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The Node: The First Step to Making Sense of the Token Economy

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·5 min read
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Let me tell you about the biggest ah-ha moment I ever had covering crypto. It’s maybe the ah-ha moment that has kept making everything else make sense from that day forward.

The insight answered this question: How did digital tokens create a new and different way to make it worthwhile for teams to devote years to building some online product?

This article is excerpted from The Node, CoinDesk’s daily roundup of the most pivotal stories in blockchain and crypto news. You can subscribe to get the full newsletter here. 

Related: State of Crypto: Infrastructure Bill Shows Congress Sees Crypto as Here to Stay

If you weren’t there for the initial coin offering era, here’s an oversimplification: Folks were raising money to build services that would be open source and charge no platform fees to their users. They did this by selling tokens, which weren’t stock in the company but typically some kind of access enabler for some part of the new service.

There are a lot of forms tokens take, but here’s the simplest: Most of these ICO startups created some kind of marketplace, enabling a connection between people who needed a service and those who could provide it. While the marketplace itself didn’t charge fees, it would enable transactions only with the native token.

The ICO era may have passed, but what clicked for me then is still relevant now.

Take that initial idea and add complexity and innovation and that gives you the plethora of companies created in this vein up through today. In truth, basically no one uses the model above, but the idea started there.

Related: ‘Preying on Human Weakness’: Why Investors Are Nervous About Robinhood

So this part about not charging fees for building these marketplaces kept bugging me. How would the creators make money?

I think it clicked while I was talking to a founder making a decentralized auction site, like eBay. The big selling point was that the protocol would allow folks to host all these items for sale and it wouldn’t charge anyone any money for them to host the listing or for the protocol to manage bids on it.

Obviously, this is a very nice deal for users, but how the heck did it make sense for this team to spend a lot of time and money to build it?

That was what was so clever about the ICO model, though. It created an incentive to build something valuable that the creators could eventually walk away from and let run itself. The way it did it hit me that day, so let me help you see it, too.

Once this insight slips into place, it’s fairly easy to make other token projects make sense from here.

EthBay

Let’s imagine a simple decentralized eBay. Let’s call it EthBay.

On EthBay, to host a sale, sellers would need to hold a certain amount of EthBay tokens. They wouldn’t need to pay to sell, but they would need to buy that token and prove it to EthBay for as long as they wanted to run listings. Once they were done selling, the merchants would be free to unstake and sell their tokens.

Most projects quickly walked away from the idea of the token as the transaction medium of their protocols because it created too much friction for users, but requiring businesses running on one to stake some token could be used to protect users, because bad operators could lose their stake.

So the staking requirement creates demand for the token, and it slows what’s called “token velocity” – the speed at which a token gets sold after a new person attains it. (Note: Slower token velocity should increase price so long as there is demand.)

Obviously, more listings would require more tokens, and eventually other services would get built on top of EthBay that would also require tokens to operate (such as arbitration services).

The pure idea of an ICO was this: A team would create some finite supply of token that made sense for them, set aside a portion to use to attract early adopters with giveaways and promotions, set aside a portion for the team and investors and set aside a portion to sell to the public.

The sale to the public would serve as their operational funds to get off the ground. Then, if they built it and the people came, the token value would start going up.

So here’s the insight:

It was that rising value in token value that would, in theory, pay for all the hard work of the founders and the team. If they built a good product, the tokens they had set aside for themselves would go from, say, 10 cents in the ICO to $1 by the time the team was ready to wrap.

But only if the finished product created a marketplace that users wanted to use.

Just the beginning

Tokens were a nascent concept when this clicked for me. Folks didn’t know whether to think of them as arcade tokens or receipts or insurance or licenses. The truth is they are all those things and more now. 

Still, whenever a new project doesn’t quite make sense to me in cryptocurrency, I try to picture where the token sits in its particular concept, how the creators envision value going to that token and how they can see that token making their work as builders worthwhile.

Looking at new projects through that frame, I have found, can make them much less baffling. 

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