A Token Needs A Market (Part I)

This post is part of a three-part* series. In this post, I look at price movements for 3 recently listed assets that raised private capital and were listed this year. From that, I try to extrapolate potential reasons why these assets experienced the exhibited price movement. In part II, I plan to talk about some regulatory history, and dig into some of the data the SEC and FINRA has made available. In part III, I will talk about potential paths forward, along with if and how we can knock out a bird that the SEC wants taken care of (harmonizing access to markets) with some of the conventions we currently see in crypto.

From 2016–2018, hundreds of ICOs raised billions in notional value in ICOs.

Per the tweet below, Blockstack did a Reg A+ offering in 2019, and the token’s current price is down from the Reg A+ offering. While the Reg A+ offering has some stipulations (can’t be traded on non-ATS/securities exchanges, potential lock-up periods, etc), non-US persons who hold tokens are not affected by those factors, and they can sell. This price action is not dissimilar to other tokens (Algorand, Hashgraph), who collectively raised hundreds of millions to be the next big blockchain.

Hedera Hashgraph


Why Though?

To find out why assets move in price, people use ways to value equity and debt. 3 popular methods that people use to value assets are:

  1. Fundamental Analysis (looking at news and other trends that could change the fundamental value prop. If you were about to buy Macy’s stock, you might ask “Do people still shop in malls?” or, “What’s this company’s influencer blockchain strategy?”)
  2. Technical Analysis (traders use formulas based on past price movement to determine if it’ll determine future price movement.)
  3. Market Sentiment (looking at things like volume and volatility over time to figure out what the price might be. Put simply, “based on the clouds and the news, does the mah-ket think the number will go up or down?”)

There are a number of reasons why STX, ALGO, and HBAR prices moved the way that they did, and I think the most important one is what a really smart trader once told me:

print "There were more sellers than buyers"

When there are more sellers than buyers, number go down, and vice versa.

I think that there are more sellers because the value proposition (and from that, the memes that flow) are not yet as well-defined as BTC. Bitcoin has always been discussed as a non-sovereign currency, which makes price movement related to nation-states’ implicit acceptance or disapproval of Bitcoin or digital permissionless assets.

Conversely, when you look at the value propositions of these tokens primarily backed by VC firms (“VC Coins”), they all seem to compete with Ethereum from a fundamental standpoint. Orthogonally, the broader cryptoasset class usually moves in lockstep with BTC. This can be attributed to factors like the acceptance of Bitcoin being related to acceptance of tokens, the lack of a distinct value proposition (or distinct difference in regulatory treatment that , as well as the fact that the majority of liquid altcoin pairs are against BTC. This means that when BTC moves up or down against USD, a given token’s price against USD will likely follow suit (as the math is ALT/BTC * BTC/USD = ALT/USD).

With that said, there are few fundamentals for cryptocurrencies (OnchainFX charts a number of them), but not many that work for non-equity native tokens for pre-utility networks.

  • The earlier backers are looking to cash out sooner rather than later, especially if regulatory uncertainty creates an incentive to not leave profits on the table
  • When people look at the recent launches of Professorcoins and VC coins (coins where primarily VC firms and other accredited investors were the only parties able to buy in early, due to securities law restrictions), current prices of tokens have cratered in value respective to their initial sale prices.
  • There are no clear products that allow US retail to purchase, sell, and trade the longer tail of cryptoassets. While platforms like Coinbase remain on the cuttings .

Additionally, the retail US market for cryptoassets is very important, as American retail appears to amplify price movement. According to the Bureau of Economic Analysis, in Q3 of 2019 American personal savings totalled over $1.3 trillion. Based on a Gallup report, 55% of Americans own stocks. With apps like Robinhood and SoFi facilitating retail investment (you can even buy a fraction of a share with Schwab), and with apps like Coinbase letting you learn and earn, then buy crypto, American retail can be quickly onboarded as investors into this asset class. While there have been reports of banks clamping down on crypto purchases (probably for compliance/chargeback risk reasons), Americans on average have a lot of discretionary income (while not precise, one could take the 1.3 trillion and divide it by the US population, you get ~$4500 per capita) to buy alternative assets like cryptoassets. While this isn’t as strong a signal as, say, China’s stance on Bitcoin vs. blockchain, it’s still valuable.

