Discounts vs. Payments: Comparing Discount Tokens with Utility Currencies.

Recently, prompted by an investor friend, I read an excellent analysis of the utility currency investment thesis by John Pfeffer. While I don’t fully agree with some of the points John makes in his paper, the basic conclusion that the value of utility currencies is unpredictable and may, in fact, be very low is, in my view, quite well-founded. However, blockchain-enabled cryptoeconomics presents a broad design space for tokens of economic value. In this post I would like to compare utility currencies with discount tokens, an idea first proposed by Scott Nelson, the founder and CEO of Sweetbridge.

On the topic of utility currencies, John writes:

A given protocol is analogous to a simplified economy. The GDP of such an economy would be the aggregate cost of the computing resources necessary to maintain the blockchain, based on the quantity of processing power, memory and bandwidth consumed, multiplied by the unit cost of each. The token is typically the currency used to pay for those resources [bold mine — AB].

We see from this paragraph and from the subsequent analysis that John aptly provides, that his main focus are tokens that are used to pay for the services of a specific decentralized network. In truth, however, this is only a part (albeit a significant part) of the spectrum of possible token mechanics. That’s why I call these tokens utility currencies, so as to distinguish them from other tokens that can be used to receive utility on a given platform, yet, do not function in a currency-like manner.

Utility currencies, just like any other currencies, conform to the money supply equation. Again, in John’s words:

The total network value is analogous to the money supply M (i.e., all tokens in issuance), where M = PQ/V; PQ (Price x Quantity) is the total cost of the computing resources consumed, V is a measure of how frequently a token is used and reused in the system (its velocity, V). The value of a single token is therefore M/T, where T is the total number of tokens.

With this in mind, let us now turn our attention to Scott Nelson’s discount tokens. Unlike currencies, discount tokens are not given to others when services are purchased. Instead, discount tokens are activated for a given time period, during which they can not be transferred or reused. The network that issues discount tokens can use any suitable currency (or multiple ones) as payment for its services. Activating discount tokens merely offsets some of this fee.

The Sweetbridge paper describes the mechanics of how discount tokens create growth incentives for the networks to which they belong. For purposes of this analysis, however, let us focus on the comparative economics of discount tokens (used to offset the cost of some services) vs. utility currencies (used to pay for the same service).

First, we note that similarly to currencies, discount tokens possess monetary velocity, which can be expressed as the number of times the token can be activated in the given period. But unlike currencies, the velocity of discount tokens is strictly bounded by the activation period. If the activation period of a discount token is set to one month, its annual velocity is no greater than 12. The system explicitly prevents them from being used more often than that.

This property makes the investment characteristics of discount tokens much more predictable than that of utility currencies. Given their unlimited velocity, utility currencies may stabilize their economic value at a very low number, which is one of the most important points in John’s analysis. In contrast, discount tokens’ velocity is bounded. Consequently, their price is bounded from below by their utility.

An additional difference between these two classes of cryptoassets is in the incentives they create. The value of a utility currency is identical to both users and passive investors of a decentralized network. This is because the value of a unit of a utility currencies is spent when utilized. Spending it, in other words, is not different from selling it and should carry identical economic benefits to both sellers and users.

Different dynamics are apparent with discount tokens, which hold two different kinds of economic value: (1) resale value, as before; and (2) discount value that can only be realized through discounts on actual services. Consequently, an investor holding discount tokens for passive appreciation is by definition underutilizing them, only able to capture their resale value, but not the discount value.

Discount tokens are intended as a mechanism to drive active use of the network. An active long-term user is less likely to sell their discount tokens because of the on-going value they generate. This is expected to cause a slow transfer of early tokens from investors to users, based on active demand, a dynamic not obvious with utility currencies.

In summary, discount tokens are quite distinct from utility currencies, while at the same time remaining a utility-backed asset. I intend with this post to illustrate an important point that traditional investors often miss when looking at cryptoassets. Blockchain enables a vast design space of programmable economic value. Having identified a class of assets that behave in a certain way (e.g. utility currencies) one should not assume that this is the only possible design. Continuous innovation is ongoing in this space and we expect to see many new models developed in the near future.

Disclaimer: Neither the author of this article, nor CoinFund, LLC, provide investment, financial, or legal advice. The content provided on this site is for informational and discussion purposes only and should not be relied upon in connection with a particular investment decision or be construed as an offer, recommendation or solicitation regarding any investment. The author is not endorsing any company, project, or token discussed in this article.

Disclosure: The author of this article is a compensated advisor to SweetBridge, Inc. and has a financial interest in its cryptographic tokens.

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