Traditional Investor “A Utility Token is neither real equity nor is it a bond; so it must be a scam”
Cyber Investor “Utility Tokens are the first new asset class in a long time; I want to get in on the ground floor”
SEC “If an investor likes it, it must be a security, we don’t care what you call it”
Entrepreneur “A Utility Token is the game-changing new tool in the venture building toolbox”.
Like blind men groping around an elephant, we all see Utility Tokens from our own perspective. This Chapter aims to offer a wide-angle view so that we can actually see the elephant.
This is Part Three (Chapter 2) of The Blockchain Economy book.This serialised book is a practical guidebook for investors, entrepreneurs and employees who want to learn how to prosper during the transition to an economy where value exchange is permissionless and disintermediated. For the index/table of contents of The Blockchain Economy book please click here
This Chapter describes:
- Analog Token analogies for the Traditional Investor.
- The Etherum ETH Token story (so far).
- Science-first innnovation capital.
- The Token User/Investor is a new way to get to Product Market Fit.
- A Utility Token can apply anywhere in the stack.
- Non-Fungible Tokens.
- How to make money buying and selling Utility Tokens.
Analog Token analogies for the Traditional Investor
When something radically new emerges, many seek a simplistic view such as “it must be scam” or “it must a security in disguise to fool regulators”.
A Utility Token is radically new. There is no equivalent in Legacy Finance. So we need to reason from first principles to see the whole elephant. That is hard, so we start with two analogies from the analog world:
1. The New York Taxi Medallion. This Token gives you access to a network (of passengers in New York).
2. A seat on a trading floor. Examples include LIFFE or NYSE or CBOE. This gives you access to a network traders.
These are Tokens, albeit not the modern cyber/digital Tokens that we call Utility Tokens. They are “Analog Tokens”.
Analog Tokens demonstrate three things:
- The User/Utility story comes first, the asset appreciation is a secondary consideration. You buy a New York Taxi Medallion, because you want to make money from people who need taxis. You buy a seat on a trading floor, because you want to make money trading. If the price goes up, that is a bonus and when prices go up, speculators jump on board and the price may go beyond a reasonable value and you may decide to sell, but that is not why you bought the New York Taxi Medallion or the seat on a trading floor in the first place.
- Scarcity Value matters. If there were unlimited New York Taxi Medallions or seats on xyz trading floor, they would have no value. Supply and demand is an immutable law.
- Utility Tokens are also subject to disruption. A New York Taxi Medallion is less valuable thanks to Uber and a seat on a trading floor is less valuable when we can trade digitally from anywhere. This is the key point about cyber/digital Tokens. They are on the right side of today’s big wave of disruption (the digitisation of value exchange aka Blockchain).
The Etherum ETH Token story (so far)
The Ethereum ICO in 2014 now looks like the gold standard, with early “investors” making a fortune. It did not look that way at the time, except to a very small number of nerdy early adopters.
The reason I use quotes around “investors” is that the people who buy Tokens when a new platform launches are not traditional investors who are smart about money. The earliest “investors” in Ethereum were totally naive on finance but could evaluate technology risk. They could evaluate the chances of Ethereum succeeding by writing test Dapps (aka Decentralised Apps). Some of these Dapps could be successful and by doing so the Dapps would make the platform successful. Then their tokens would become very valuable. By writing those Dapps they helped make the platform successful, by bringing the platform from MVP (Minimum Viable Product) to PMF (Product Market Fit).
Seen from one angle, this looks like investing – buy low, sell high. But this is not something that the smartest finance guys (such as those who have studied Buffet and worked at Goldman Sachs) think about. This is more about science/tech than investing, which is what VC was like in the early days before VC became another asset class for the finance folks. This is a science-first approach to funding innovation and it is a total game-changer.
Science-first innovation capital
That science-first approach could unleash a whole new wave of innovation. Ventures that are too risky for traditional VC because they have technology risk may get funded this way. Imagine a high risk Biotech venture. Biotech Scientists can evaluate risk better in an early stage Biotech venture better than a bunch of finance guys on Sand Hill Road. Ditto for clean energy and reversing climate change and other things that really matter to us.
The sort of ventures getting funded through ICOs would never have got through the Legacy VC gauntlet (with endless VC chants of “come back when you are more mature”). Legacy VC would never have funded Ethereum for example. In the traditional funding model, ventures with a risk profile as high as Ethereum (both technical and market risk) would have either not got funding through the traditional Angel/VC route or would have got $100k Seed and then fallen into the Series A Chasm due to lack of capital to execute properly. That all changed in the Long Hot Summer of ICO in 2017, when a new breed of entrepreneur raised more money Pre MVP than ye olde entrepreneur used to raise in an IPO (Tezos, Bancor etc). The market jury is still out on the class of 2017 ventures, but the market has given its verdict on the class of 2014 led by Ethereum.
The Token User/Investor is a new way to get to Product Market Fit.
Like it’s legacy counterpart (the IPO), an ICO is as much a marketing event as it is a capital raising event. If you succeed in selling Tokens to people who will use your product you have in one shot a) moved from MVP to PMF b) raised the capital needed to move from PMF to Scale. You can see why smart entrepreneurs around the world believe that a Utility Token is the game-changing new tool in the venture building toolbox.
However it must be done right. If it is really just a capital raising event without real users buying the Tokens then two other stories become true:
- “A Utility Token is neither real equity nor is it a bond; so it must be a scam”.
- “If an investor likes it, it must be a security, we don’t care what you call it”
If done right, an ICO can help an entrepreneur get from MVP to Scale. That is hugely valuable to the entrepreneur obviously, but it is also useful to the users/customers and the investors.
A Utility Token can apply anywhere in the stack.
The Blockchain stack, like every other technology innovation, has two layers:.
- Top Layer = Applications = described in Part 2 of this book. The users are anybody who has a use for the product on offer.
- Bottom Layer = Technology Layer = described in Part 1 of this book. The users are developers who build the Top Layer products. Ethereum is an example.
A Utility Token can be bought by users at both layers.
Note: you could split the Bottom Layer into Protocol at the bottom and Middleware Services above that, but for investors the key question is “who is the user/customer” and in both cases it is the same – developers.
Fungibility is great, but a fungible Token is not a Utility Token. To use the Analog Utility Tokens example, you cannot swap a NYC Taxi Medallion for a seat on the CME. At least not directly – you would have to sell one and buy the other. So when you buy a Utility Token you really expect to use it and capital appreciation is a bye-product of many people making the same decision. There is a different standard for Non-Fungible Tokens (ERC 721).
How to make money buying and selling Utility Tokens.
Follow the new smart money. The new smart money are people who bought the Utility Token because they understand the utility being offered. They are not “investors” even though they make a lot of money with their capital. Their expertise is domain specific. In short, follow the customer. That is an old golden rule of investing. Taking the Ethereum ICO of 2014 as an example, if you see a bunch of programmers buying ETH because they plan to build Dapps on Ethereum, then follow that smart money (the programmers in this case).
Here is an update that describes how entrepreneurs who use utility token to reduce CAC (Customer Acquisition Cost will create the most valuable Security Tokens.
Bernard Lunn is the CEO of Daily Fintech and author of The Blockchain Economy. He provides advisory services to companies involved with Fintech (reach out to julia at daily fintech dot com to discuss his services).