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Why Token Velocity Matters

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These are still the early days in understanding token based crypto-economies. Whilst many of the principles of economics used aren’t new; the ability to hardcode rules into a system offer unparalleled opportunities to experiment with behavioural economics and game theory to try to make markets behave in certain ways.

At Outlier Ventures, we work with our partners at Imperial College London’s Business School and computer science department, to assist the open source projects we invest in, to design sustainable, efficient and orderly digital economies. This is the first in a series of regular posts where I, as Head of Cryptoeconomics, and the wider Outlier team will share with you some of the principles and learnings from this work.

Whether it’s designing token economies for implementation or evaluating cryptoassets for investment, token velocity is a key factor in guiding our thinking on the future value of tokens. This post aims to introduce token velocity as a principle and discuss some of its implications for economic design and valuation.

The Basics: MV = PT

Today, most tokens aim to represent a network-based medium of exchange. This means a network is created whereby sellers can offer digital services to buyers interested in acquiring them. A token is issued as a means of value in this digital economy and is required in order to facilitate the exchange of these services.

To begin understanding token velocity, we must refer to traditional economic concepts like the velocity of money and the equation of exchange:

The velocity of money, is the number of times money is exchanged from one transaction to another over a period of time, or in other words, how often money is turned over. This is important because velocity is useful for assessing the health of an economy.

The equation of exchange, is used to demonstrate the relationship between money supply, velocity of money, price levels and an index of real expenditures on newly produced goods and services. It is expressed as:

MV = PT

where:

M = money supply

V = velocity of money

P = average price level of goods

T = index of expenditures (such as the total number of economic transactions) Note: As this is usually difficult to measure. it’s often substituted by Y=national income.

Connecting Token Velocity & Token Value

Likewise, for token economies, the velocity of a token offers us insight into the economic health of a network. Token velocity can inform the level of hoarding within a system, speculative trading, utility value of a token and the broad efficiency of the digital economy. For cryptoeconomies, token velocity can be determined through modifications of the equation of exchange (courtesy of Chris Burniske and Vitalik Buterin respectively).

Burniske has applied the equation of exchange for cryptoassets as such:

MV = PQ

where:

M = size of the asset base,

V = velocity of the asset

P = price of the digital resource being provisioned,

Q = quantity of the digital resource being provisioned

The token value would be determined by solving for M and dividing by the number of tokens in supply.

Meanwhile, Vitalik has his alternate modification of the equation of exchange for medium of exchange tokens:

MC = TH

Where:

M = total money supply (or total number of tokens),

C = price of the currency (or 1/P, with P being price level),

T = transaction volume (the economic value of transactions per time),

H = 1/V (the time that a user holds a token before using it to make a transaction)

To determine token value, one must solve for C in this case.

The implied takeaway from these different equations is that token velocity has an inverse relationship with the value of a token. More succinctly, the longer participants hold onto their tokens, the higher the price of their tokens.

Layered Economics

When examining token economies, we essentially look for the merged optimization of two sets of economics:

  • ledger layer economics
  • market layer economics

As the market exchanges digital services, the ledger layer is where key attributes of each transaction need to be verified and simple contracts need to be executed. The main goal of the ledger layer is to drive costs of verification to as low a level as possible, ideally as near to costless as possible. Cost reduction and disintermediation is the primary advantage of blockchain based services over traditional intermediary or audit based economies where substantial value is lost in the process. Common examples of where a token is used to facilitate low cost transactions for digital resources in payments, computation, and data storage are Bitcoin, Ethereum and Filecoin, respectively. We can associate this layer of economics more closely to protocol tokens.

Source: ‘Some Simple Economics of the Blockchain’ – https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2874598

Christian Catalini, MIT & Joshua Gans, University of Toronto – Rotman School of Management

At the market layer, economics are designed to realign the distribution of value to achieve a more efficient market that also leverages powerful network effects. The token is used as an incentive or disincentive to participants to behave both in their best interest and the greater good of the economy at large. This layer is generally exhibited as an app token.

An example of market layer economics is illustrated below by the Basic Attention Token (BAT), where users, publishers and advertisers are re-aligned to disintermediate middlemen, eliminate the economic waste and generate new value. In this blockchain based digital advertising market, the Brave browser blocks ads to the user and records where users spend their time.

