Token valuation models are used to evaluate token prices. But what’s wrong with them?
2 things about token valuation:
- Token valuation is not as important as you think it is. It is important from an investor’s point of view, but from the token economics and design perspective, it is the last thing to consider.
- Tokens should be valued with endogenous, not exogenous variables.
For the longest time, I am struggling with the last design aspect of token economics: “Token Design”. I struggle because I’m trying to balance what is necessary (variables needed to be considered in designing the token) and what people want (how much will my token be worth).
MV=PQ Token Valuation Model is wrong?
Let’s address the elephant in the room.
No, it is not wrong. This model is known as the “Quantity Theory of Money”, under the category of “Monetary Economics”. It is used to price money. Money itself has no price, but it has a value. We can extract this value from such models.
In the physical-fiat world, you have central banks governing our money. How do they price our money? The philosophy came from the general idea that price levels is directly proportional to the money in the market. Even in the physical world, this theory is challenged by Keynesian economics. Because prices are sticky and velocity is not stable in the short-run, this is a flawed model. This model is useful in the long-run.
The link with Token Economics?
Okay, so what the hell does it have to do with token economics?
2 things: (1) model for currency and (2) the idea of velocity.
1) This model is meant to get the price of money.
👉🏻 Your token is not always money. It’s like trying to use a fruit knife to cut a slab of beef. Please use the right tools instead.
2) Focuses on exogenous (external) variables.
👉🏻 Token ecosystems are amazing because you get to design many endogenous (internal) variables of the token. By that measure, the token’s value should be defined from the endogenous variables, not the exogenous variables. This is why token ecosystems are DIFFERENT from the fiat world ecosystem. We have comparatively more control of the output, given the input.
In token ecosystems, velocity is an exogenous factor because you can’t control how quickly your participants change hands. It can be indirectly linked to network effects, congestion, even your incentive mechanisms. But if we have direct links to the value the token ecosystem can provide, why not use it?
Why do people still use it?
Frankly, after speaking to many people in the industry, it boils down to 2 things.
(1) It is an easy model.
(2) This is the only model in the market.
To which I’d like to comment:
Easy doesn’t mean it’s good
It’s not the only model
So what token valuation models then?
Firstly, value tokens with endogenous factors.
Some variables that can allow tokens to have endogenous value:
Expected value of funds
Dynamic price equilibrium (Athey et al., 2016)
Exchange rate of tokens to dollars reflect buyer’s willingness to buy (ex-ante, market clearing condition)
Scarcity of tokens included by pricing choices causes buyer competition that reveals consumer values
Rational expectation of exchange rate in next period by agents
Value of price commitments
Demand growth from demand of buyers
Savings function/incentives to save
Function of expected growth through demand of platform or money supply
Value to consumer
Heterogeneity of user base
Disclaimer: this is not an exclusive list. This is not applicable to every token business model. It varies from the token function. There is NO one solution that fits every ecosystem.
Secondly, allow the market to dictate the price.
Read more about the various auction types and examples using these auction mechanisms.
Dutch auctions are more for homogenous good while VCG is for heterogenous goods.
Dutch auctions are a great pricing mechanism as the market will determine the price (value to buyer) instead of seller (usually monetary focused). It is a fairer way to allocate value to everyone in the network than being hostage to the dictation of a few people. Dutch auctions is also used by government when selling bonds.
The literature is researched till here, utilities and some extent of securities. I’m interested in valuation models for crypto securities. What is the current model for non-crypto securities (bonds, stock, options). What additional considerations needs to be in place for securities in the crypto economy? How different does securities need to be, when shifting from the physical to digital marketplace.
Sources and further reading:
- Initial coin offerings and the value of crypto tokens
- Tokenomics: Dynamic Adoption and Valuation
- Quantity Theory of Money: https://en.wikipedia.org/wiki/Quantity_theory_of_money
- Equation of exchange: https://en.wikipedia.org/wiki/Equation_of_exchange
- Incentives and behavior in English, Dutch and sealed‐bid auctions