For example, Uniswap generates significant trading fees, but none of the revenue is passed onto its token holders. This is one of many examples of a protocol that does immense good and generates tremendous value for its users, but where the underlying token doesn’t capture this value.
To evaluate a token's intrinsic value (and arrive at a potential valuation), it’s necessary to consider its value creation and capture mechanisms. To achieve long-term success, tokens must move away from being purely speculative and become more productive.
In this article, we'll explore various ways through which tokens can capture the value created by the protocol.
Value creation vs value capture
"Value creation" is the act of generating new value or enhancing the value of a product, asset, or service through innovation, efficiency, or other methods. The benefits of value creation can be measured by factors like increased productivity, reduced costs, or enhanced accessibility.
"Value capture" involves the process of retaining or extracting the value that a product, service, or system creates. For example, if a lemonade stand incurs costs of $50 for lemons, sugar, and paper cups and earns $100 in sales, it creates $100 in value and captures $50 of it (as profit).
Typically, value creation and value capture are interlinked. Peter Thiel began his famous Stanford lecture by stating that "value creation" is about inventing and innovating something new, while "value capture" involves figuring out how to profit from that innovation. Value creation and value capture must work together for a business to succeed.
Value creation & capture applied to crypto protocols and tokens
Many crypto protocols create value — it can be measured in a multitude of ways, such as fees generated, total value locked, number of active users, or time spent on the protocol.
A couple of examples of positive-value protocols and project archetypes include:
- Uniswap — a decentralized exchange with the lowest fees, more liquidity for the market and liquidity for any tokenized asset
- Lido — allows users to earn a yield on their staking tokens without having to worry about managing their own staking infrastructure or dealing with the technical complexities of running a node
- Crypto gaming — players get the utility and enjoyment of an entertaining game
- Smart contract platforms — execution of decentralized applications
However, not all of these have been able to capture the value they’re creating.
Tokens that capture value
Smart contract platform tokens (e.g., $ETH)
Layer-1 smart contract platform tokens have effective value capture mechanisms. The tokens act as the primary currency for transaction processing, meaning users and developers have to purchase them to use the network (e.g. $ETH on the Ethereum protocol). Users buying $ETH to use Ethereum’s transaction processing is evidence of the value created by the protocol.
Ethereum's native asset, Ether ($ETH), captures value through transaction fees that exceed the platform's expenses, creating a deflationary mechanism that reduces supply and boosts the price of $ETH. This process is reinforced by the network effect, as new use cases and applications are unlocked through developer activity on the platform, driving more demand for $ETH. As more users purchase and use $ETH, the network becomes more valuable and useful, attracting even more developers to build on top of it.
When designed carefully to avoid Ponzi-like mechanisms, crypto gaming tokens have the potential to capture value. If the game is entertaining and players are willing to pay for it, then the underlying token has some intrinsic value. Crypto games create value through the entertainment they provide and capture value through the in-game tokens they monetize.
However, it's important to note that there have been many examples of unsustainable token economies in crypto games. Speculation became the primary motivation for buying tokens rather than the enjoyment of the game. Therefore, the underlying assumption is that the game itself must be truly enjoyable to create true value.
Examples of tokens that do NOT capture value
Uniswap fees vs governance
To understand the intrinsic value of DeFi protocol tokens like Uniswap, it's necessary to understand what relationship the token has to the underlying protocol.
While Uniswap does generate value (measured through the fees it generates and its TVL/active user base), these fees aren't passed to token holders and shouldn't be used to determine potential valuations of the token. Currently, demand for these tokens is primarily driven by governance and speculation about future utility or value capture.
Until token holders receive a share of the fees these protocols generate, the only relationship between the tokens and the protocol is the ability to influence its decisions and operations through governance voting.
Governance can be useful, and therefore provide some value capture mechanism. But in most cases, governance is a small subset of the overall demand and thin capture of the protocol’s value.
To increase UNI’s value capture, they could implement some pass-through of the fees (however, it may not make strategic sense at this time).
Note: The author does not intend to single out Uniswap for any personal bias or agenda but rather uses them as examples due to its widespread recognition.
How tokens capture value
Here are some common methods:
- Revenue sharing: Token holders receive a portion of the revenue generated by the protocol, such as transaction fees or staking rewards.
- Example: Lido and $LDO via their staking rewards
- Governance: Tokens give holders the ability to vote on key decisions regarding the protocol's development, including upgrades and changes to the underlying code.
- Example: Curve and $CRV — a special exception, based on Curve’s potential to increase stablecoin liquidity makes its governance tokens valuable to other protocols
- Token utility: Tokens are used as a means of exchange within the protocol or platform, such as paying for fees or services.
- Example: Braintrust and $BTRST — $BTRST can be used for free and discounted software, products, career resources, and community perks.
- Scarcity: Tokens are designed to have a limited supply, which can increase their value over time as demand grows.
- Example: Ethereum and $ETH
- Intrinsic value: Tokens can have inherent value based on their use case, such as providing access to exclusive content or services.
- Example: BanklessDAO and $BANK
Future token success
It’s essential to evaluate a token's value creation and capture mechanisms when assessing its potential for success. As the crypto industry continues to mature, token buyers will benefit from focusing on tokens that provide value to their holders.
Are you ready to take the next step in designing a successful token? Discover how Liquifi's experts can help you create a token that captures value and maximizes success.