Meanwhile, BAT is used as a unit of account between advertisers, publishers and users and to directly measure, exchange and verify attention.

The result is a system that is transparent and efficient. Publishers generate more revenue because middlemen are removed. Users that opt in receive fewer, better targeted ads (with far less malware). Lastly, advertisers receive better data for their spend.

Basic Attention Token (BAT)

Basic Attention Token: https://basicattentiontoken.org/BasicAttentionTokenWhitePaper-4.pdf

Economic Implications of Token Velocity

Velocity can have significant impact on the economics layers of a token economy, based on  the following:

Ledger Performance: If a ledger is suboptimal in facilitating exchange because of low throughput, latency, etc, this can cause service providers to become unmotivated to leverage  the ledger for their offerings. Such problems can be particularly exacerbated, when transaction volumes are high but token holders are also hoarding for speculative purposes. This results in transaction verifiers suffering by being required to  complete more costly work at a slower pace, thereby limiting their economic gains. We’ve seen the Bitcoin network attempting to deal with these important scalability issues for some time now. As shown below, Bitcoin hasn’t really

Source: http://woobull.com/determining-the-ideal-block-size-for-bitcoin-a-story-of-three-graphs/

Speculative Holding: When too many tokens are held by purely speculative investors (otherwise known as Hodlers), tokens generally do not get utilized within the market for their designed purpose. Instead, investors are simply waiting for the right time to sell off tokens for profits, and this causes low velocity in the system. Furthermore, speculative holding affects the system’s throughput, latency, etc putting pressures on the ledger layer as less tokens are available to facilitate transactions.

Note: Early on, a healthy amount of speculation is often advantageous in generating network effects and rewarding early adopters and contributors. In fact, what makes token economies so ripe with potential, is that they combine the two most powerful examples of network effects, financial exchanges and software, within a new digital economy.

New Equilibrium: As token economies progress or regress, new price equilibriums are set through behavioral feedback loops that are ultimately driven by token price itself. As Ethereum’s Vitalik points out, when the token price starts to increase, crypto traders begin to acquire and hold tokens based on expected returns, which are assumed to be higher than other cryptoassets. This increases the price of token and often closely resembles Elliott’s Wave Theory (a form of technical analysis) in setting a new token price equilibrium.

Provided the ledger layer can efficiently verify transactions, a price increase could also greatly benefit the market layer economics by making fees cheaper and further stimulating the economy. Both of the above positive feedback loops create a new token price equilibrium.

This chart of Monero illustrates new equilibriums in July ‘17 and again in October ‘17.

Source: https://coinmarketcap.com/currencies/monero/

Conversely, if the token price starts to decline, the token suffers as an opportunity cost to other seemingly more attractive tokens investments. As the sell off continues, the further the token price decreases, this time suffering from a negative feedback loop.

Stagnant Utility: Early adopters of a token will often hold the belief that a given decentralized market will be able to offer unique value propositions for digital services yet to be developed. If these services are too limited, tokens will be exchanged at a substandard velocity. Although the equations above suggest lower velocity would increase the value of the token, in this case, declining transaction volumes will lead to economic collapse and token price crash.

Another scenario derived from lack of utility, is when a token serves as an optimal medium of exchange for a dominant, high-demand service between a buyer and seller, where neither party has any motivation or incentive to keep the token for further use. Instead, opting to convert into a more desirable speculative or usable currency (like fiat). In these cases, velocity of a token would be high and drive down the price of the token, which further reinforces this behavior.

Featured image courtesy of Shutterstock.

Important: Never invest (trade with) money you can't afford to comfortably lose. Always do your own research and due diligence before placing a trade. Read our Terms & Conditions here. Trade recommendations and analysis are written by our analysts which might have different opinions. Read my 6 Golden Steps to Financial Freedom here. Best regards, Jonas Borchgrevink.

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The Basics of ICO Investing: A Brief Reminder to Those Who are New to the Game

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The ICO market has been heating up for a little less than a year now, but it truly has turned into a new wave of technology. The amount of wealth being created is insane, and it can be difficult to keep up with the rate of change that is occurring within the industry. It is like the tech boom of the early 2000’s all over again, and this is your chance to mint a lot of money.

