The Math and Logic Behind Tokens + ICOs

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We’re headed towards a world with 1 Million coins, just like apps

Why would anybody in their right mind buy an ICO Token that is neither equity nor debt, backed by no asset, and with no promise to every be worth anything?

It took me a while to get my head around it. Here’s how I see it.

Suppose you have a network of buyers and sellers, transacting items (typically digital services like file storage), and paying for these items in a crypto currency we’ll call xCoin.

Initially let’s say 10 million xCoin are minted at a price of $1. Every new buyer coming into the system will need to purchase xCoin to transact. If we get, for example, 100,000 new users entering the system and each wanting to buy $10 worth of xCoin, then it’s exactly like a new fund deciding to buy 10% of the entire issue of an IPO.

Now given that all the initial investors bought in at $1, it’s very unlikely that 10% of them will want to sell at anywhere close to $1. More likely, the price will be closer to $2, or higher. Hence, if you have a service with real transactions, the price post ICO will tend to rise considerably.

Now, as these transactions are actually completed, the service providers will tend to convert xCoin into Bitcoin and then Fiat currency. This will have the effect of reversing much of the effect — but not all. Many sellers will still keep some xCoin as a “float”, exactly as buyers do.

This float can become enormous relative to the original monetary cap of the token. Imagine if, six months out, Uber had released uberCoin at a 10MM market cap. Now, the daily transactions and the float of uberCoin would both be in the Billions. The only way this can happen, mathematically is if the coin massively appreciates.

The thought experiment with UberCoin works for any massively growing network. And here’s the clincher — by issuing coins to grow the network (via incentives) — the effect is compounded. It’s hard for companies to give away cash. It’s easy to give miles or coin.

This does not prove in any way that all ICOs are great. If the service never actually finds users, there will be no upward pressure on coins, and no natural buyers for coins if the investors of the ICO lose interest. Things can downward spiral to zero pretty quickly.

So how is this possible? Where does all this “value” come from? Well, in all cases, at the expense of the equity holders. In the hypothetical example above, money is being moved away from equity holders and into token holders.

A bad ICO is the same as a bad Angel Investment. Both will go to zero. But if you find the next Uber, the tokens will be a good investment, along with the private stock. And — a liquid investment as well!

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