So, you want to get RICH?  Go ahead and BUY, BUY, BUY into the next hot ICO or crypto asset!!!

Ok, maybe not, but what should you do?   Well, how about, for a start, learn about what you might be investing in.  Is it a company with growth prospects, a commodity that everyone is going to need, a debt instrument selling for a fraction of its value or something else entirely?

The sad reality is that a great many investors who don’t know what they are buying are piling into crypto-assets.   Many may end up earning incredible returns, but, then again, maybe not…   What is certain, however, is that the most important thing to understand about any investment is what you are buying with your hard-earned money.   After all, if you don’t know what you are buying, how can you judge its potential value in the future?

There are of course two reasons for any investment:  either buy with the intent of selling to an even greater fool later, or investing based on understanding potential value, where investment is based on the belief that the asset being purchased is under-priced at a point in time.  I won’t spend a lot of time talking about the “greater fool” theory, except to say that it CAN work, but only if one has great trading instincts.  Most people, however, tend to “pile in” towards the top, and lose lots of money when the market inevitably collapse.  (see CMGI, Pets.Com, VerticalNet, etc, from 17-18 years ago…)

Now, before my inbox fills up with Crypto enthusiasts telling me that this time it’s different, remember that I said there are TWO ways to invest in a new type of investment.  The second way is to understand what you are investing in and use that knowledge to discern value.  In this case, I believe we are seeing the birth of a new investment type, which I like to call a Network Token.  Many ICOs and crypto-assets fall into this category as they are selling tokens that are used within emerging blockchain enabled networks.

A Network Token has value only if there is both value to the network that it represents and the token itself has value within that network.  For example, if one owned a fraction of the internet itself, that ownership interest would only have value if people using the internet paid a “toll” for its use to the owners, OR if there were specific use rights that were reserved exclusively for owners.    To bring this better into focus, let me describe an example that we are familiar with, the soon-to-be-introduced “RouteCoin[1]” that CoinRoutes plans to issue.

The RouteCoin will allow holders of sufficient quantity to “stake” their coins to gain access (along with mandatory participation and acceptance of rules) to the “network effect” information generated by all the SOR(s) on the network.  This will allow routers that clients build for their own use or built by competitors to CoinRoutes to create fully informed strategies that are much more efficient than they could build on their own.

To understand how this would work, consider the following diagram:

In this simple diagram, if the client on the left was buying a crypto-asset on multiple exchanges, and had quantity in reserve, and the client on the right was selling the same crypto-asset, the SORs would enable those two client orders to meet on the most efficient market available for the reserve quantity, while ensuring that the orders sent to the exchanges were matched as best as possible.  As the network expands, the value of this service would increase exponentially, and markets would become far better integrated.  At first, the network will be developed by and for the CoinRoutes SOR, but the plan is to offer it via the RouteCoin once it has critical mass.

The key to this succeeding is to ensure that the shared information is used exclusively for routing and not for nefarious purposes.  To do so, the design is to use the RouteCoin to  provide both consequences to SORs for failing to abide by network rules and incentives for participants to detect and report malfeasance.  This will be achieved by setting the “stake” of RouteCoin, which would be subject to forfeiture for rule breaking, high enough and by awarding the forfeited stake to the participants that detected and reported the infraction.  Governance will need to be established independently of CoinRoutes, based on holdings of RouteCoin, and incentives will need to be carefully monitored.

In this example, it is easy to see the value to the network of the coin as it maintains the information value of the network, and the value of the coin is also clear since the supply is fixed and firms operating SORs will want access to the network.  Thus, it meets both criteria noted above, and would grow in value as the network grows and attracts more clients.  Importantly, even though in this example, CoinRoutes will likely be the only router in operation until there is a critical mass of users, the value of the coin will eventually grow separate from that of the corporation, once competitors join the network.  This is important, since the network, once launched, will be independent from the CoinRoutes corporation and will take on the characteristics and governance of an autonomous network.

Another example of the creation of network tokens was described in a well-written article titled “This company will self-destruct after its ICO.”   In that article, the ideal network is described as having three phases: “Network Build-Out,” “initial trial of the token economy,” & “Token-only” as the centralized company is “time bombed” away.   While there are doubtless examples where such a model would make sense, there is no need for that if the initial central company is treated precisely the same as other companies using tokens as a “stake” on the network.  The key will be the proposed transition plan to an autonomous network where governance is controlled by coin holders and network participants.

From an investment perspective, if you are buying coins that you believe to be network tokens, that means that you should judge whether the network itself is likely to build value and if that value will be sufficient to create demand for the coins.  In addition, investors should consider the governance structure, in particular if it will support demand for the coins, or if it will create conflicts of interest that reduce it.  Networks that can benefit from true “network effects,” properly administered and governed, could provide investors with excellent returns.  Networks who fail these tests, however, will probably end up the same as the infamous “sock puppet” from Pets.com.

 

 

 

 

 

 

 

[1] Trademark filed, not yet granted