Valuing a token economy — practical case

  • Summary how the project works
  • Stakeholders and incentives
  • Bottom-up valuation
  • Valuation recap — Sum Of Parts
  • Size of the opportunity
  • Trade-offs
  • Side effect
  • Freelancers: offer their skills for money
  • Employers: post jobs and look for talent
  • Moderators (workers): people who help settle disputes on the system and earn tokens for their work
  • Holders: hold (invest in) the token to receive fees and be able to vote during the deployment of the ICO funds
  1. Do you need a blockchain solution for that? With the ultimate goal being to build an open, censorship resistant platform and eliminate rent-seeking, probably yes.
  2. Do you need your own token? The ERT token is used for governance, staking, moderating and fee collection so let’s assume yes.
  1. Employer locks ETH equal to the job value in escrow.
  2. Both the employer and the freelancer need to stake ERT for the job duration (calculated as % of the job).
  1. Freelancer receives 99% of the locked ETH (most likely) sells it on the market to cash out.
  2. The remaining 1% ETH is a fee, which gets split evenly between the employer and the freelancer in the form of ERT.
  3. The staked ERT are released to both.
  1. ETH staking for the duration of the job
  2. Demand increase for ERT from both freelancers and employers
  3. ERT staking reduces its velocity (and potentially caps it)
  4. Further incremental demand for ERT with every successful job based on the 1% fee
  5. ERT kept by freelancers has its velocity reduced further until the optimum holding amount is reached at which point the excess is sold on the market
  1. The ETH from the escrow.
  2. Its staked ERT
  3. The ERT of the minority voting mods
  1. The majority voting mods get the ERT of the losing side proportionally to their stakes. They have to optimize for available staking capital, i.e. keep the newly earned ERT or sell it. Mods who sell the earned ERT push the price down and velocity up. Mods who decide to accumulate ERT produce the opposite effect. Speculators or investors could participate in this part of the platform only and treat it as a pure financial trade.
  2. The minority vote mods lose their staked ERT to the winning side. No impact on the price, but heavy incentive not to be a losing mod.
  • Customer adoption according to the S-curve model (more here) to get to 770k freelancers (1% global market share)
  • Average annual earnings per freelancer of $19,480 based on Freelance Union estimate of the global market size of $1.5trn and 77m
  • 1 job done per freelancer with an average job duration of 2 weeks leading to $750 per job
  • Employers to freelancers ratio of 0.5x
  • 20% staking by each party (freelancers, employers and moderators in dispute cases). For simplicity, I have assumed all mods are external, hence the full incremental token demand is added. In reality, this number will be slightly lower
  • 10% disputes of all jobs done
  • Founder tokens are released over 3 years, rest is available for trading from day 1 of the network launch
  • ICO price of $0.50 — the ICO did not happen so this is an arbitrarily chosen price corresponding to an ETH price of $500
  1. Use the assumptions for # of freelancers and employers and average job value to estimate the total value of jobs per year.
  2. Calculate the staking demand in USD using the staking % assumption.
  3. Using the ERT release schedule assumptions, translate the amount of staked USD chasing ERT to arrive at an implied ERT/USD price. For the avoidance of doubt, this would be the equilibrium price where demand and supply meet. The market price will (almost) always be different and impossible to predict. The fundamental equilibrium price is something we can at least use as a reference for the value.
  4. Discount the equilibrium values to the present day
  5. Compare to the ICO price
  1. Liquidity by the founders: another way would be for the founders to have a token working capital pool which is used to provide supply when needed at “some price”. This is tricky — at what price? Many challenges arise. Maybe the ICO price should be the floor? That would be fair to ICO investors. A lower price could reflect the state of the network but could be problematic for marking down of investor books. Such a liquidity provider of last resort would be akin to a state intervention in a free market and could trigger a sell-off spiral. Founders need to make sure that they provide liquidity to the network users and not to speculators who don’t contribute to the network growth and know that there is a backstop if the network is not developing as planned (for which there is a non trivial probability). The usage and growth of the platform should be leading here because this is the only factor leading to higher prices in future. Solving this will be key. ICO investors simply need to wait for the natural token demand to build up. It becomes a matter of timing and cost of capital.
