On the Economics of Tokens

If you know much about crypto-currencies then it probably hasn't escaped your notice that companies are now issuing so called, Initial Coin Offerings (ICOs). There are several types, but the one that interests me is the most common type - the utility token ICO. In this scenario the company states that it will only take payment in x-coins in order to increase the value of the tokens as the company itself grows.

Now, this could be viewed as quite appealing. In traditional investment, you are investing in the overall asset cap of a company, principally driven by the profits (or losses) that said company makes. It's not uncommon for companies to have huge revenue but be heavily loss making. They usually cover that by issuing more equity, which dilutes the stake of existing investors.

With a utility coin, you are investing to some degree in the revenue of the company. That means, if people are using it, the value of your investment should increase regardless of the underlying performance of the company. How do you value such a thing though?

I recently came across a paper by John P. Conley (2017. "Blockchain and the Economics of Crypto-tokens and Initial Coin Offerings," Vanderbilt University Department of Economics Working Papers 17-00008, Vanderbilt University Department of Economics.)

https://ideas.repec.org/p/van/wpaper/vuecon-sub-17-00007.html

This suggests that the Quantity Theory of money could be used. i.e.

Token Value = Value of all transactions / (Number of tokens * velocity)

Velocity is hard to calculate, but it seems to me that if a company was really successful it might live to regret having to take payment in utility tokens. It is probably going to make it as easy as possible for customers to convert fiat -> token , take payment in tokens and then sell those tokens to the next customer, probably in an automated fashion.

So, let's assume in order to do that they are transacting on the Ethereum blockchain. A transaction is generally considered safe after 12 confirmations or 3 minutes. So the steps are:

Sell tokens to customer (1 transaction)
transfer tokens back to company for payment of goods
Repeat

That's two transactions on the blockchain per actual transaction, or 87,000 actual transactions per year (max).

Let's look at PowerLedger, the decentralised energy trading company. It has 363mln tokens in circulation at time of writing. For a revenue figure, let's use British Gas in the UK. They have revenues around $37 bln per year. So our minimal token value is:

v = 37e9 / (363e6 * 87e3) = $0.001 each

Powerledger tokens currently cost $0.42 on the open market! So in the more pessimistic case they would need revenues 400x those of one of the UKs largest energy suppliers just to not lose investors money.

A complication with Powerledger is that POWR tokens won't be used directly to pay for transactions, they'll be used to generate Sparkz to do that. However, I struggle to see the difference other than that the velocity for Sparkz could actually be much higher. The main reason for doing it seems to be that a unit of electricity has a local price, whereas POWR tokens have a global value. Suppliers have to buy POWR tokens to generate sparkz. The faster they turn them round, the fewer they need. You now have incentive to maximise the velocity rate.

You could argue that investors will HODL tokens to reduce the supply, though Powerledger reserve the right to print another 600mln of them!

Let's try a sanity check. If people in the UK paid their BG power bill daily on an automatic basis, they would need a combined (27 bln / 365 =) £73k. Call it $100k. If they paid it in POWR that would mean each token is worth about $0.27. So, even in this somewhat optimistic scenario they'll need to be twice as big as British Gas for investor break-even.