Market Context & How we got here
2018 in cryptocurrency has been marked by a significant decline in the market through to August, with prices across most major cryptocurrencies collapsing to a fraction of the all time highs achieved at the start of the year.
There have been a variety of reasons driving a change in market sentiment: regulation had a significant impact on the ICO market, whilst uncertainty as to how regulators would approach the industry more generally created significant FUD (fear, uncertainty & doubt) around the use, access and treatment of crypto currencies in major markets.
One of the most significant underlying issues in the crypto industry however, is that so many ICO projects have failed to delivered on their vision (this will be explored in a forthcoming post).
The major problem with this is that cryptocurrency tokens are ultimately nothing but intangible ‘permissions’ within a software platform (which may or may not properly exist yet). Until tokens actually become essential to carrying out various functions as promised (which for many ICO projects is a long way off, at least at a commercial scale sufficient to justify token prices) it can be difficult to justify tokens’ value other than through speculation. The speculatory value of cryptocurrencies is heavily challenged by crypto skeptics.
Put differently, the more removed a token is from some established form of value, the harder it is for a token to assert and maintain perceived value at the present stage of crypto’s commercial development. (This discussion relates more to utility tokens and is to be contrasted from ‘true’ security tokens, an issue which will also be explored in future posts).
Whilst the commercial real value and usefulness of cryptocurrency remains unclear, volatility in prices will likely remain as markets try to determine the ‘right’ price with limited reference points to established, non-crypto forms of value.
Herein lies a lesson and an opportunity for crypto projects. To establish more justifiable, sustainable prices, cryptocurrency ultimately needs to graduate from an industry where token valuations are based chiefly (if not solely) on projects’ potential, towards a technology that is used for activities with a clear, proven and sustainable commercial value. This will come with time.
In the interim, it is likely that the more there are obvious ‘proof points’ between established forms of value and a particular cryptocurrency, the easier it is to determine (and justify) that cryptocurrency’s value.
Such proof points can act as a kind of validation by providing some form of link or connection between a crypto token and some more widely recognised, established form of value. Whilst the true usefulness (and therefore ‘justifiable’ long term value) of cryptocurrency remains uncertain, these proof points are especially important.
There are various ways proof points can be established, and this article is by no means an exhaustive list. In particular, the nature of blockchain protocol projects mean that the proof points for these projects will often differ from ICO/crypto projects which essentially apply blockchain technology to revolutionise a particular industry or market.
Two key proof points that can be utilised include a project’s commercial success; and a connection or proof point between a token and another form of recognised value.
1. Commercial Traction Proof Point
As the crypto market cools, many of the major capital investors are beginning to become more similar in their assessment of projects to the approach taken by conventional means of early-stage funding (particularly as VC funds become increasingly active in the crypto/ICO market). In turn, commercial traction becomes a key proof point of a token’s value.
As with more traditional early-stage venture investing (angel, VC, PE, etc) a core determinate of a project’s execution risk profile is how much market traction has been achieved to demonstrate the market appetite and the project’s success in capturing it. The more developed a project is and the greater its level of commercial success, the more it has ‘proved’ its commercial value, and the closer it is to establishing non-speculative value (think number of commercial users/partners of a project’s technology — is there a real business underlying the project?)
Reflecting this, successful projects are increasingly those at a more developed stage; eg some recent successful ICOs are in a stage of development where they may otherwise be considering taking Series A funding or beyond. Post-ICO projects with stronger traction and stability in the market are often those with a more secure underlying commercial position.
2. Recognised Value Proof Point
Tokens with a clearer, more direct connection to established forms of value are likely to have a more relatable, clearer basis upon which their token price can be justified and sustained. Essentially, this form of proof point can seek to support token price reference to the value of an existing asset class / value chain that a token seeks to capture. Core considerations here include the strength of the linkage or connection to the existing form of value; and the order of magnitude behind the value sought to be captured.
For instance, a token that will act as the primary means through which a blockchain platform unlocks latent capacity in infrastructure typically has a more obvious value than a token which can be used to purchase merchandise.
In the former example (infrastructure capacity), the value being captured is typically clearer: the token will be the primary means of capturing the value behind that latent capacity. If the underlying platform/project is among the first to market to capture that infrastructure capacity, then the token price would be clear — if the project is successful, the token’s market cap ought to reflect the liquidity needs behind the value being captured (broadly speaking, and among other things).
In the latter example (merchandise sales), the token value is far less clear. Not only is the value of the asset class being captured potentially less obvious, so too is the token’s connection to that value. For instance, why and how would the token be capturing the value behind the sale of merchandise?
In this case, the obvious question becomes: is the token directly connected to, the only, or the best way to access this established value, or merely a loosely connected to established value? Will the token by central to capturing, or be merely a currency-type token which people can elect to use in lieu of money or some other form cryptocurrency. Cementing this proof point also requires an assessment of the underlying token use case — ie why couldn’t fiat or Ether be used instead?
Most realistic projects are able to clearly articulate an identifiable basis for a strong token price, based on real-world value proof points. On the other side of the equation — and at varying levels of sophistication — many in the crypto market make this kind of assessment of a project. Key questions asked of projects remain ‘what’s the problem solved?’, ‘what’s the underlying market?’, ‘how big is the potential market (cap)?’.
Hardware & Tangible Proof Points
Having a strong, clear connection to some established form of value is therefore likely to be of great assistance to a token’s price and stability, and they provide a clearer basis for a project’s value, and offer some sort of platform from which a real-world value assessment and (somewhat less speculative cf. other projects) valuation can be arrived at.
Whilst by no means the only method of doing so, an interesting opportunity exists in respect of hardware projects. Various research has shown links between tangible hardware products and a more easily understood, recognised value in the mind of consumers.
Research has also drawn a link between stronger emotive connections and hardware products than intangible points of value (eg, a stronger link between a physical iPhone than a software app). Additionally, emotive connections can also support hardware products which ‘do good’, over those which do not, so CSR hardware may also find it easier to establish token value through proof points and securing mindshare.
Where tokens are linked to real-world hardware, they may therefore have a stronger basis for making their project (and therefore token) differentiate itself from an increasingly market or projects which have found it difficult to prove their worth.
A corollary of this is that, in the context of the high rates of unsuccessful projects, a tangible product is an easy way to differentiate by demonstrating real-world usefulness, traction, and development in a way that can be harder to convey to the broader public when a project is purely software-based.
Connections to tangible products may therefore have a particular psychological ability to capture mindshare, show development, and obtain support for a project, its goals, and its development towards delivering its vision. In doing so, their token value may be more readily obvious, and their value may become more stable as it has a closer connection to established forms of value.
We expect that larger successful ICOs will (with the exception of ‘pure’ protocol/software projects) increasingly involve those with a real, developed underlying business. For this reason, having a clever, effective linkage between the blockchain and hardware or other innovations is a good way to mark a project out as being more developed and higher potential, and reassure markets that it will not be another project that fails to deliver.
As the market evolves, projects with stronger, clearer touch-points may find themselves more able to establish and retain token value. The psychological advantages of value identification with tangible products may provide those tokens a further advantage.
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This article is was written jointly by the teams from Lupercal Capital (a cryptocurrency strategy consulting & investment firm) Nexsis (a tech company in clean water/renewable energy).
If you have an exciting, high potential project in the crypto/blockchain space, please contact us at [email protected].
This article is strictly not advice, endorsement, or recommendation in respect of investment or otherwise; nor analysis that can or should be relied upon in making such decisions. Readers should conduct their own research and may need to consult a suitable professional.