Cryptoassets as a Feature Set of Design Incentives
Cryptoasset design may include many features, such as utility, payments, and coordination. This is a nascent but powerful innovation opportunity. Today, far too many projects design cryptoassets for use as a medium of exchange for “ecosystem transactions” or speculative pure currency use cases with marketing one-liners like “digital X”. Eventually the market will come to appreciate that a broad feature set of incentives and economic actors can help build fundamental value in a diverse set of participatory networks through incentivized supply, demand and development equations.
Ethereum’s cryptocurrency, Ether, is globally accessible and can buy computation, make payments, receive airdrops, govern the protocol (someday) and potentially earn in return for securing the network under Proof-of-Stake. The combination makes it both more difficult to value and prospectively more valuable: because of the interdependencies of these use cases that form the ecosystem, a sum of the parts exercise would make any financial analyst’s head explode.
This economic complexity may be warranted, as the “single use-case” rhetoric may be a death trap for certain cryptoassets — take Ethereum Classic (ETC) as an example of a “store of value” token that has no community or ecosystem. If we can agree that the valuation of pure currencies is based on a combination of technology, accessibility, ecosystem utility, and adoption, we can then start to understand what the cryptoasset opportunity means when combined with fundamentals.
The three properties cryptoassets should seek:
- An instrument that is digital, secure, trustless and globally accessible.
- A developing ecosystem to use and accept it.
- A utility function that correlates value with fundamentals.
Today many cryptocurrencies satisfy the first property but very few satisfy the second and even fewer the third. With the introduction of stablecoins, the transactional utility from volatile currencies may fade away and be a major negative catalyst for applications leveraging native currency use cases. At the same time, new cryptoasasset designs will also help compartmentalize various risk assets from digital cash assets. Many business use cases may opt to utilize a stablecoin at the transactional layer and a utility token, if necessary, at the project layer. The result is a more advanced cryptoeconomy, but on balance a far less convoluted one. In a digital environment interoperability is a feature and two or three token ecosystems even if not native offer clear benefits (e.g. Steemit, Maker, Augur, 0x).
The additional property of realizing fundamental value from utility tokens is the million dollar crypto (legal) question. A security-linked solution was implemented by Sia (dubbed Siafunds) in their decentralized storage platform which earn a proportionate share of the usage from fees recorded through the platform. However, in order to avoid the sale of unregistered securities, Sia funds are privately held instruments and therefore violate the second property and will not benefit from aligning incentives of network participants. Attempting to incorporate all three properties of cryptoassets are:
- 0x Project is a pure governance token with a burgeoning ecosystem that will allow holders to benefit from voting on future economics. As a protocol the value today is the “benefit of coordination” across an ecosystem of users and developers.
- Augur REP will govern the prediction marketplaces by allowing holders to resolve markets and value will be fundamentally linked to the dollar volume of predictions.
The Value of Discount Tokens
We are proposing another method, the discount token model conceived by our portfolio company Sweetbridge’s CEO Scott Nelson, along with my partner Aleksandr Bulkin, and Michael Zargham. It sounds underwhelming because discounts are associated with gift cards and coupons, but let’s break it down to understand the economic implications and benefits for decentralized business models. Simply, token holders are entitled to a perpetual discount on services but structured in a way that the discount is mathematically equivalent to a revenue or fee royalty but only if you utilize the services.
As defined in the Sweetbridge “Discount Token Whitepaper”:
In brief, discount tokens are digital assets that give their holders a limited right to receive discounts on purchases of products or services from an organization — a company, a coop, or a blockchain network.Unlike gift cards, discount tokens are not invalidated when used (“burned” in blockchain parlance), but remain in possession of the holders. The specific size of the discount that each token realizes for its owner is designed to grow in step with the overall utilization of the network.
The term “discount,” is often described as a one-time or perpetual, i.e. a 20% retailer coupon or a 10% student discount. Instead, let’s redefine the perpetual discount to mean a fixed proportion of future network-wide utilization. For example, if you own 10% of the Amazon Prime token supply and in year one total subscription fees are $1,000 you can offset $100 of personal spend based on your ownership. Assuming the cost of Amazon Prime is $100 per year you don’t owe a balance. Next year if Amazon Prime subscriptions grow to $10,000 you can offset $1,000 of personal spend. Again you don’t owe a balance for your membership but now you have a surplus of discount and can gift or sell 9 memberships to other users.
