What Do You Get When You Buy A Crypto Token?
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**The question we all should ask ourselves is what are we investing in when we buy a token?**
If there is not a tangible product or service, not a clear audience to market that product to, and not merely an utopian ideal but something that is legal and can be successfully adopted and supported. What are you buying?
Even assuming that you clear all these points and you are ready to make the jump we still have to ask ourselves: ” **What are we getting in return for our investment?**” because unless we are buying a club membership, or season tickets to watch our favorite team, or other payment into a leisure activity, we should treat our decision as a financial investment, just like when we buy stocks, bonds, or any other financial asset.
Let’s take a step back.
The early years of the internet gave us Hotmail, Geocities, Altavista, Yahoo… so it gave us a reason to believe in that new market/channel that extended beyond mere promises.
There were real allure and opportunities, and everyday citizens craving those products and services, not people interested in investing, came to the market in droves and made the internet both widely adopted and as a part of our daily lives ... later the broader investments came in, driven by the fast adoption and the potential that it could signify.
Regarding the investments, as with new technology, investors got ahead of themselves. The early success of the internet got those early investors enamored with the potential of the technology and they forgot to look at the underline business and economic models of the companies they were investing in. At that time, you could be giving money away, it didn’t matter, as long as you were doing it online you would get funded.
Driven by the promises and early success of this new technology, investors funded businesses that should have never been funded, overestimated the profitability and investment needs of many of those businesses, and bid up the stock prices to absurd proportions, resulting in the collapse of the bubble in 1991.
Not only they failed to look at the business model, there was also the problem with infrastructure. Today companies like Amazon can deliver you the products you buy online in less than a day both cheap and conveniently. This was not the case at the earlier stages and many companies failed to anticipate their true business and capital requirements and thus failed.
**What we have in crypto is an economic anomaly that dwarfs the internet bubble.**
In crypto, there were investors, primarily small retail investors with no financial background, before there were any real products, proven usage and real large problems to solve. **We have 1,500 token and not one mainstream application, we have no way to estimate fundamental valuation for most of the active tokens, and we don’t even have a stable platform for crypto to expand.**
This is the rough equivalent of buying a white paper internet stock based on the internet development in the 1960's. Yes, the internet bubble was bad, but the technology not only survived but thrived because there were real uses and millions of people looking to it for communication, commerce, and research among other uses. The users were there, and so we're the applications. After the bubble burst, the internet 2.0 companies just refocused in creating a business model based on a growing and existing market and demand, leveraged an improved infrastructure that was being build at the time (3g, Wifi, etc.) and Google, Amazing and Facebook were created.
The other main difference between the stock market bubble and what’s happening in crypto are the expected returns on investment. When Jeff Bezos raise $1 million dollars to found Amazon in 1994, he raised it by offering equity, which allows early investors to participate in the success of the company and aligns the objectives of the founder and investors. What would happen if instead, when Jeff Bezos asked for seed money for Amazon, the investors asked the question we are asking here: “what are we getting for our investment?”. What if the answer was: “You will be able to use our platform when and if it is successfully implemented and get 20% discount on transactions for 4 years”. How much Money would he have raised? This is not an investment, this is a pre-sale of Prime subscription that would not be available at Amazon for another 12 years.
Before you go there, let me make a quick point. The whole conversation of centralized versus decentralized misses the point on the investment part that we are discussing here. There are plenty of altruistic reasons you might want to fund a blockchain project, but do not mistake it for an investment decision if you don’t know what you are getting in return.
**Investment in early stage companies are extremely risky and seasoned investors would require a much higher return (compared to other investments) in exchange for capital**. Since it is a boom of bust scenario, the investor has to make sure they make enough money on the companies that do succeed to wash out the losses of the investments that fail. Venture capital is not a philanthropic endeavor, and if you are looking to invest that should not be your reason either.
But **in crypto this risk reward equation simply does not exist**. Once the ICO craze started many companies, most which don’t have anything really do to with blockchain, came into the market and got funded under the umbrella of a “utility token” (a term that has been completely misappropriated by the cryptocurrency space), raising staggering amounts of money without compensating the investors for the risk they are taking, while at the same time bypassing most if not all security laws.
Let’s park the discussion around the main platforms such as Bitcoin and Ethereum for now to focus on centralized companies, which are incorporated and have a CEO, a board of directors and all the makings of a regular corporation. Companies like Binance for example (Dr. Nouriel Roubini recently published a paper with a critique of blockchain and crypto if you want to cover those topics https://www.upvotenation.com/links/detail/662).
