Some cryptocurrency ventures promise prospective token holders rewards for acquiring and holding their cryptographic tokens while they simultaneously promote their cryptocurrency’s suitability for use in everyday commercial transactions. These cryptocurrency ventures double up on token use cases thinking that they are engineering a more valuable token: a token that is a form of currency that also rewards you for holding it. Instead, they create a token with conflicting fundamentals for unsuspecting participants in their ICO and potentially put their project in jeopardy.
The problem is rooted in fundraising ventures issuing tokens that initially have no function or value. These rewards tokens are created purely to take advantage of the advances in crowdfunding provided by the Ethereum network and ERC-20 smart contracts.
Unlike cryptocurrency tokens that can immediately be used for something on a distributed network, rewards tokens are a purely speculative creation from their inception.
Token purchasers collectively assign value to rewards tokens based on their assessment of the possibility that the venture will make good on the promises in its white paper and online marketing materials. The dilemma surfaces as competitors, also fundraising, enter the marketplace. Since funds are scarce, these competitors need to signal that they are a better value to speculators.
For example, after the fundraising success of the first venture to promise a cryptocurrency debit card in a token sale, several competing cryptocurrency debit card projects followed suit. In order to differentiate their projects, each venture engineered more enticing rewards programs and appealing value propositions. Strategies included claiming to support over 8 different major cryptocurrencies to providing 0.2% rewards on card transactions.
Medium of Exchange
One competitor decided to establish relationships with real estate companies and obtained agreements requiring the customers of those realtors to transact business exclusively with their rewards token. In their white paper they guarantee that the rewards token will appreciate in value because of this scheme. However, they would need to continually invest in expanding the number of goods and services that use their token as an intermediary instrument, without financing benefits that mining affords proof-of-work networks like the Dash network.
In promoting the token as an intermediary instrument to facilitate the purchase, sale, or lease of real estate, the rewards token becomes a medium of exchange. However, the supply of rewards tokens is fixed. The supply is engineered this way so card transaction rewards are not diluted.
The venture guaranteed the token price increase, wagering that there would be increasing demand for the few houses that the token supply represents.
Unfortunately, it is a wager that assumes that the tokens provided sufficient incentive to change, perhaps intransigent, consumer behavior. For example, seniors are not likely to begin using cryptocurrencies to buy, sell, or lease property. It is too expensive a behavior change for consumers not in the young, male-dominated, tech savvy demographic that embrace cryptocurrencies. Instead the reverse is more likely. Demand for token-denominated houses will fall.
Even if adoption wasn’t an issue and demand was unaffected by the scheme, if the supply of real estate transacted using the rewards token decreases then the tokens become less valuable collectively. This scenario is very possible when demand for housing remains the same in the short term, but the cryptocurrency venture doesn’t have sufficient partner agreements in place to replenish the supply of units that have been purchased or leased. Under these conditions, the fixed supply of tokens represent an increasingly smaller supply of real estate, diminishing the collective value of the tokens.
Rewards tokens have different economic fundamentals. When a token offers rewards, there is an incentive to hold on to the token. The larger the expected reward, the higher the incentive to hold becomes. When many owners of the token decide to hold, the result is an appreciation in the price of the token. The reverse is also true. If many token holders decide to sell, there is a depreciation in the price of the token.
Assuming that the token purely represents the right to a portion of the future rewards provided by the venture, and is not used to buy and sell goods and services, its price would never be influenced by the supply of real estate.
When a venture decides that its rewards token should also support real estate transactions as a medium of exchange, it confounds its rewards strategy to a varying extent. The problem may be particularly acute if the marketplace for goods and services is relatively small in comparison to the expectations market for token rewards. Fluctuations in supply could have a disproportionate impact on token price.