Original Link: Tokens: Investment Vehicle or Medium of Exchange (Not Both)

Author: Cathy Barrera, PhD

Summary & Commentary

Catalini and Gans's research paper, "Initial Coin Offerings and the Value of Crypto Tokens," explores Initial Coin Offerings (ICOs) as a funding mechanism for blockchain ventures from both the startup's perspective and potential investors' standpoint.

One key insight from their paper is the trade-off between developing a token that serves as an attractive investment vehicle and one that functions as a practical medium of exchange. They argue that it might be challenging, if not impossible, for a single token to fulfill both roles efficiently.

They consider a typical "utility token" model in which a blockchain platform raises funds via an ICO, then uses that token to purchase goods or services on the platform. The value of these tokens is determined by three factors: the size of the platform's user base, the token supply, and the value of the platform's product or service.

The paper outlines a problem: if a token issuer wants the token to appreciate in value (becoming a good investment vehicle), they should aim to expand the user base rapidly while restricting token supply. However, this might lead token holders to hoard tokens expecting further appreciation rather than spending them, resulting in a dormant platform.

On the other hand, if the issuer wants an active platform (meaning the token is a good medium of exchange), they must encourage spending, which in turn requires token holders to perceive that the token won't appreciate significantly in value.

Although their model oversimplifies certain aspects, such as the option of selling tokens on an open market, it does shed light on the fundamental trade-off in token design and policy. Founding teams must decide whether to make the token an attractive investment (prompting saving or selling) or an appealing medium of exchange (encouraging spending).

Here are a few actionable insights from these findings:

1. Clearly Define Your Token's Purpose: Blockchain startups must decide early on whether they want their token to function mainly as an investment vehicle or a medium of exchange. This decision will dictate many aspects of the token's design and the overall ICO strategy.

2. Consider Different Token Models: The "utility token" model is not the only option. Depending on your objectives, other models such as "security tokens" or "governance tokens" might be more appropriate. It could also be worth exploring hybrid models or dual-token systems, where one token serves as an investment vehicle while the other facilitates transactions.

3. Don't Overlook Traditional Funding Routes: While ICOs can be a viable way to raise funds, traditional venture capital shouldn't be overlooked. This is especially true if the need for a utility token isn't clear or if the market is too speculative.

4. Target the Right Audience: If your token is primarily a utility token, consider targeting the token sale towards potential users of the platform rather than speculators who are mainly looking for a return on investment.

5. Explore Dynamic Monetary Policies: A well-designed monetary policy could allow for an initial appreciation in token value post-ICO to attract investors, followed by a stabilization of prices to encourage usage once the platform is operational.

Remember, every project is unique, and what works for one might not work for another. The key is to design your token and ICO strategy with clear goals and a solid understanding of the trade-offs involved.