Opinion: What Are ICOs Actually Worth?

ICOs were driving me crazy. In fact, as I think about it, a lot of “altcoins” were driving me crazy, too. Why were they worth much of anything at all, much less billions of dollars?

Just because a bunch of Japanese banks are using XRP to transmit money transfer information, why is XRP worth $5 bln? Simply because lots of contracts are using (and far more will use) the Ethereum blockchain for smart contracts, why does that make ETH worth $28 bln?

Why are shares of common stock worth anything? As a theoretical matter, there are three basic reasons: voting, dividends and appreciation. Those are far and away the three greatest (if not the only) sources of value of a share of stock.

Let’s examine each in more detail in a modern context and try to determine which scores higher.

Voting

Who actually votes their shares of FANG stocks or just about any other company at shareholders’ meetings or by proxy? If you have AMD stock, do you vote? If you vote, do your 10,000 (or even 1,000,000) shares make any difference?

Google (or, more precisely, Alphabet) has 700 mln shares outstanding. For all but the very largest shareholders, voting at shareholders’ meetings is irrelevant. Given some corporate structures (Facebook shares anyone?), even from a theoretical standpoint, voting common has virtually no impact.

Plus, organizing and holding shareholders’ meetings or any other sort of voting is incredibly expensive, costing large companies millions, if not tens of millions, of dollars annually.

So voting isn’t particularly advantageous for stocks when comparing them to tokens.

(As a quick aside, notwithstanding the term “ICO”, I will henceforth refer to the assets which a company introduces into the crypto space as “tokens”. That term makes far more sense.)

In fact, the opposite is true. If one wanted to implement a modern, corporate voting system, the Internet, Blockchain and tokens provide a far better way of doing so, whether the voting be on resolutions for a company or for public office and referenda.

Score one for tokens.

Dividends?

What tech company, or all but the most conservative of non-tech companies for that matter, pays dividends? For years – well preceding the development of the crypto sector – there have been strong arguments against paying dividends at all.

The argument, from the company’s perspective, goes as follows: if an investor gives us money because he thinks we are a good investment, why should we give it back and force the investor to decide where to invest his money all over again? Rather than us deciding for him, if the investor needs money or thinks the stock price will drop, let him sell!

From the investors standpoint, it’s no better: “I just went through a major exercise to determine where to invest my money and now I’ve got to through it all over again every quarter?! Give me a break!”

So dividends aren’t particularly relevant either.

Score two for tokens.

That, of course, leaves appreciation. So let’s examine it in more detail.

Appreciation

Appreciation is a reflection of value of the company as perceived by investors. We’re not going to examine here how individual companies are valued based on specific metrics. Instead, we’re concerned with the other half of the equation: how the ecosystem influences the value of a company.

The painfully obvious example is Alphabet: that company is not only one of the most valuable in the world because of its internal metrics (EBITDA, growth, number of searches using Google, etc.), but also based on the health of the overall search environment and the relative market share of Alphabet within it.

Said another way: if Google’s percentage of the search market share started dropping sharply and steadily, even though its internal metrics continued to grow (logically due to the overall search market suddenly increased substantially for some reason), Google’s stock value would drop – or even plunge – even though its internal metrics and projections remained unchanged.

Not clear (yet) which wins this one, stock or tokens, but enough already of the discussion of  fiat equities!

So what does this have to do with ICOs and tokens, you ask? Finally, here’s the answer and my epiphany: Tokens are a reflection of the value of the ecosystem created by the company which releases them.

The high valuations of these ecosystems make sense because they include almost all relevant elements used to value the company itself.

The only missing element is, of course, that tokens are not directly related to the value of the “token company”, as stock is. However, in the absence of a company value (when a company per se even exists), tokens are a perfect reflection of the perceived value of the ecosystem created by that company – including the company itself.

This brings us to another difference between stocks and tokens: there is the critical aspect of value which (most) tokens have, which shares of stock (or, for that matter, any other fiat security) don’t: utility.

(Mr. SEC, please take note here. This distinction takes many tokens, however “issued” out of the realm of securities; utility is a critical element of how many tokens can “pass” the “Howey test”.)

So, has anyone ever been able to pay for Google adwords with Alphabet stock? Thought not.

However, you will (i) be paid for searches using Presearch, (ii) pay for storage using Filecoin, (iii) be paid for content using Engagement Token, (iv) monetize your attention with BAT, and (v) even get paid in VOTES to votes! (A few legal problems with that last one, but you get the idea…)

Not only can you do these things with tokens, using tokens is the only way you can do them – you can’t with fiat securities. Tokens unlock entirely new business models based on the additional synergies made possible between purchasers and sellers, creators and users, developers and customers, that are much more creative, powerful and direct than traditional business models. In one word, disintermediation.

So, between the fact that tokens have no material disadvantages compared to shares of stock and actually possess additional characteristics which shares of stock don’t, it is clear that tokens legitimately have significant value.

Now, I don’t claim that this is the entire answer, but it’s a major piece of the puzzle.

I see two outstanding issues:

  1. How to value tokens?

  2. What to do with companies which “issue” both stock and tokens?

Valuing tokens

Returning to the “specific metrics” mentioned above, the methods for valuing companies have been very well established for decades. Using revenue, margins, EBITDA, PPE, enterprise value, etc., in DCFs, comparable company, comparable transaction and other valuation methods gives you a hard number.

These techniques can’t apply to tokens (yet) because there is not nearly enough data (and what data should we collect?) and the ecosystem(s) is(are) still evolving. (I have some ideas for the type of metrics that could be used, but that’s for a later piece.)

Stock and tokens

So, what about token companies which both issue stock and tokens? (Full disclosure: I’m on the advisory board of one of those.)

Then, does the stock represent the value of the company and do the tokens represent the value of the ecosystem created by that company? Isn’t the former a subset of the later? Perhaps. I don’t believe the line can be clearly drawn (yet?).

The values are so interrelated that I even know one token CEO who believes that the stock in his company is worthless and all of the value of the entire ecosystem (including his company) is in the tokens. He might be right, but I’m not convinced.

- By Timothy Enneking, Managing Director, Crypto Asset Management


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