How Token Hodlers Create Added Volatility

A post from late September by Primoz Kordez, an advisor at ICONOMI, on token “hodlers” create volatility:

…there will always be a certain share of token holders who act as investors, either active or passive. Even if these investors are passive in their behavior, do they really have no effect on a network at all? Interestingly, in the token economy an investor is someone who impacts the floating number of tokens that can be utilized. By having more “hodlers” or passive investors in the token ownership structure, they effectively take tokens out of circulation for use. Assuming velocity of tokens and total spending stay constant, the floating value per token must increase if more tokens are hoarded by investors.

Essentially, the number of active tokens is reduced thus making them more susceptible to large swings caused by a large buy or sell from a passive investor. If a number of tokens are suddenly dumped onto the market:

It can lead to a downward spiral in which investors’ decisions cause underutilization of tokens exchanged, leading to lower network value and causing additional investors to flee.

This problem is most costly when token utility users (as opposed to passive holder) need more tokens to meet increased utility demands. They must trade for the tokens from another coin at a poor rate and don’t benefit from a higher token value since they require tokens for real usage.

The best scenario for stable and predictive token dynamics is to have more actual users in the ownership structure, but this isn’t something that can really be controlled.

Good projects need to be owned by real users – not passive investors. Users get the most value out of the network and should be rewarded for usage. Perhaps it’s possible to reward heavy users with increased token values or additional tokens. Using Vitalik’s idea of a predetermined sink, some percent of unused tokens could be burned, thus slightly reducing the number of tokens held by non-users? (A holding tax of sorts).

For stable token values, sinks are highly beneficial

Vitalik published a post on the valuation of medium of exchange tokens, which have dominated the ICO landscape. This type of token implies that it can be exchanges for goods and services on a platform built by the development team. It’s similar to a Kickstarter-style funding, except that tokens must have ongoing value. It’s not sufficient to deliver a product once.

…the cycle is not complete, and in fact it never will be; there needs to be an ongoing stream of buyers and sellers for the token to continue having its value.

He goes on to the many factors that go into determining the value of a token, concluding:

One immediate conclusion from this particular insight is that appcoins are very much a multi-equilibrium game….Another, and perhaps even more important, conclusion is that the market cap of an appcoin depends crucially on the holding time H. If someone creates a very efficient exchange, which allows users to purchase an appcoin in real time and then immediately use it in the application, then allowing sellers to immediately cash out, then the market cap would drop precipitously….hyper-efficient exchanges are around the corner

Due to this, he says values cannot be sustained solely on their usage as a medium of exchange; there are too many outside factors. He cites Etherdelta as an example of an alternative model, where fees are collected in the interface. Another option it to set a side a specific amount to buy back tokens and burn them, thus reducing deflation/costs of holding over time.

The important thing is that for the token to have a stable value, it is highly beneficial for the token supply to have sinks – places where tokens actually disappear and so the total token quantity decreases over time.

There’s been a lot of discussion lately about the value of tokens and the right way to do a token sale/ICO. The standards around tokens/ICOs need to be raised and hopefully this helps push more projects in the right directly. Of course, it won’t do much to help the dozens of poorly structured projects that have already raised millions.