For those companies, **an ICO is the equivalent of free financing**. Because the target audience to fund those ICO’s are retail investors, mostly which are emotionally attached to crypto and the ideals behind the original Bitcoin project, and who do not possess much of a finance or investing background, they can raise cash without having to give back any real value.
I not even going to comment on the many ways where these companies assign value to their token on a whitepaper just to change their reward program after they have raised all the money and blame regulation and compliance as an excuse. I will just focus on the broader problem.
For once, **the “utility token” model creates significant misalignments between the financial interest of “investors” (although we are not really investors per se since you bought a utility token and not a security) and the interests of the owners/equity holders**.
After the ICO money is raised, the main goal of the owners of these companies is not to maximize token value, but to maximize revenue and income and thus grow the company. You might be thinking that those two different goals will need to coincide at some time, but that’s not the case. In many cases the token becomes an inconvenience to the business and over time became only tangential to the platform.
An example is a company that provides education courses and was funded thru an ICO. It is not a blockchain company, it’s competitors are not blockchain companies, blockchain will do nothing to improve the current offering and, the token, other than being a way to raise free capital has no real purpose.
The company is continuing to grow, hire and increase it’s offerings. At the same time the token price is 90+% below the ICO price. Why? Because companies soon realize that if they require users to use their tokens to be on their platform that this will severely hurt their business model. The number of potential customers would be very small (limit to token holders), an increase in the price of the token would further limit customers ability to use the network (creating a severe conflict of interests between token holders and the equity owners of those companies), the cost of doing business would render them non-competitive, and many other reasons. So now, tokens can only be used to buy a course at a certain % discount. ( In this example you didn't invest, you just prepaid for a service you didn't want).
Remember my Amazon example? There is no value on the above example, and because this market is completely unregulated, more companies and not less are going to use the ICO market to raise capital.
Targeting inexperienced retail investors is also a real issue. Look for example at supply chain companies whose business models is to connect suppliers with buyers of products and track their transactions thru the blockchain. You may say, well this is a true blockchain project, what is the problem here?
As I mentioned above, on a regular market, seasoned early stage investors would required a very high return to fund a company at the white paper stage, no matter how good or revolutionary the idea is. But with crypto you can flip that around and completely bypass those investors and go directly to free financing. Think this way, for what other reason would a supply chain blockchain company sell a “utility token” to retail investors that will never user their platform? Why not go to potential customers and investors in the supply chain business? The audience that are targeted by those ICO’s, advertised in all the various ICO sites, are retail investors with minimum financial background, and that’s intentional. **You are not getting the early scoop and being on the same plain as Venture capitalists, you are been taken advantage of**. That Congress allows this to happen is an absurdity.
The reality is that many of these concepts are nothing more than pie in the sky vaporware and would not be funded anywhere but in crypto, not even on the bubble days of the internet. While blockchain will evolve and will possibly have many applications in finance, supply chain and healthcare, the companies doing ICO today’s are not solving those problems and in many ways not improving on the current solutions.
What about disclosures? **After a company takes your money in an ICO there are no future disclosure requirements**, they don’t have to file 10-Q’s or 10-K’s, they don’t hold quarterly conference calls and take tough questions, they do not provide you any metrics that will help you understand the token and token valuation. Rampant on the crypto space instead are borderline unethical marketing campaigns promising everything under the sun, overblown and exaggerated partnership announcements, a cult of personality to drive way from the undeniable fact that you have no rights to real information to help you assess your investment. Things that would just not fly under a regulated framework.
I know that many of you are against regulation and think banks and third-party intermediaries are bad. **Over regulation is certainly an impediment to the business, free markets are a good thing. But that’s not the same as saying the an anarchist society free of any rules is the right approach.** We need criminal laws, we need taxation to build roads and pay for defense and the common good, we need rules to regulate society, so we can all coexist in a productive manner. For those same reason we need a regulatory framework to provide a minimum level of oversight for crypto, otherwise scams will only continue to grow. Self-regulation will not work. Also, third-party intermediaries only exists because they perform functions that society finds valuable. Most of us would rather go to a supermarket than have to deal directly with farmers and different companies to get our groceries. Banks are more equipped to give you a loan, than your neighbor is, this illusion of peer to peer transactions is delusional, because individually we don’t have the capability to absorb and quantify risk and have a diversified portfolio. It also doesn’t mean that regulations are without fault. **A poor regulatory structure and even worst congressional oversight allowed the financial crisis of 2008 to happen. But last not overcompensate and throw out the baby with the bathwater.**
Back to token investment. What about investor’s rights? The ability to vote to oust an underperforming CEO, or make a change in the board? None of that either. Taking a step further. If a normal company is underperforming and their stock is under pressure, the CEO and the management team will immediately be worried, not only that they can be replaced by a shareholder vote, but also that the company might be subject of hostile takeover among other things. This is not the case in crypto. As I mentioned above, a token can go to zero and have absolutely no impact in the company or the actions of the management team. It will not give them a sense of urgency or make them blink. Just go to a telegram chat and will hear the hard core “believers” chanting for patience and misquoting Warren Buffett. This is not what you expect when you invest in anything where you expect a return.
