Most investors will tell you that one of the most important considerations when assessing investments is the idea of value – how it is created, how it is captured, and how it is conserved. This is true for all asset classes and blockchain is no different.
Deciphering Blockchain will be exploring the concepts of value creation and capture through the deconstruction of Joel Monegro’s ‘Fat Protocol’ Argument (original post and updated thesis).
We had fun discussing the Fat Protocol thesis and enjoyed how engaged the audience was that night!
Our first post on Deciphering Blockchain is the audio recording and slides from our “Primer on Security Tokens” (link to presentation below) event held at ConnectionsSF on August 9, 2018.
We’ll go through what makes something a security, walk you through the process of issuing security tokens from the perspective of the entrepreneur, and lastly go through the implications of investing with security tokens from the perspective of the investor.
I have argued that security tokens offerings (STOs) will be the new standard adopted by blockchain companies for raising capital. In essence, the invisible hand will push buyers of digital assets to invest in security tokens over utility tokens. Would Adam Smith cringe at the fact that a term he coined (pun intended; not going to point them out but more puns to come) back in the 1700s is being applied to crypto, or would he crack a smile at the fact that his brainchild is still very much lending a helping hand to those of us thinking through novel concepts such as the incentive mechanisms of blockchain ecosystems? He did, after all, demonstrate a propensity to adjust his world views.
Scenario (3): Developed Product; Existence of Security Tokens
Security tokens are an obvious answer to the “zombie network” phenomena. In this article, security tokens are defined as tokens that have equity-like characteristics. For example, if HouseChain issues 100 HouseSTs, and a person owns 10 of those, then he or she owns 10% of HouseChain and has 10% of the shareholder votes.
By insisting HouseChain raises capital through a security token issuance, cryptoinvestors are separating raising capital and the speculation associated with it from the product HouseChain is selling.
Scenario 2: Role of Utility Tokens in an Environment Where Security Tokens Do Not Exist and Blockchain Companies Have Developed Products
Fast-forwarding to the point when HouseChain has developed its decentralized short-term rental service, let’s analyze how purchasers of HouseCoins will use their tokens. This analysis assumes that HouseChain matured to a developed state without security tokens ever becoming the standard for raising capital (i.e., HouseChain issued HouseCoins, instead of HouseSTs, to raise capital).
The above assumption implies that a HouseCoin has two potential uses:
Scenario 1: Role of Utility Tokens in an Environment Where Security Tokens Do Not Exist and Blockchain Companies Have Yet to Develop Their Products
Originally, utility tokens were proliferated (not necessarily sold) across a wide set of users: founders, developers, prospective miners, members of the crypto community, and anyone else that was teach-savvy enough to have a cryptowallet. Early crypto enthusiasts pointed to network effects as to why this practice was necessary. If the network reached its critical mass of users (i.e., critical mass of token holders), then demand for the utility token would increase with minimal or zero user acquisition costs — in other words, the utility token would appreciate in value.
You probably have heard of or read in newspapers the words cryptocurrency or utility token when it comes to describing types of digital assets. Cryptocurrency implies desire to function as a currency — think of Bitcoin, Litecoin, Monero, or even the stablecoin DAI. As for utility tokens, my previous post explains what they are and how they are functioning within the cryptosphere.
Security tokens are another type of digital asset, or what I like to call a cryptoasset, that have been garnering quite a bit of attention lately.
A utility token is a non-physical token (think of a Chuck-e-Cheese or Dave & Busters arcade token that you can’t touch, or hold in your hands) that has been created for crowdfunding purposes (think of KickStarter, GoFundMe — those types of sites). This means that the buyer of a utility token has paid the issuer of the token money NOW so that the company can develop a product that the buyer of the token can LATER redeem for that good or service.
Blockchain startups raised $5.4bn (Source: CoinDesk) through Initial Coin Offerings (ICOs). An ICO is the process of when utility tokens are issued and sold in a crowdfunding manner.