  2. Via the token price: users of the platform price the service in USD so they don’t care so much about the token price itself. In other words, if 1 job is $750 and both sides need to stake 20%, they need to buy $144 in ERT tokens each. Whether that is 200 ERT or 100 ERT, they would not care. Those who care are the ERT holders who decide at what price to part with their ERT. Obviously, people can’t mark up the price indefinitely, as, in a free market, available supply will emerge at different prices for different reasons. For example, the ICO investors paid X ETH for the ERTs and hence and bear the opportunity cost of Ether. If the platform is not developing as quickly as desired, some people may decide to sell their ERT at a lower than the ICO price. Investors may have a required rate of return, which, once reached, will trigger a partial or full sale of their position. Fundamentally, if the platform is developing well, the token mechanics should allow an increase in price due to the supply cap and demand growth. Herein lies the challenge with this driver: if people just hold the tokens and wait for ever higher prices, the network will die. It absolutely needs the early liquidity.
  1. Participate in dispute resolution — I touched upon this in the Moderator section using an example from the whitepaper. One could do very simple probability weighted calculations to arrive at an expected return. Using the example in the moderator section and a 50/50 chance of either losing everything or winning 143% return, the expected return is 21% for the duration of the dispute. Things are, of course, more complex than that, but if someone approaches it with multiple bets over the year, the annual return when the network is mature could be in this range. One way to mentally crosscheck whether people would participate in the so designed moderation system would be to use Prospect Theory.
  2. Hold ERT if the option to distribute the dispute fee of 1% as a reward among all ERT holders is implemented (like a dividend). Having cashflows means we can use traditional NPV valuation models from corporate finance to value this part of the network. For example, buying ERT at the start of each year at the respective equilibrium price, you earn 6.5% dividend yield for a year. However, what investors will do is monitor the implied dividend yield based on the current market price and decide when to enter. A similar idea is the yield on running a masternode and receiving crypto (for example, Neptune Dash does this with Dash). As an ICO investor, if you invest at $0.50 per token, hold for 10 years, receive dividends and sell in year 10 at the equilibrium price of $4.20, the IRR would be 29%. Using 25% discount rate, the NPV comes to $0.67 per ERT (above the ICO price of $0.50). Needless to say, the discount rate is a huge driver. I have written more about its effect on valuations here.
Table 5
  1. Onboarding: how do you onboard employers and freelancers? How do you explain the concept of tokens and the need to stake which increases the effective cost and hampers UX? How do you enable seamless conversion from fiat to Ether and back. Where do you buy ERT and how is it stored securely?
  2. Staking: when staking ERT, how do you ensure price stability during the job — asan employer who wants to sell the ERT released back to them once the job is done, how do you explain or prevent price volatility?
  3. Fees: is the eliminated commission of 10–20% plus payment fees high enough for people to switch to a 0.5%-1% fee alternative while sacrificing UX and convenience?
  4. Network growth: centralized companies have unified product management, quality testing, growth hacking and scaling approach. They don’t have to optimize for trust, verifiable assets and price, rather for customer experience and adoption. Simply spending a ton of money on AdWords and similar online channels to get users on the platform will surely be insufficient in order to replace a well functioning centralized organization with energetic and capable leadership, product vision and dedicated team.
  5. Business development: centralized marketplaces are obsessed with product-market-fit and spend a ton of time on business development and product testing — they optimize for that. A crypto team needs to first develop the network and then start massive business development to attract partners, customers, suppliers etc. It takes a lot more money, time, skill and effort and it is not clear if an amount raised upfront (unless it is insanely high), will be enough to sustain a team and new hires for a long time. Centralized marketplaces have cashflows to aid them along with regular capital raising into the billions of dollars.

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Climate, crypto, macro and tech M&A

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Climate, crypto, macro and tech M&A

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