Token value accumulation is critical. Valuable tokens secure their blockchains. Validators require economic incentives to participate honestly. They need to be rewarded in tangible value. Without incentives, they cease validation. The absence of validators jeopardizes blockchain security.
There are over 2,500 tokens in existence today. Token types have expanded beyond Layer 1 (L1) blockchains. Blockchain tokens are used to secure blockchain networks. Bitcoin (BTC), Ethereum (ETH), SOL, AVAX, and NEAR are examples of native blockchain tokens. Protocols and applications running on blockchains have their own tokens. In cryptocurrency, value creation and accumulation are becoming increasingly important. Native blockchain tokens have clear uses and inherent value. For protocol and application-related tokens, this isn't always the case. Across all tokens, value accumulation and distribution often appear unclear.
This article outlines four pathways through which tokens acquire value, detailing their limitations and relevance to different token types.
Pathways to Token Value
Tokens can obtain value through four primary mechanisms:
Utility
An asset possesses utility value if it consumes labor or material in some endeavor. Commodities and currencies exemplify utility. They are often termed consumable or transformable assets. For instance, gasoline is consumed when a car operates; euros are used for a European vacation. They are useful and valuable because they provide means to an end, such as transportation or a holiday.
Tokens hold utility value. They serve as mediums of exchange on blockchains. Users employ a blockchain's native token to purchase block space. Validators receive payment in native tokens for ensuring transactions are correctly recorded on-chain.
L1 blockchains require native tokens. These tokens ensure decentralization and coordination among various parties. They prevent the blockchain from falling under centralized control. Imagine if interactions on Ethereum were conducted in US dollars—the decentralized, permissionless model would collapse. A central entity, the US government, would effectively control Ethereum. This central authority could censor transactions and reorganize blocks, contradicting a core purpose of blockchain technology.
Native tokens are essential for designing decentralized, permissionless networks. However, this isn't universally true for all token-based projects. Beyond L1s, there are often no validators to pay. Projects invent various demand points to manufacture a form of utility for their token. For example, their native token might be required for transactions within their protocol. Token holders are incentivized to "stake," which is often a misnomer. This "staking" typically isn't about validating transactions but rather about preventing token sales, artificially inflating the token price.
This token hype creates a reflexive model. The more people interact with the protocol, the greater the buying demand. The more tokens get locked. But once buying demand subsides, little supports the token price, leading to a crash.
Artificially manufactured utility exists for a reason. Entrepreneurs, developers, and communities building these useful protocols design token economic models to get paid, which they should. They develop valuable technology. However, artificially creating token "utility" solely for entrepreneurial compensation leads to suboptimal token economic models. Balancing token design between developer rewards and long-term sustainability is necessary for the industry's continued growth.
Token "utility" can also be a guise. Tokens cannot directly represent equity-like interests in a protocol without potentially facing regulatory challenges. Tokens can provide non-essential utility functions for a protocol and trade as synthetic equity.
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The cryptocurrency market hosts a vast array of tokens. L1 tokens possess clear and necessary utility. The utility of other tokens can be ambiguous.
Productive Assets
Productive assets generate yields. Real estate, corporate stocks, and bonds are all productive assets. They are also known as capital assets. They produce something valuable. They are purchased based on the expectation of future returns or a contractual obligation. Bonds contractually obligate the issuer to pay a disclosed interest rate to the holder. Real estate owners receive returns via rental income. Equity owners hold a claim on a company's cash flows. Their returns come from either reinvesting those cash flows into the business or distributing them to shareholders.
Tokens exhibit characteristics of productive assets. They generate something valuable that people are willing to pay for. They generate revenue and incur costs. The difference is profit. L1 tokens often redistribute earned profits by burning tokens. Burning removes tokens from circulation.
Beyond L1s, the accumulation and distribution of profits are often ambiguous. This is likely due to regulatory uncertainty. If a token distributes profits to holders, it might be classified as a security.
The market is grappling with how tokens accumulate value. Some argue that protocols not charging fees or accumulating value for the token are worthless. Others believe they forgo fees to solidify market share and avoid potential regulatory challenges. They assume reinvesting funds into business development offers a higher return on capital than returning value to token holders.
Many Web3 protocols are analogized to Amazon. Amazon lost money for decades to cement its dominance. It only occasionally returned capital to shareholders via meager buybacks. This analogy is only accurate to a degree. Yes, protocols might be solidifying market share and reinvesting like Amazon. However, Amazon always had the option of how to allocate its capital. It weighed the pros and cons of reinvesting in the business versus returning capital to shareholders. For protocols, these alternatives are less clear, at least for now.
The key for a protocol today is understanding how it creates value, how it captures this value, and how this value might be distributed in the future. In this context, the Amazon analogy is apt. If the market believes a protocol can create and capture value and manage the created capital responsibly, the market will care less about distribution. If a protocol cannot actually capture the value it creates or makes irresponsible capital allocations, the path to distribution becomes more critical.
Protocol treasuries are increasingly accumulating created economic value. The question of how treasuries handle accumulated capital will become paramount. Will the treasury distribute capital to token holders? If so, how? Will it reinvest the capital? Who makes these decisions? How are alternatives evaluated? Suddenly, the code that incubated the protocol now requires an organizational structure to decide what to do with the created value.
