users who have all the same goal: have their platform successful. And we stress it's their platform, as they become the stakeholders.

So when we distinguish between utility and non-utility tokens, we can distinguish also two different target audiences.

  1. Non-utility token contributors are often attracted by the potential short term financial gain and will always demand a strong focus of the company on marketing and communication, with the goal of increasing the valute of the tokens and making a bigger profit. Hence they do not have a long-term bon or commitment to the platform.
  2. Utility token contributors, by contrast, have a way of exchanging their tokens on the platform, and can also have the possibility to earn tokens for free as early contributors, advisors, referrers, alpha testers, and so on.

This is why we believe utility tokens have the potential to augment the growth of a blockchain startup much more than non-utility tokens

A controlled amount of inflation in a token is a needed condition for long-term success

We also believe a certain level of inflation in the token is required, in order to create a mechanism for providing continuous reward to users of the platform. We very much understand the need for a fixed amount of tokens released under discretionary circumstances. We believe, however, that inflation should be a core component of a token and the rules should be encoded in an audible algorithm.

In fact we have noticed that ICO investors are usually crowds pushed by hype of viral marketing campaigns, big focus on design rather than technology. Think about Ethereum itself, one of the most successful crowdsales ever: during the first year of development, few information were known, the focus was on building the technology rather than generating hype around marketing. 

Not many will remember, but the Ethereum Frontier website had a huge red warning flag! The technology was not user friendly at all, as most of the tools had to be built manually. There were no easily scalable infrastructure on Ethereum like INFURA or  an Ethereum browser like MetaMask, and more importantly, Ether was not tradable on cryptocurrency exchanges. Yet an extremely powerful community was created and is still growing around the technology and the tokens. 

Interest disalignment in the current ICO model

Given the unique skills required to evaluate a blockchain project (finance, game theory, smart contracts and software architecture background), it is quite natural most of the contributors rely on influencers. The biggest paradox is that most of the people participating to contributions or ICOs are not buying the product for using it later, but rather they are just buying on the hope of getting rich quick with the hype, or just out of FOMO (Fear of missing out). Confirmation of this is that only a very small percentage of contributors are actual users of the alpha platforms. 

Legal issues will arise

Non-utility tokens look very similar to traditional securities. The ICO world is still largely unregulated, but wise entrepreneurs will envision that, one way or another, regulation will come into play. And the reason is the success of ICOs and speculation around the sector. Hence creating a model of shared interests protects a startup from future legal issues, and allows it to focus on delivering the technology first and leaving the door open for future funding when needed.

The emerging alternative model

We must recognize that platforms today require at least one extra effort by their users in comparison to traditional centralized platforms. We also have to recognize that running a full local node is too cumbersome for many, and this is an obstacle for adoption. But here is the point where customer support and feedback is most important: when a platform is in alpha, heading towards a more stable release, the startup is eager to get feedback on every aspect of their platform. The obstacle is adopting the technology has a further advantage: theoretically let in anyone, but in fact let in only the most interested people in one particular platform. 

This model is in sharp contrast with the current ICO model, where theoretically everyone can take part to new projects at pre-listing prices, but in fact the biggest contributors usually manage to get a lion share in the tokens as they are more organized. This also leads to a centralization in teh holding of the tokens, which will later result in a more centralized DAO.

So our whole concept turns around a more decentralized structure of stakeholders, who are genuinely interested in the long-term success of the project. So that the underlying structure will allow for a pure DAO to be managed through the tokens. In fact, if the majority of the tokens were held by one or a handful of parties, the whole DAO model would be useless. There's a very interesting article of Primoz Kordez on a method for token valuation. In the article, a very good case is made: the network effect is augmented by the velocity of transfers of tokens, hence a concentration of the tokens in the hands of a few holders would create a majority penalization. This is opposed to traditional stocks, where investors are willing to pay a premium for having control of a company. Hence our view that a good token should have by design a certain level of inflation, being adjustable by its stakeholders and with a maximum rate cap. Current ICO models, furthermore, leave future partners without room for receiving appropriate incentives: tokens held by the startup are meat to be used for future development, and not for employee incentives, hence it is a current limit for creating a long-term incentives mechanism.

Conclusion

We still believe ICOs are a very powerful tool of getting finances for blockchain startups. However, we believe it is in everybody's best interest to delay the moment of access to public funding. With the model we explained (which we believe is emerging among existing blockchain leaders as crowdsale model alternative) we believe startups will be able to raise some minimum necessari amount for delivering their engines to production, and later perform a crowdfunding which will be able to fuel those engines and satisfy market demand for the product. The current model of over-allocating funds to startups (because they will not be able to perform a second crowdsale as the total amount of existing tokens cannot be increased) poses an issue in the hands of blockchain entrepreneurs: what to do with all the money they raised and which cannot be invested in their own business given current scalability constraints. And further to that, how can we guarantee that a startup who need an X amount for delivering a project, raising 10X the amount, will have the same incentive in delivering the project? We all realize the need for constant improvement, and with the very rigid structure of smart contracts, some degrees of accountability will make projects less risky, entrepreneurs more motivated, the network more involved. If you want to read more on bubbles here another piece by RigoBlock.


Gabriele Rigo avatar
Gabriele Rigo

founder of RigoBlock, the decentralized hedge fund platform. Blockchain and cryptocurrencies enthusiast, former head of investment at international asset manager and treasurer at global hedge fund. MSc Finance from Bocconi & HSG.