As of 2018, the US represents 40% of both equity market cap and bond market outstanding, and the rules that dictate those markets are often replicated across the world. US capital markets regulators finding creative solutions to managing the risks that cryptoassets may pose to investor protection would then suggest that other jurisdictions would follow suit. Increased regulatory clarity could lead to more crypto-native exchanges allowing US retail to trade more assets available worldwide. Since these tokens are for networks ultimately focused on building consumer-facing applications (if it’s a B2B network, and you have enough information to easily sue the other participants, it doesn’t make the most sense to use a blockchain), I predict that this would motivate retail persons to use the applications they’ve bought into (“skin in the game”, “dogfooding”, etc). Increased retail use would lead to institutional investors determining ways to value the network based on bespoke, tweaked, or traditional valuation methods, and trade based on retail use. Moreover, a number of capital markets (EU’s MiFIID II, HK’s SFC, ) regulate instruments in ways similar to that of the US. So if the US markets find a way to allow this asset class to grow, it’s likely that others will follow suit in order to foster innovation.

Who Can Fix This?

Without pointing at a primary cause/solution, I would argue that operational clarity for nascent crypto-native projects will allow teams to focus less on regulatory uncertainty, and more on value creation and their paradigm-shifting vision. One way to provide this operational clarity is for a token to have a well-defined market.

Before the “bull market of 2017”, there were not very many markets for cryptocurrencies or tokens. In 2013, Bittrex was founded, and 2014 saw the creation of Poloniex; these two markets were two of the most popular marketplaces for trading altcoins (coins that aren’t Bitcoin). From that, I would argue that 2017 would not have happened without the existence of Ethereum, the ease with which entrepreneurs could create new networks while anchoring network security to Ethereum, and marketplaces like Poloniex being able to quickly list them.

Product + Marketplace = Value

Companies like Coinbase, Coinlist, Republic, Sharespost, and SeedInvest** are interestingly poised to serve as a short- to mid-term access product for primary and secondary access to ICO tokens, as they all have broker dealers (or partner with one, in the case of Republic). A crypto company with an exchange or listings product and a broker dealer would be equipped to offer tokens that could be deemed investment contract securities to US retail. Assuming that cross-borders securities concerns are resolved from an operational standpoint, and regulators are comfortable with businesses’ responses, I’m sure that we will see more ATSes (Alternative Trading Systems) in the US.

  • “What’s an ATS,” you ask? It's a broker-dealer that can act as a marketplace for secondary trading of securities, listed or unlisted. It's different from securities exchanges like the NYSE in that there isn't a rule book, and the ATS can't punish participants outside of firing them as a customer.

According to the SEC:

“Regulation ATS establishes a regulatory framework for “alternative trading systems” (“ATSs”). An ATS is a trading system that meets the definition of “exchange” under federal securities laws but is not required to register as a national securities exchange if the ATS operates under the exemption provided under Exchange Act Rule 3a1–1(a). To operate under this exemption, an ATS must comply with the requirements set forth in Rules 300–303 of Regulation ATS.

An ATS is an entity that isn’t a National Securities Exchange (think NYSE or NASDAQ) that the SEC will allow to run a marketplace for securities. Ideally, I predict that the most ideal ATS for the US would resemble Binance Launchpad/Labs, offering the following:

  • Seed Funding
  • Token Sales (public and private)
  • Marketplace for Assets (be it tokens, NFTs, tokenized IRL assets, etc)
  • Advisory Services
  • Chaperoning/Market Maker Program (to bridge the liquidity gap between US and ROW products)
  • Marketing for Listings, Trading, Post-Listing Support
  • Post-Listing Support (staking, governance from within the site if the token supports it)

What are the Barriers?

In no particular order:

  1. Get FINRA approval for the ATS that can support listings, public offerings, staking/governance, and other MVP features
  2. Build a compliant tech stack (WORM, information barriers, etc)
  3. Compliance/governance policies that mitigate insider dealing/trading
  4. GAAP (Generally Accepted Accounting Principles) guidance for the custody and trading of digital assets (Fun fact: Based on the net capital rule, it’s kinda tricky to have BTC or other crypto-native assets as quote pairs without locking up excessive amounts of USD to meet minimum liquidity)
  5. Open questions on what/who is a good transfer agent, and how to square post-trade finality/settlement concerns (The DTCC wrote a really good report on this; here’s a link)
  6. Generate a pipeline for tokens
  7. Build trust in tokens listed, so that customer base gains more trust in the asset class, and the BD’s ability to list and support valuable tokens
  8. Build a customer base of people interested in alternative assets and funding paradigm shifting products.

It’s a high standard to meet, but the first few to market with a solid pipeline of valuable projects would have the opportunity to revive the token market in the US. While it appears that the lack of fundamentals lead to market immaturity, and that market immaturity promotes speculative price movement, a token needs a market.

Thanks to Carla C., Tyler, Dan R, and everyone else who proofread this!

* Prices pulled from CMC on November 21, 2019.
** As of the time of writing, the author is an employee of an affiliate of this company.