Thin Protocols, Lack of Network Effects and A Theory of Value for Security Tokens

Understanding how value is created and accumulated in a technology market is the most effective, and arguably the hardest, way to develop a unique thesis about the space. In the case of security tokens, formulating a value creation thesis seems to be particularly difficult given the early fragmentation of the space. After a year of frantic development, hundreds of new players, many more press releases and the first group of issued tokens, we still don’t have a clear picture of how the main value creation avenues in the security token space. Today, I would like to explore a few basic ideas that might provide some clarity into how value will be created and accrued in the crypto-securities market.

The challenge of formulating a theory of value for security tokens is particularly difficult when the space still hasn’t seen major investments. Venture capitalists and institutional investors tend to deploy capital in areas in which they believe value will be created and accumulated and, consequently, are an early data point for short-term and long-term value creation thesis. In other words, “following the money” is a simpler way of formulating ideas about value creation across the lifetime of a technology market. In the case of security tokens, well….there is no money to follow yet.

When thinking about value creation in security tokens, there are three areas that concern me greatly:

1. Product vs. Network Friction: Differently from other crypto markets, the crypto-securities space seems has been evolving as a collection of isolated products without an underlying network.

2. Lack of Long-Term Network Effects: Related to the previous point, the security token market doesn’t seem to be creating strong network effects as it evolves.

3. Thin Protocols Effect: The first wave of crypto-securities seem to be dominated by very basic protocols and tokens instead of a strong platform foundation.

Product vs. Network Friction

Until today, the security token market has been evolving as an isolated collection of products without an underlying network or incentives to influence the growth of the entire ecosystem. The value of a crypto-network is not only a great value-creation mechanism but also a channel to distribute value across the different participants in the network. With a network, some products might benefit from the value created by other participants in the network. Without that, value is going to be accumulated on specific product categories but not easily spread across the rest of the ecosystem.

Lack of Network Effects

Related to the previous point, the existing generation of security token products are creating very minimum long-term network effects. Most of the network effects in security token transfers happen at the Ethereum level which has very little ramifications onto the rest of the security token ecosystem.

Thin Protocols

The fat protocol thesis was one of the main value creation theories for crypto-assets. If you read this blog you know I am not a big fan of the fat protocol ideas but I recognize that it captures the value creation dynamics for a relevant part of the crypto ecosystem. In the case of security tokens, the entire space is based on very thin protocols like DS-Protocol or R-Token and applications. Why is this relevant? Well, why this type of thin protocols can capture value during specific areas of the lifecycle of security tokens like issuance or compliance, they are unlikely to capture or distribute long term value.

A Theory of Value for Security Tokens

Recognizing the DNA and challenges of the current security token ecosystem, we can start formulating a basic theory of how value is going to be created in the space. If we visualize a timeline of the evolution of the security token space from the value creation perspective, we might get something like the following:

Some notes that might help to understand the previous diagram:

· The initial value in the security token space has been captured by the issuance platforms.

· Slowly security token exchanges might start to accrue some value from the listing and trading activities of crypto-securities.

· B2B scenarios such as the tokenization of corporate bonds will be one of the areas that capture a lot of value in the initial wave of security tokens.

· Liquidity pools such as crowdfunding marketplaces might capture some relevant value in the security token ecosystem.

· Crypto-financial protocols in areas such as debt, derivatives, disclosures or compliance have the network effect required to capture and distribute value for security tokens.

· Sophisticated security token products such as derivatives that serve large institutional investors will be one of the ultimate value creation engines in the security token space.

· If the idea of a blockchain specialized in security token materializes, we might see a shift on the value creation dynamics of the security token market.

These are some of my initial ideas about the value creation challenges and dynamics in the security token space. I expect some of the ideas outlined might result controversial or even incomplete but hopefully will help to trigger the debate about this important subject.