As the hottest innovation in the financial markets for years, Initial Coin Offerings (or ICO’s) saw a huge upswing in popularity during 2017. Everyone wants to get on the investment train, however, the underlying economics behind these offerings can be hazy. The hope is that once the ICO stage is completed, the underlying business will list its tokens on an exchange, thereby opening up the market to new participants and increasing the liquidity of the underlying token. In theory, this should increase prices past that of the initial offerings, allowing early token buyers to unload their holdings at a profit.
Indeed, for the last months, this has proven to be exactly the course many of these new ICO’s take. However, as time goes on the ongoing success of these investments will increasingly lie with the underlying token economics.
Everyone understands that the appreciation of any given token is dependent upon the underlying business. It is simply prudent investing to examine the strength of the business case and the financial stability of the offering party. However, just as critical to the appreciation of the tokens is sound token economics.
Over the past months, there has been a growing trend for ICO’s to offer so called “utility tokens”. Obviously, these tokens must play some critical roll in the ecosystem for appreciation to occur. Furthermore, in order to pair the appreciation of these tokens with the success of the underlying business, a two primary conditions must be met.
For one, the emission of the utility tokens must be capped so as not to expand with the user base of the company. If supply of the tokens grows along with the company, then while the company could increase revenue, the tokens may not increase in value. In this case, the ultimate appreciation or depreciation of the tokens would remain undetermined and would be dependent upon the relative increase in demand versus supply of the tokens. Thus, a good ICO investment should be capped in supply of the tokens. That way, an increase in demand for the company should lead to a corresponding increase in price of the tokens.
In addition, the suppliers of the goods or services (the “utility”) must be willing to accept the coin. This is an important consideration when making any investment.
Consider for example ClearCoin. This startup hopes to provide advertising services for clients in return for its proprietary utility token. It’s emission is capped, however, in this case, the providers of the services will be third party advertisers. While the demand side for advertisements may be tangible, it is highly doubtful that conventional websites and publications would be willing to supply advertisement space in exchange for ClearCoin, a hitherto illiquid crypto token. This is because these are conventional companies who are not initiated into the crypto space.
This structure contrasts with Shardix, another recently launched ICO with capped supply. Shardix provides decentralized database services wherein database miners provide storage space to consumers. In this case, Shardcoin (a utility token) is used to transact between the two sides of the network. However, here, in contrast to ClearCoin, the suppliers would be much more willing to accept the cryptocurrency payment. Miners would be of the same form as any other miner in the crypto space and would be providing a more homogenized product- here storage space instead of unique advertisements. Thus, both sides of the network should be willing to transact with the underlying utility token. As such, Shardcoin, fulfilling both requirements, emission and transaction, would be likely to appreciate in conjunction with the success of the underlying company.
In the end, no ICO is a sure bet. However, by applying sound economic analysis, you can narrow down the list. That way, you can spend your time on the underlying company- just like any other investment.
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