Be Careful What You Wish For
By: Mark Roddy
Tags: Emanate, Insights, Ethereum, Cryptocurrency, Token Economy

If we look at today’s economy and specifically the share market, what we see is the idea of ‘short-termism’ becoming increasingly prevalent. This is the idea that the returns on investments need to occur as quickly as possible. We see this in the form of portfolio turnover that has risen from 30% in the 1950’s to 140% in the last decades.

This shift hasn’t caught anyone by surprise. In fact, in the midst of the great depression in the 1930’s Keynes warned that the stock market would become

“a battle of wits to anticipate the basis of conventional valuation a few months hence, rather than the prospective yield of an investment over a long term of years”.

With the rise of High-Frequency Trading portfolio turnover has no doubt increased dramatically in recent years.

However, Keyne’s prediction of monthly valuation foresight has now become not so much about capitalising on others incorrectly pricing but merely not having access to the equipment that the HFT firms have. This practice is not investing; it is value extraction which is a recurring theme in modern corporate structures.

This short-termism effect is evident in the management of major corporations, who have also succumb to this ideal which is seen in the name of a practice known as Maximise shareholder Value or MSV. MSV grew in popularity in the 70’s as an attempt to revitalise corporate performance by doing what was believed to be the sole purpose of a company: creating shareholder value.

As an example, we see MSV play out continually in Private Equity firms that purchase successful companies, leverage them full of debt and begin extracting value from the firm by selling down equity to new investors or often voting immediately in favour of ‘special dividends’. Usually, the shareholders are left with increased wealth, but the company that was once successful and now fails because it was ultimately designed to leaves behind it a trail of stakeholders who do not share in the same value creation process as the private equity firm.

Securities are no doubt inevitable in Crypto, but we must be careful what we wish for because creating the same system in the new ‘protocol of value’ ignores the reasons why cryptocurrencies as a macro theme grew so popular initially, that is that the current system is broken and there is a better way. A system that discourages value extraction and encourages value creation for all stakeholders.

You might be asking, what we mean here? The answer lies in ‘Tokenomics’, specifically utilising a hybrid of a Utility token and Security token, where defining the rules of the ‘protocol’ can force stakeholders to align their incentives towards value creation oppose to the value extraction. However, before we dive into how this might work, let’s first understand that value creation is a collective process.

Shareholders are no doubt significant, they often are the ‘lead risk takers’ with no guaranteed rate of return. Although, as explained above, for sophisticated investors, this is becoming less the case. Despite that, it is hard to imagine a company’s success without the involvement of many groups; employees, suppliers, distributors even the broader community whom all in their own right take some form of risk associated investment in the company. This is even clearer when we consider the modern behemoth corporates, Facebook, Google, Amazon etc. that describe themselves as ‘platforms’. These platforms are valuable for shareholders because of the users that interact with them, and yet the value that is created by these users is often extracted via profits to the shareholders. Now, without sounding biased, users take a lot of value from platforms like Facebook, Google and Amazon that allow them to use a range of services for ‘free’.

My point is not that these platforms do not provide a valuable service but the fact that the corporate structure inherently ensures that shareholder value is prioritised over stakeholder. The incentives are not aligned.

A Hybrid token, combines the benefits of a security token, the idea that we are owners of a company, with utility tokens, which are required for the service or product that the company offers, in turn, the token may start to look like a currency or be accepted as currency by users.

This, in turn, aligns the incentive of the stakeholders, whereby the incentive is value creation for all. Further, rules in the protocol can enforce such behaviour, i.e. major players must stake tokens or stakeholders might receive tokens for providing valuable services.

The question might remain, how does this work in practice? The reality is that this can happen in many ways and the “best” token models like corporate governance structures are yet to be fully realised. In saying that, we can see the beginning of such models and their effects, good and bad.

Dash Masternode holders are a good example of the good and bad behaviour, Masternode holders must lock up a certain amount of tokens in exchange for an ongoing revenue stream of tokens. In essence, they are signalling that by putting their tokens at risk; it is in their best interest to provide a good service to the project. Masternode holders vote on proposals about the future course of their project, in a recent proposal they voted for an increase in salary for themselves. This might be frowned upon but because the only form of payment that the Masternode holders receive is in DASH, voting for continual salary increases will inevitably lead to users that are dissatisfied with the governance structure and will drop the DASH currency, I.e. by voting for unsustainable proposals, they will damage their ongoing revenue stream and the capital they have at risk. However, this is a simple example and the protocol rules can be much more effective.

At Coin Hunter, we have recently advised a project around token economics (emanate.live). In this project, the design was to ensure that those that are most likely to extract value from the platform had their incentives aligned to the future success of the platform. With this in mind, Emanate forces stakeholders, in their case record labels, distributors, artists etc. to stake the token. By staking the token they put at risk capital in return for extracting capital from users of the platform. Further, Emanate reward people that add value to their platform like artists, playlist creators, developers etc. This creates an environment where those that are adding value to the platform are most rewarded for their efforts. In other words, It encourages value creation over value extraction.

Securities will have their place but value creation is a collective process and properly designed token economies have the potential to recognise this. This aligning of incentives of stakeholders is the true beauty of a tokenised economy and we mustn’t forget this even when our bags are loaded and heavy.