The most common reply I hear for this scenario is that the owners own a large portion of the tokens, so it is in his or her best interest to keep tokens price up. That is valid to an extent, but if there is a choice to be made between token value and the value of the company, which will undoubtedly happen, They will sacrifice the token every time. Binance total token value is $1.2 Billion today, their 2018 profit is expected to be $1Billion. If Binance is to be sold, it would fetch a multiple of EBITDA which will likely be in the Billions of Dollars. So clearly the company and token valuation are independent and company valuation is much more important for the equity holder.
Talking about valuation, there are not good valuation models for crypto. Going back to Binance. Binance tokens are valued at valued at $1.2B, if they buyback and burn all tokens except 1, is that token now worth $1.2 billion? The answer is no. So the buybacks sound good as a marketing ploy, but do nothing for value. If you take away the buy back there are two things left. One is the token structure discounts, but those will be eliminated in 2020. The second is the tiered trading fee discount (Similar to what you get for free with most credit cards), that in itself has arguably some value but very limited because of the exchange risk and opportunity costs that goes into holding that balance. It is as if Fidelity required you to hold their stock to give you a trading discount. It would artificially inflate the stock price and detach the stock price from the company performance which would eventually lead to a bad bubble or be washed and trade at the company’s intrinsic value. But since Binance intrinsic value (which is in the billions) is completely disconnect to token value (see above), that there is really no good way to quantify it.
Similarly, when a company sets up a price for their ICO, it is mostly based on the amount of cash they want to raise and have nothing to do with the fundamentals of the token. When a regular company goes thru an IPO process in normally engages companies like Goldman Sachs to prepare a model and come up with an IPO price, there is normally a range and they set the final price after getting a sense of the market. In crypto this just doesn’t exist. Want proof? **Ethereum raised $18 Million dollars on it’s ICO, which was the largest ICO at the time and ethereum is not a small crypto. EOS raised $4Billion just a couple years later and Bitdegree raised $22 Million. Those amounts are just not comparable and shows the lack of consistency and the lack of financial acumen of people investing in ICO’s.**
Many people feel hopeful when they see groups like Pantera and institutional investors coming into the market. Gives them a sense that they beat the big players to the market. This is nonsense. First, this is an unregulated market and most transactions are private, so you really don’t know the terms of the deal, but I can say with strong confidence that they did not went to Binance and bought the token at market price. Second and under the same point (that we don’t know the terms of the deal), we don't know if those investors are buying purely the token of also getting equity and using the tokens as a publicity stunt. Whatever the answer to those questions are one thing is certain, institutional investors are getting a much better deal than you are, and in many case they should be. They bring not only a large cash injection, but brand recognition, free publicity, networking contacts, and in many cases management support. **Neither Bitcoin nor any other cryptocurrency will not today or ever allow you to get the same deals as an institutional investor does.**
I could go on for another 4 pages, but let’s eave it here for now and conclude with the questions we started with “what are we investing in when you buy a token?” and based on my view of the ICO market, the answer is not much.
Certainly nothing that justifies the risks that we take when buy an ICO. On a risk adjusted basis we would be much better off putting our money into alternative investments. The only Money you should put here is your lottery money, and just like with the lottery you will lose much more often that you will win. Unless you are a professional trader, trading momentum and taking advantage of volatility, not your run of the mill crypto investor.
Everyone can say that this market will go up 10X or 100X because it did in the past, and might just well do it again, but it will not be based on fundamentals, because there are none. I certainly have never seen a convincing value model for any crypto, despite what your favorite youtuber may say. A hodling strategy here, where companies give you nothing of value back and have no fiduciary duty to you is guaranteed to bring you nothing but pain.
Because of that believe that this market is in a bubble that have not completely popped yet.
I will write another articles on my views of why looking at cryptocurrencies as replacement for FIAT currency makes absolutely no sense.