Do You Know How Fast Your Token Was Going?
• 12 min
• 12 min
It’s great having you back for another adventure, and congrats, you’ve made it to the end of the WBS. Just kidding, it’s only the end of the network economics series! Now is a good time to tell you that we’re almost done with “Blockchain Securities 101,” and unless you flunk the final, you’ll be getting a (Reg!) A+.
In the coming weeks, we’ll be transitioning the WBS to posts about what’s happening in the world of blockchain securities right NOW! So stay tuned :) oh, and there is no final.
You’ll also notice links to papers and articles in this WBS. If your goal is to become an expert blockchain securities investor, we suggest you explore advanced WBS topics further. The good news is that we’ve done part of the work for you by providing links to resources we believe are worth reading.
Now, let’s get on with this week's WBS on Token Velocity (TV or V for short), and it’s role in models for network/token valuation and, ultimately, the future health of a blockchain network.
Much like in real-world economies, a blockchain network's (a mini-economy!) value is a factor in determining, on a macro level, the current and future health of a token economy. One common method to determine a network’s value is to consider its “market cap” - just take the token price and multiply by tokens outstanding - we’ll call this perceived value. But blockchain networks are not like traditional companies, and therefore the “real” network value must consider things like changes in token supply, utility vs. speculative token value (and resulting token hold times), the number of participants, the cost of the products or services, and of course how often the tokens are being transacted - the token velocity. (for an excellent paper on this, click here)
Token velocity is a critical variable that is linked with network value because it quantifies how many times a year, on average, a token changes hands, or moves between digital wallets, on a specific blockchain network. Tokens changing hands, or transactions occurring, signify that network participants are using the token supply. Why is that important? Because it means a network is ACTIVE, but activity itself doesn’t mean much because it can be the result of a few participants transacting a lot, or many participants transacting a little - or anything in between. Therefore it can have drastically different effects on real network value as opposed to perceived value. Imagine a network with lots of token supply and a really high token price, but few transactions (possibly because the token is too expensive or there aren’t enough participants). In this example, V is very low, and the network economy is obviously not doing well even though the perceived network value may be high. You may be thinking that if in the above example there were LOTS of transactions (V is high), then the real network value and overall health would be higher - but it’s just not that simple.
Brace yourself, we're about to venture into a bit of algebra!
There have been quite a few attempts to relate TV or variable “V” to a network's real value by incorporating other variables we alluded to in the last paragraph. Most equations are derived from traditional economics.
In 1911, Irving Fisher formulated the Equation of Exchange, MV = PQ. Where M is the average money supply (market cap), V is the velocity of money, P is the average price level for goods/services, and Q is the total expenditures on goods and services.
Many people in the blockchain world have proposed modified versions of Fisher’s equation (for a good summary, click here) by replacing the variables with ones existing in a token network economy. A few of the most notable proposals come from Vitalik Buterin, Chris Burniske (read the book) and Kyle Samani.
Overall, what they all have in common is establishing the relationship between TV, the (token) cost and total volume of utility transactions (products or services paid for in tokens), and token supply. And notice a very important inverse correlation in the formula: as V increases, the real network value decreases - unless more products/services are purchased and/or for higher prices. Vitalik makes an interesting tweak, though, where he uses average token holding time instead of velocity - and for good reason.
While math is great for figuring out numbers, we’re here to explain what the numbers actually mean and why they are so important (and frankly, there’s just not enough space and time to get into equations).
Let’s revisit our example and think about how TV can be very high or very low and why average token hold times are so closely related to this.
High TV can imply that people on a network are selling their tokens very quickly after receiving them or using them very quickly after buying them. This is usually because the tokens can only be used to purchase products or services on the network, meaning they only have utility value. Think about it; if you wanted to use a service or purchase a product provided by a blockchain company but had no native tokens, you would buy the necessary number of tokens right before (since that’s the only way to pay). Participants receiving tokens for providing a service, like DApp creators or miners may also try to exchange them for FIAT money or more liquid cryptocurrency as quickly as possible - unless certain conditions encourage them to hold onto them. In this case, a high TV means the tokens are not functioning as a healthy currency because people don’t want to hold them as they are either not a good means to store value, not stable, and/or have no speculative value. Therefore the future of the network is not as promising as the activity suggests because there are not enough HODLers (that’s an intentional misspelling of holders - look it up!). Unfortunately, this is a bit of a rabbit hole as stability of the token may mean it won’t appreciate, and speculation may have a negative impact on utility transactions. Add to that token price supply/demand dynamics and artificial methods used to control TV such as incentives to hold, staking based consensus, token related voting power, high non-utility gas fees, profit share, and/or stablecoins, and you start to get a sense of why it’s so important to understand the details underlying TV and the role they play in evaluating the viability of a network long term. And that my friends is why a blockchain network economy is so complicated!
Oh, and if you really like formulas, take a peek at these research papers:
Remember, all of this is related to how an investor can determine the value of a blockchain security! For an example of the things that an investor needs to consider in analyzing a token economics model, click here.
And if you want to go deeper on modeling a token economy, this is a great start for the math majors out there.
Ok - unless we change the WBS to a weekly research paper, we’re done for this week.
Join us next week for...actually it’s a surprise (meaning we have no idea).
“A person who won’t read has no advantage over one who can’t read.” That’s Mark Twain telling you to follow the links! (and no, we do not get paid for referrals to these sites, and I’m offended you would even think that).