Researching ICOs

If you’re looking to put some money into an ICO, the first step is tracking down the right one for you. There are lots of websites devoted to the different ICOs that are currently underway or planned to be soon, but CoinSchedule is my personal favourite right now. You can find out about new ICOs here, and then the hard part begins.

You need to perform your own due diligence to figure out if the ICO is right for you. You can look through forums and Reddit, but gaining an understanding of the fundamentals of the company (team, product, market size) is the only way to avoid losing all your money in the long-run.

Telegram is a great chat platform for connecting with others, and there are a lot of expert level people who are willing to share tons of information about cryptocurrencies and ICOs, so I would recommend you check out that tool.

The Due Dilligence Process

There are a few key insights you need to apply in your investing process. First, the cryptocurrency community is segmented into different use cases, and there likely to be only one successful project for each use case. So before you do any investing in a certain project, it is time to do an analysis of the competitive landscape. You don’t want to be betting against yourself by putting money in multiple projects in the same sector, so it is likely you’ll want to choose only the project you think is most likely to succeed.

To learn more about the project, most companies have Telegram channels where you can observe the community and get and idea of what the developers are like and where the project is heading. In general, Telegram is an invaluable research tool.

Finally, you’ll want to examine the amount of supply the company is keeping to itself. You want the founders to have “skin in the game” still, but you also don’t want them to have such a high proportion of coins on hand that they can gain a profit and then start to de-risk by selling off their holdings.

Going Through with the Purchase

Assuming you’ve finally selected a coin you would like to purchase, it’s time to execute. Most coins are supported by Ethereum, so you’ll need to purchase some Ether and move it to a wallet that will support a variety of coins. Currently, I use MyEtherWallet.

Purchasing the coin is actually much simpler than you would think. All you need to do is get the public address of the ICO and send them the amount of Ether you want to invest. They will send you your tokens when the ICO closes, and you have successfully participated in your first ICO.

Know Your Client (KYC) rules are for keeping track of your identity and following the security regulations of your jurisdiction. In the beginning, it was rare a company would follow them, but now that regulators are cracking down, you will likely have to provide all your identification information in order to participate.

If you do want to sell your tokens at any point, you can use an exchange like Binance that allows trading of a wide variety of tokens.

Watch for Pump n’ Dumps

As long as there have been equity investments, there have been pump n’ dump schemes. Aptly named “shitcoins”, there are numerous projects that ICO without a product or even a hope of developing them. The lack of regulations is making this possible, and this is exactly why you need to do your due diligence.

An often pointed out criticism of ICOs is that no one on the team has built anything yet. There is the feel of a group of people seeing an opportunity and jumping on it because there is a chance of high profits, rather than them being able to contribute a lot to the space. So as you look out for “shitcoins”, you should be especially aware of projects that talk about the amount of money they’ve raised, rather than what they’ve built.

Understanding the Risk

The first thing that everyone should know about ICOs is that they are still unregulated. Where IPOs receive intense regulatory scrutiny, ICOs are mostly self-regulated at the moment. Considering the fact that most of these companies are coming from people with little or no track record, it is imperative you are careful about where you invest your money.

Yes, it is a  good thing that you can now make large asymmetric bets that used to be regulated out of your reach, but research is always the answer. For example, if you have a token for a company that doesn’t have a use case aside from funding the company, it won’t serve as a good store of value. With the implementation of the lightning network, cross-chain atomic swaps will eliminate the need to hold these tokens, and their value will trend to zero. Understanding future shifts like this is the key to a long-lasting investing career.

Featured image courtesy of Shutterstock.

Important: Never invest (trade with) money you can't afford to comfortably lose. Always do your own research and due diligence before placing a trade. Read our Terms & Conditions here. Trade recommendations and analysis are written by our analysts which might have different opinions. Read my 6 Golden Steps to Financial Freedom here. Best regards, Jonas Borchgrevink.

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How ICOs Changed the Way Companies Are Built

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With cryptocurrencies now becoming a household name, investors are starting to look into plays they can make that are more off the beaten path. The market for initial coin offerings (ICO) offers just that, albeit with a dash of risk that traditional initial public offerings (IPOs) do not offer. 

