Wandering Through the Noise

Saying “crypto tokens are a scam” is akin to looking at a failing restaurant, or a fraudulent company and saying “equity is a scam”. Equity as a mechanism was a magical invention but many operators utilize it poorly. The same is true of crypto tokens.

I’ve had three conversations arguments with investors I deeply respect about the merits of crypto tokens in the prior weeks. These people generally start by asking me why I’m wasting any of my time in the space and follow up with the all-to-familiar line, “I think blockchains are useful but crypto tokens are a scam.” I tell them I completely disagree, at which point they ask me to name one business that actually needs a crypto token.

Feeling like a broken record in my explanation, I decided to write down my thinking…. So here it is…

The most magical businesses in my opinion are asset-light networks with strong network effects. At run rate scale they are defensible, maintain decent margins, and provide large utility to their end users. A select few even poses flavors of increasing marginal utility and operate in markets that are vast. Some people refer to these businesses as digital marketplaces. Examples include Uber, Airbnb, eBay, etc. They all focus on coordinating a desired action between 2 or more parties. Sadly, the number successful high utility digital marketplaces is small.

The challenge with these models is that they’re extremely hard to get going from a cold start. Solving this problem generally requires incentives and this is where crypto tokens come in.

Crypto tokens are the worlds best mechanism to:
1.) Grow a network
2.) Get users to work in support of the network
3.) Stay aligned with the network

At this point in the argument, the person typically says, “I understand networks and incentives, why don’t these network founders just use cash to incentivize users to join.”

This is broken thinking as cash has two core flaws.

1.) Using cash requires having cash. Most start-ups don’t have cash.

2.) Cash is fixed in value. It has no upside as the network starts to gain traction. On top of this, there is no reason for the user to stay involved and positively support the growth of the network.

After ceding that cash is indeed flawed, people then say, “What about equity?! Just use equity.” This is the right inference but ignores the flaws of equity. Equity fails to be useful for two core reasons as well:

1.) Issuing, transferring, and selling equity in a private company is nothing short of a nightmare!! Lots of paperwork, lawyers, IRS fillings, and yearly tax information. It’s logistically infeasible to do at scale. (I have personally learned this lesson the hard way)

2.) There is a law that caps the number of shareholders you can have at 2,000 in a private entity before you need to transfer to public status. Most networks have far more than 2,000 participants very early on. It’s not reasonable or possible for a seed-stage start-up to go public.

As people start to come around to the thinking, they then say, “well this is all great in theory but is anyone actually using tokens this way?”

The answer to this question is, yes!! My favorite example is a company called Hivemapper that is building a crowd-sourced map. Google only has the resources to collect street-level data every 1-3 years for their Maps product. With a crowd-sourced map, the data can be updated every hour. In order to have high density though, you need tens of thousands of participating contributors all over the world. (real everyday people adding data from dash cameras in their cars.)

When Hivemapper first started they actually tried using cash to incentivize participation for their first 2 years. When asked about why they switched to a token, the company’s CEO Ariel Seidman confirmed all of the points made above. On top of these points, he also added that when building a global network, trying to pay people internationally with cash was a nightmare. It was expensive and slow. Tokens solved these problems.

In the closing stage of the argument, people cede the points above but then say, “there is no long-term intrinsic value, it’s just a Ponzi scheme to get people in the door.”

This is also false logic, in a correctly designed network. The token acts as the currency that can be exchanged for the utility of the network. As long as the network is producing something of value that people need there is value in the currency. In a great network, the network’s utility grows as the network grows. If growing utility is met with growing demand, there is an opportunity for price appreciation. The intricacies of how much the tokens are worth is a field of study similar to equity valuation. There are lots of levers and inputs that change the ultimate value.

If you need to rally an army of aligned contributors to build a network, cash and equity are sub-optimal. Crypto tokens are the worlds best available mechanism.

99% of crypto tokens today look like the failed restaurant or worse outright fraud. Despite this, the mechanism of tokens is extremely valuable if channeled correctly. Just like equity is a mechanism, so are crypto tokens. They can be used poorly, or they can be used well, but neither at a mechanistic level are a “scam”.

If you’re building a high-utility token-powered network, please reach out. I am your biggest fan.