Store of Value Assets
Store of value assets include art, collectibles, and gold. They are valuable due to their scarcity and social status. People believe they have value, so they do. It's a memetic effect. Gold didn't suddenly become a store of value. It became one over centuries. When da Vinci painted the Mona Lisa, he didn't intend to create a store of value asset. It became one over time. Satoshi Nakamoto aimed to develop "a peer-to-peer electronic cash system that allows online payments to be sent directly from one party to another without going through a financial institution." The Bitcoin whitepaper didn't mention "store of value."
An asset cannot be designated a store of value. It's a moniker bestowed over time due to certain attributes and societal development. Consequently, being a store of value is largely irrelevant for crypto assets beyond Bitcoin and Ethereum today.
Governance
Governance rights only hold economic value if they relate to an asset possessing economic value. This economic value can reside in a productive or commodity asset. The right to vote on how a company or protocol allocates capital is valuable. The right to vote on how OPEC controls oil production is valuable.
In cryptocurrency, governance itself holds no inherent value. Governance must be coupled with something that has productive or utility value.
Synthesizing Token Value Pathways
Utility and productive assets are the two most important pathways for crypto assets. A protocol needs a utility component for someone to purchase the token initially. It needs a productive asset component for someone to continue holding it. Bitcoin and Ethereum are unique. Both possess utility and store of value attributes. Additionally, Ethereum exhibits productive asset characteristics.
It's suspected that the value of the "utility" aspect (outside of L1 protocols) will diminish over time.
Beyond L1 blockchains, other applications/protocols might not inherently need a native token. A liquid staking protocol could operate with its liquid staking derivative and ETH or a stablecoin. It doesn't strictly need a native token. The same holds for decentralized exchanges.
Native tokens are sometimes created for understandable profit motives. They are quasi-equity but not actually equity. To fit within regulatory frameworks, they are wrapped in a "utility" cloak.
Ironically, the "utility" aspect of a token can destroy value. Protocols grant tokens to users to promote usefulness. For example, if users need the token to interact with the protocol, the token must reach users. Airdrops accomplish this. The problem is that as more tokens are granted, the protocol's future value is divided among an increasing number of tokens, lowering the value per token.
Regulatory clarity might eliminate the need for token utility. Protocols could then remove unnecessary and costly issuance and reflexive token models. Users could simply interact with the protocol using the native L1 token of the blockchain it's built on or a stablecoin. The result would be a vastly improved user experience. Cryptocurrency nearly requires a different token for everything. Interacting with each different L1 requires its native token. Using an application might require another token. All these tokens need to be acquired beforehand. If a user wants to use another blockchain, assets must be bridged, making them vulnerable to hacks. It's a user nightmare.
Imagine if a customer had to use a different currency at every store. It would be an inefficient mess. This is the cryptocurrency experience.
There are 180 currencies globally, but most global trade occurs in US dollars, Chinese yuan, and euros. The crypto economy will be similar. Most interactions will revolve around a few utility assets. Behind the scenes, many different tokens might facilitate interactions, but the user would be unaware.
If tokens don't require a utility disguise, they can become hidden quasi-equity for many.
But wait... isn't this recreating the securities we already have?
Sort of, but better.
Tokens are a novel invention. They are easy to create, track, exchange, and settle. They are far superior to traditional securities. Blockchains using tokens are more efficient and transparent than our outdated financial infrastructure.
Tokens will likely represent blockchains, crypto protocols, and on-chain representations of off-chain assets. Beyond L1 blockchains, the source of token value will be its productive attributes. Most tokens will be regarded as productive assets. Therefore, their value will depend on their product's quality, the scale of market demand, and network effects. Very few crypto assets will possess the attributes of utility, productive, and store of value assets.
Frequently Asked Questions
What is the primary purpose of a native blockchain token?
Native blockchain tokens primarily secure the network by incentivizing validators or miners. They are essential for maintaining decentralization, coordinating participants, and preventing centralized control over the blockchain's operation and transaction history.
How do tokens act as productive assets?
Tokens act as productive assets when the underlying protocol or application generates revenue, often from fees. This value can be distributed to token holders through mechanisms like token burns (reducing supply) or direct distributions, similar to dividends or share buybacks in traditional equity.
Why is regulatory clarity important for token economics?
Regulatory clarity helps define whether a token is a security, commodity, or something else. This distinction determines legal obligations, how value can be accrued and distributed to holders, and can remove the need for artificially constructed "utility" that complicates user experience and economic models.
Can any crypto asset become a store of value?
Becoming a recognized store of value is not a design choice but a societal adoption process that happens over a long period. It requires extreme perceived scarcity, security, durability, and widespread belief in its long-term value preservation, traits currently associated mainly with Bitcoin.
What is the difference between staking for security and staking for rewards?
Staking for security involves validators locking tokens to participate in consensus and secure the network (e.g., Ethereum). Staking for rewards often describes users locking tokens in a smart contract to receive emissions or a share of fees, which is primarily an economic incentive mechanism rather than a core security function.
How might the user experience for interacting with protocols improve?
Improvements could come from reduced reliance on numerous protocol-specific tokens. Users might eventually interact seamlessly using only major L1 tokens or stablecoins, with the underlying protocol handling any necessary token conversions automatically in the background.