Restrictions on Venture Capital

If you want to make money in Silicon Valley, you need two things: connections and capital. Connections are required, because a lot of projects end up oversubscribed anyways, and you need an advantage over many of the other investors. It also helps if you can provide aid to the company additional to just giving them your capital (e.g. advising on product, marketing, or hiring). The unspoken rule is that you do usually have to be located in Silicon Valley to do well as a startup investor.

Large amounts of capital are also required for regulatory and convenience reasons. Venture capital is considered to be very risky, and as such, it is generally restricted to be accessible only to accredited investors, who must have either an income greater than $200,000 per year or a net worth greater than $1,000,000.

Additionally, most companies didn’t have the bandwidth to deal with having hundreds or thousands of smaller investors, because of the meetings, due diligence, and paperwork required. It was much easier to take larger investments from a small group of people, and keep things simple.

Democratizing Venture Capital

For both these reasons, the number of people who have benefited from the gains in massive technology startups have been very few. Now, with ICOs the possibility arises that investors may join in on the gains, thus democratizing the gains and spreading them out throughout the country and world.

The ability to make asymmetric bets (wagers where there is a high possible upside, but limited downside) has been restricted for a long-time. Lottery tickets are the closest example of a purchase you can make that could result in a 10,000x return, but with the downside capped at the size of your investment.

In a world where income inequality and wealth distribution is a constant source of conflict, the spreading out of these returns could prove to be increasingly important for making sure it doesn’t get worse.

Structure of an ICO

As Hacked readers are no doubt aware, an ICO generally occurs when a cryptocurrency startup wants to raise money. They either have something they’ve already built, or they have a white paper that outlines their business plan and how much money is needed to create and scale the project.

The ICO is carried out by exchanging fiat currency or other cryptocurrency for the “token” in question. A token is considered equal to equity in the company in this analogy, although most firms contend that the tokens are not securities for regulatory reasons (see: Howie test).

ICOs are popular for both investors and traders, as there is an expectation in an increase of market price after the ICO, as well as high volatility (which traders love). Looking at a website like Coin Schedule, you can see the amount of hype that is floating around ICOs at the moment.

Recent Trends in Fundraising

As ICOs become more popular, many companies are going through similar experiences during the fundraising process. Some companies are asking for such high valuations right off the bat that there is little upside for the investors, and a greater chance they will lose money.

If excessive amounts of money are raised before a product has even been built, there is much greater risk in the project. Additionally, there are fewer investors who have made enough money on a project to justify staying invested during a bear market. Compare this to Bitcoin, where some have owned it since its price was in the single digit range, and you can see the difference.

Projects that are heavily inflated upon ICO’ing are losing out on the longer-term opportunity, unfortunately. Some people forget that the most well-known cryptocurrency of all began using an organic mining process rather than an ICO. Although there is almost no money inflow when this is done, it creates a rabid community of supporters who believe in the product, rather than short-term speculators. This solution would not work for all ICOs, but for some, it might be a viable solution.

More than Just an ICO

The ICO is the most well-known part of the process, but often these projects will require money to get them to that point. This is where the Pre-ICO and Pre Sale come from. The Pre-ICO is similar to the “friends and family” money that any business starts off with. It is what is required to get the project off the ground. Then you have the Pre Sale, which is where larger investors who are going to help build the companies product and profile get to buy tokens at a lower price than the ICO price in exchange from their help.

Finally, and it is very necessary to make this clear, all of these projects carry a ton of inherent risk, and a significant amount of research should be undertaken before any investment is made. Where many of the past IPOs had undergone a massive amount of due diligence and had backers who understood the technology, we are seeing many investors hop on the investing train without fully understanding how everything works.

Featured image courtesy of Shutterstock.

Important: Never invest (trade with) money you can't afford to comfortably lose. Always do your own research and due diligence before placing a trade. Read our Terms & Conditions here. Trade recommendations and analysis are written by our analysts which might have different opinions. Read my 6 Golden Steps to Financial Freedom here. Best regards, Jonas Borchgrevink.

