Blockchain technology is revolutionary, promising to disrupt many of today’s industries. In contrast, the cryptocurrencies that live on the blockchain – to avoid confusion, I’m going to refer to cryptocurrencies as “tokens” – are really just high-tech manifestations of traditional ideas.
Broadly speaking, there are three kinds of tokens today:
- Tokens like Bitcoin that are intended to function as currencies
- Tokens that represent economic interests in businesses, e., securities
- Tokens that give the holder some kind of contract right in the business conducted by the issuer, g., a distributed storage network
Tokens that are intended to function as currencies are like, well, they’re like currencies. They’re secure, they’re anonymous (maybe), they’re decentralized, but fundamentally they’re like paper money. The idea of paper money was revolutionary, rendering the barter economy obsolete. A digital representation of paper money is incrementally better, but not revolutionary.
Tokens that are securities – digital stock certificates – are helpful and better than paper or Excel spreadsheets but obviously not revolutionary.
The most interesting kind of tokens are the third: tokens that give the holder the right to participate in a business.
Imagine you’re Henry Ford designing an automobile. You need a lot of capital. Your investment banker suggests you sell stock on Wall Street, but someone else suggests a different approach. You publish design specifications for your new automobile in something you happen to call a “Whitepaper,” and you sell to the public a limited number of licenses giving the holder the right to manufacture tires (or oil filters, or whatever) based on those specifications.
You just sold tokens, even though the blockchain doesn’t exist and you keep track of the sales in a red leather book.
Financially, you’ve pre-sold licensing rights. Some pros and cons versus selling stock:
- On the plus side, you still own 100% of your company.
- On the minus side, you have reduced or eliminated a future revenue stream for the company, e., licensing revenue.
- On the plus side, because the tokens weren’t a security, you didn’t incur all that time and cost.
- On the minus side, you really, really care about the quality of your cars – the whole future of your business depends on it – but the tokens might not end up in the hands of the highest-quality suppliers. That’s especially true in a market frenzy that reminds you of Tulip Mania in 1637, where many buyers are low-information speculators.
- On the plus side, if raising money by pre-selling licensing rights happens to be a super-cool thing, the token sale might raise a lot more money than the licensing rights are actually worth.
- On the minus side, you didn’t get to deal with securities lawyers.
What about the pros and cons to token buyers?
- On the minus side, you have far less legal protection, as a buyer and owner of the token, than you would as the buyer and owner of securities in a public company.
- On the plus side, your specialized expertise as a parts designer or manufacturer might give you a unique ability to increase the value of Ford, and therefore the value of your token.
- On the minus side, while you know a lot about your own abilities, and might know a lot about Henry Ford and his team, you know nothing at all about the other token buyers. If they turn out to be lousy parts designers and manufacturers, you lose.
- On the plus side, if you think Ford Motor Company is going to be hugely successful and tokens are the only thing they’re selling, you have no choice.
- On the minus side, the token probably gives you the right to benefit from only one aspect of the company’s business, g., parts for the the Model T. If the company pivots or expands, you might find yourself left behind.
- On the plus side, if you’re in a Tulip Mania market, maybe you’ll buy the token today and next week you can double your money selling it to someone else.
- On the minus side, if we look hard at Ford’s Whitepaper we realize it’s very ambiguous. Do I or Ford really know what I’m getting? Or is this going to end up in litigation?
Who knows where the pros and cons come out. Someday economists will explain whether and in what circumstances a token is more economically efficient than a traditional security.
I feel quite sure that tokens that are currencies and tokens that are digital stock certificates are here to stay, because while not revolutionary, each represents an undeniable, if incremental, improvement over today’s technology. I’m not so sure about tokens that represent prepaid products or services. Until we hear from the economists, the jury is still out.
Questions? Let me know.
3 thoughts on “Cryptocurrencies: There’s Nothing New Under The Sun”
Surprised you gave the “utility” tokens a pass on securities classification. Seems like many will due to state risk capital tests for early-stage services and there’s massive fuzziness about Howey expectation of profit (vast majority of token buyers will not be providing services and may not be using service).
wrt to quality of suppliers… it’s a hard analogy here as there are clear “quality” guarantees built into these service specifications – you either demonstrably (algorithmically) show that you’ve provided the service or not. Many service provides compete to provide the *identical* level of service – no such thing as a faulty, expensive or late muffler.
Through the lens of a traditional entity selling traditional products with traditional financial models, I can see your points, but most issuers of tokens today are focused on creating networks of participants who, through implementation and usage of services, themselves are almost 100% responsible for the performance of the token… and the financial returns to the originators of the concept are basically just appreciation of token value (realized on an exchange).
Having said all that, I do wonder how tokenization impacts longer-term relationships based on access to products/services from traditional entities (imagine spending $1000 up front to get 30% off a local restaurant for X meals over 12 months, or 50% off of wine from a winery for 5 years, etc.). And if you change your mind, simply sell your token on an exchange.
Does this provide an interesting middle ground between single reward crowdfunding and investment crowdfunding.
Great comment. Yes, for the sake of simplicity I’m assuming that utility tokens are not securities, although I realize that’s not a given.
My view is that if you look hard enough, most (not all) utility tokens are just variations on traditional finance. The question is whether, and in what circumstances, financing through token sales is better or worse than traditional finance.
By way of example, Facebook could have sold tokens rather than stock, giving token buyers the right to create pieces of the network and even advertise. In what ways would that have been better or worse than selling stock? It’s a fascinating question.
How do you think the SEC’s announcement this summer that they can and will regulate ICO will affect future “cryptocurriences” like future bitcoins? Bitcoin is already out in the market, but as new Bitcoins get released to increase supply, will the SEC insert themselves? Will the Bitcoin founders cede and comply at the start? I read an article ( https://www.strictlybusinesslawblog.com/2017/08/29/can-initial-coin-offerings-regulated-securities-sec-says-yes/ ) that goes into some of these details for reference.