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Dear crypto-investors, you cannot acquire a network

by TropycMay 22nd, 2018

Too Long; Didn't Read

Most of Initial Coin Offerings have recently started to seek funds from conventional startup investors (Angel Investors and Venture Capitalists) via a tokenised seed round, also known as <em>Private Sale.</em>

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featured image - Dear crypto-investors, you cannot acquire a network

Why go private when you can go public?

Unlike Pre-ICOs, Private Sales occur in closed doors and remain, most of the time, extremely opaque. Pre-ICOs on the other hand offer attractive price discounts to early investors, but the deal is open and transparent.

Private Sales are opaque because public sale investors do not have visibility towards two crucial metrics:

Amount of tokens sold (% of the total token distribution)
Price per token

Without this information, public sale investors cannot estimate the network valuation at the time of the Private Sale. They have therefore no clue whether an ICO is engineered to guarantee profit to private investors, at the expense of public investors.

ICO investors enter the “token cap table” at a higher valuation than private ones— which is fine, since they enter at a later stage.

However, the delta can be ridiculous and absurd, sometimes as high as 50x … and only in a matter of months.

1. Networks versus conventional investment

“Utility” crypto-tokens and financial regulated securities have little in common when it comes to their fundamental value.

In mainstream finance, a security represents ownership (or rights to ownership) in a legal entity or a creditor relationship with a third party.

On the other hand, in cryptocurrency network investments, tokens represent a stake of a collaborative economy.

For instance, let’s consider a fictional dAPP for the global shipping market. It would gather container liners, ships, harbours and businesses (with shipping requirements) onto one single marketplace. In this scenario, the token “SHIP” is a financial guarantee after a booking is confirmed.

Here, the total supply of SHIP tokens would, therefore, represent the number of containers booked on the application. Holding a SHIP token would represent a fragment of the SHIP network’s economy.

Common securities on the other hand, would only supply ownership into a single entity of the shipping market, not the eco-system as a whole.

Mind that cryptocurrencies can represent a security, such as an index tracker or a right to a physical asset. Not all cryptocurrencies intend to build a “network”.

2. The case for token distribution and velocity

Not every successful business aims to go public and introduce their shares on a secondary market. As such, it is perfectly fine for a business to restrict its stock to private shareholders. Most of today’s businesses are not publicly listed, but rather owned by a family or a handful of individuals.

Unlike companies, network has to be public.

Well, technically, a wealthy economic agent could decide to acquire a network but the “network” would only comprise of one individual.

Not a network anymore, right?

When a network is controlled by a single entity, its token cannot be utilised for its core functionalities, since there’s no one to send it across to. The purpose of the cryptocurrency becomes obsolete, as it is both centralised and inactive.

Acquiring a network removes all inherent value tied to the token, the network and the application.

A tokenised network only becomes valuable when it facilitates useful exchanges between peers as measured by its concentration and its velocity.

Concentration is the level of distribution of a given asset across users. When a single individual holds all the tokens, its concentration is at its maximum, and concentration destroys a network.
Velocity is the degree of exchange of a given asset. In other words, it measures the number of times an asset changes hands in a given period. No velocity means that tokens do not change hands and are not utilised. High/low velocity does not necessarily mean high/low value, however, no velocity implies no value in a network.

Acquiring a substantial chunk of a network’s token has, therefore, a negative impact on its inherent value because:

Asset concentration increases significantly, as the network is less distributed.
Lower distribution implies a decrease in users and usage and a velocity drop.

Of course, most of the token economies are at a nascent stage. Although they do plan to build a network, it is still far from implementation as today’s network token holders are more financial speculators than users.

3. The case for private sales

First we studied how network investments differ from conventional securities, and then how the value of network is derived from its token concentration and velocity.

Consequently, high net worth investors should be aware that the amount of tokens they can acquire is therefore limited, else it will negatively impact both the distribution and velocity of a network.

The contribution “ceiling” is obviously theoretical for now, but any significant acquisition of a network by a single player is destructive and irrational.

The investor would pay a high price to purchase tokens, that would both increase concentration and r_educe velocity_ — impacting negatively the network value.

In this sense, blockchain startups should minimise any private sale contribution. Although raising a seed round is a very efficient way to both get funds and gain expertise, private sales gather fewer investors and with a higher ticket size per capita.

In the event of substantial investments from private sales, long-term velocity and distribution would stay relatively lower, negatively impacting the network value.

ICOs: organise private sales in moderation. Why go private when you can go public?

Originally published at tropyc.co.

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