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Understanding the Risks of Mining Bitcoin

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At this point of your journey into the cryptocurrency world, you probably have a strong grasp of the fundamental mechanics of the coin, and maybe understand the basics of “proof-of-work” systems.

Assuming you already have this understanding, you know that the robustness of the network is what secures the entire bitcoin protocol. As such, there is an opportunity for money to be made if you are able to add value to the network, you will be compensated for your time. This is essentially what mining bitcoin is, and it is very possible for you to make a good return on your capital if you go about it intelligently.

Cloud Mining for Lower Risk

Mining has advanced quite a bit since bitcoin’s creation in 2009. It used to be that you could use any PC to mine cryptocurrency. The algorithm is designed to adapt the level of difficulty and work required to be done so that the average block time stays at approximately 10 minutes.

The most important decision you’ll make in terms of bitcoin mining is whether to mine using cloud services, or if you are going to buy your own rig instead. Each method comes with different levels of risk due to the varying risk structures.

Cloud mining has you rent mining hardware from a company or just get a portion of their hashing power. There are many different operators in the field, and it is important you perform some heavy research to figure out what the best investment of your capital is. Cryptocompare has a list of all the different companies you can use and how they have been rated and reviewed recently.

Personal Mining for Higher Potential

When you make the decision to go the personal mining route, you are taking a much bigger risk in terms of upfront investment. There is a significant cost involved, and you are buying some very specialized hardware. The top consideration should be whether you have access to cheap electricity, because without that, you are putting yourself in a terrible position.

Once you choose your hardware, it is all a matter of selecting the type of hardware you are going to use (there are many review sites, and this is outside the scope of this article) and then choosing a mining pool and software provider. Research is your friend, so you would do well to not neglect it.

Determining the Logistics

No matter what route you decide to go, you are going to have to make some decisions that will affect your overall workflow significantly. First, you must select a mining pool, which means you need to adjust for the amount of risk you are willing to take. Mining can be very profitable on your own, or you could go months without making any money at all. Going with a larger group will increase your likelihood of making money, but cap your earnings at a certain point.

There are pools that are set up to allow switching from mining one currency to another, depending on which is the most profitable, but we are going to stick to Bitcoin for the purposes of this article. One common point to watch out for with pools is whether they are paying out before the block properly verified, since that can cost the pools significant amounts of money.

Payout methods are the most relevant factor to consider when assessing mining pools, since they will determine the risk and return of your payments. There are ten or so variations, but it is only necessary to understand the three most common: Prop, PPS, and PPLNS.

Prop (or proportional) mining pools you are paid for the amount of valid shares you contribute to the pool when a block is found. Basically, you would be getting paid an exact amount based on the “work” you submitted. This is the best deal for the miner, but carries risk to the pool operator, since bad shares still get paid here.

PPS (or Pay Per Share) rewards miners for each submitted share. The miner knows the estimated number of shares to get the reward, and takes the risk of paying out per share before the reward is earned. As such, these generally have the highest fees.

Finally, PPLNS (or Pay Per Last N Shares) works like Prop pool, but instead of just rewarding miners for the last block, it rewards based on long-term contribution.

Afterwards, you also need to make sure you trust the wallet the cryptocurrency is being deposited into. The last thing you want is to leave a vulnerability for any of your earnings. This is an often-emphasized point, but you shouldn’t overlook it just because your past solution has worked for the small investments you put in.

Control the Risk

Never forget the fact that nothing is certain in investments, especially with bitcoin. This should steel you against the fact your investment may be lost. The fluctuations in the price of hardware, as well as the continuing increases in computing power, have turned bitcoin mining into somewhat of an arms race.

If you do find yourself feeling too risk averse to put significant funds into mining bitcoin, it might be better for you to just purchase bitcoins directly. This way, you are at least guaranteed to receive cryptocurrency.

Featured image courtesy of Shutterstock.

Important: Never invest (trade with) money you can't afford to comfortably lose. Always do your own research and due diligence before placing a trade. Read our Terms & Conditions here. Trade recommendations and analysis are written by our analysts which might have different opinions. Read my 6 Golden Steps to Financial Freedom here. Best regards, Jonas Borchgrevink.

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