The more secure a smart contract platform is, the likelier it is to capture market share. This is a secondary driver of value for a protocol and its cryptocurrency that can have a significant, but indirect, impact on the value of a crypto asset. Understanding this impact can provide important insights about a cryptocurrency’s worth. Read our report below to learn more about these secondary drivers.
We looked at the primary drivers of value earlier here. This is complemented by an understanding of the secondary factors.
As we discussed in that previous blog post, financial assets derive their value from reliable demand (currencies and store of value assets such as gold) or from providing exposure to and earning revenues from an economically productive activity. The demand for a cryptocurrency as a medium of exchange or a safe haven asset creates part of its value. This is complemented by the economic value derived from the transaction fee revenue generated by the protocol, which is paid by the users of the platform.
These primary drivers of value are influenced by various factors that determine the attractiveness of the crypto asset as a currency, store of value or smart contract platform.
These secondary drivers of value impact the token only indirectly. For example, the more secure a smart contract platform is, the likelier it is to capture market share. However, if the platform does not charge transaction fees, or the transaction fees do not accrue to the token (such as in the case of proof-of-work platforms where the transaction fees are paid to miners), the “security feature” of the smart contract platform creates no value for the token. Although the superior security feature (safety) makes the token more attractive as a currency or a safe haven asset, the applications and use cases being built on the platform do not directly contribute to the token’s value.
The determinants of the attractiveness of a currency or store of value asset are:
- Scarcity – Tokens with an inflationary supply model are not very good stores of value. Even if tokenholders can recapture the diluted value through staking the token, this is not practical for its use as a currency. (The exception to this would be an economy where goods and services are priced in a cryptocurrency – to ensure price stability, token supply would need to expand in line with the economy’s demands.)
- Authenticity – Cryptocurrencies generally have an advantage in this regard over physical forms of money, which may be forged and whose authenticity may not be easy to establish. However, the so-called “double spend” problem is a possibility with cryptocurrencies. Established blockchains such as Bitcoin and Ethereum protect against double spend, and none has ever happened on these blockchains.
- Storability – The ease of storage is an advantage of cryptocurrencies in general. However, protocols differ in terms of the security of the tokens recorded in their ledgers. The risks of hacks, bugs and compromising the chain differ across blockchains. In this sense, “security value” is a driver of a cryptocurrency’s attractiveness as money.
- Widespread acceptance – In the case of cryptocurrencies, differences in acceptance are driven by name recognition and regulation (i.e. restrictions limiting their use). The network effects are very important in this regard. It is possible to make the case that the “memetic value” of a cryptocurrency translates into name recognition and therefore wider acceptance, but the quality and longevity of the protocol are more relevant in kickstarting the network effects.
- Permanence, portability and divisibility – Although these are important differentiators of cryptocurrencies relative to most commodities or physical cash, there is no difference among digitally stored assets.
The drivers of the attractiveness of a protocol for applications and use cases to build on are:
- Security of the platform
- Execution speed
- Cost of using the platform
- Community (ability to interact with other applications on the platform)
- Functionality (developer tools)
- Reliability (in terms of not only downtimes but also sustainable funding for future development and strong developer resources)
Beyond appreciating the drivers of value, it is also important to recognise what does not drive value:
- The above factors that drive the market share of protocols as platforms to build on are negated if there is not a mechanism for revenues to the platform to benefit tokenholders.
- Governance rights are only valuable if they allow tokenholders to shape the economics of the protocol to benefit the value of the token.
- Claims about a token’s utility have varying merit. Tokens that carry rights to discounts or other economic benefits have a value equal to the value of those rights. However, claims that a token has utility because it can be used as a means of payment on the project’s own platform are meritless. This type of “utility” represents no economic value because no one needs to purchase the token to have access to the utility. In fact, projects that mandate that only their own token can be used on their platform as a means of payment attach disutility to the token.
- “Meme tokens” have no intrinsic value unless there is an intention and action taken to convert the community created around the meme into some productive activity.
Learn more about this topic in our Valuing crypto assets investment research report.
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