This is a royalty model but instead of rights to a fixed stream of cash flows, it’s rights to consume a proportion of total services offered. The discount token is a right to utilize that proportion of the total economic discount offered system-wide. Based on the growth in economic activity the owner can either (1) utilize more discount/fee offset or (2) share or sell the surplus.
The key difference in the discount model case is that the value flows to offset cost to the users. This is quite important because even though the discount is still an opportunity cost to the network, growth incentives emerge in the control of the users of the platform. It is a more competitive business model. In fact, the issuer could participate in this growth — one could imagine a scenario where the network itself only floats a portion of total token supply, and use the discount as value proposition as a rewards mechanism to introduce new service offerings.
The discount token enables next generation, technology enabled mutual companies and cooperatives.
By comparison the security token model does not align incentives or provide similar competitive advantages. One such implementation was described above, where Sia issued tokens which would earn a proportional percentage of the top-line fees in the Sia platform. In this case, the value flows from the users to investors. In order to grow the network, investors must try to promote development and activity on the platform. Investors can still play an important role as a bridge during the bootstrapping period but ultimately discount tokens unlock greater value for end users.
While the math is equivalent for issuer and user (assuming users consume the maximum allowable discount) the securities model does not directly benefit the network users and therefore impairs both its user growth prospects and open source development contributions.
Revenue share vs. discount comparison
As a closing thought, notice the following observations:
- The discount (aggregate and user-level) is fundamentally linked to the adoption and growth of the network. The discount grows proportionately.
- The overall returns to the active token holders (users) outweigh the returns to passive token holders (investors).
- The discount token allows the holder to access the discount. The denomination of the fees may be in another currency form, such as a utility token or stablecoin.
The idea of a discount is not new in the crypto-sphere. One of the largest exchanges by volume, Binance, has an internal discount coin “Binance Coin (BNB).” The idea is that Binance fees (exchange, withdraw, listing, and others) are cheaper when paid in BNB, anywhere from 0~50% depending on the vesting date. In this case, the fee denominated is actually paid in BNB; the model we propose is the discount as an access option, wherein the fees may be paid in another currency. The access model creates more robust supply and demand characteristics. We hope to see implementations beyond the exchange vertical, for example, Sweetbridge is using this model initially to offset loan origination and service fees. In this proposed future when I buy a car, I will finance it by pledging the asset to the blockchain, receiving a stablecoin in return and offsetting my origination and service fees by owning discount tokens.
The discount model satisfies all three criteria proposed for cryptoassets and can be applied to virtually any type of service. It is a breath of fresh air given the many arguments surrounding fundamental value analysis of cryptoassets. Projects are still experimenting between feature tradeoffs of various token models such as fungibility, protocol token interactions, legal frameworks, and growth hacks. While tokens allow for transactions and capital formation, discount token models are an interesting way to incentivize the growth of a crypto-powered network. And with more centralized institutions entering the crypto market and consumer-proximate applications going live, discount tokens may emerge as an innovative design tool to scale a user-base and harness contributions from developers for its open source technology.
Special thanks to Ryan Youngjoon Yi and Aleksandr Bulkin for collaborating. References to other thoughts on these topics include Sweetbridge’s Discount Token Whitepaper, Julien Genestoux’s The Discount Token Model, Aleksandr Bulkin’s Discounts vs. Payments: Comparing Discount Tokens with Payment Currencies and Multicoin’s New Models for Utility Tokens.
Disclaimer: Neither the author of this article, nor CoinFund, LLC, provide investment, financial, or legal advice. The content provided on this site is for informational and discussion purposes only and should not be relied upon in connection with a particular investment decision or be construed as an offer, recommendation or solicitation regarding any investment. The author is not endorsing any company, project, or token discussed in this article.
Disclosure: CoinFund, LLC, is a compensated advisor to SweetBridge, Inc. and has a financial interest in its cryptographic tokens.