While it’s still early days for understanding how to value cryptocurrencies, there’s been a widely shared argument (see posts by Kyle Samani, Vitalik Buterin, and John Pfeffer) that all pure utility tokens will eventually have “zero” or low value.

The claim is that as markets mature and adoption grows, utility tokens will be priced based on their “utility” alone rather than speculative value. Due to high “velocity”, the theory goes, utility tokens are doomed to low market caps and poor returns relative to counterparts (e.g. “store of value” coins like Bitcoin).

So… sell all of your utility tokens, and buy up Bitcoin (or LTC, XRB, etc)?

While I have great respect for these members of the community, I think the core argument misunderstands the medium of exchange equation (MV = PT) by assuming fast transaction rates by users mean high velocity (V).

Strong starting intuition — few users will want to hold utility tokens

Utility tokens are meant to provide access to a product or service. Let’s take a good example from Kyle Samani’s piece — say there’s a Ticketchain token that users and event organizers use to buy and sell tickets efficiently to cut out scalpers and reduce ticket fraud.

Although tokens are required to pay for the service, there’s no benefit to holding them over holding fiat currency. Since tokens may fluctuate in price and are rarely used, users will want to sell immediately after receiving them.

What’s the value of something no one holds (utility tokens are weird)?

How do you value something that, A) no one wants to hold and B) immediately sells upon receiving? Community members have turned to the “medium of exchange” equation:

Velocity = Total Transaction Volume / Market Capitalization

Here velocity is the % of the market cap used to pay for items/services on the utility token network, over some period. If market cap = $50 billion, and monthly transaction volume is $5 billion, then velocity is 0.1 — meaning each token is used to pay for good or services around 0.1 times per month.

Flipping this around gives truly alarming results for utility token holders:

Market Capitalization= Total Transaction Volume / Velocity

So high velocity means low market capitalization, but utility tokens have high velocity, so they must have low market caps…?

Faster transactions by end-users don’t guarantee high velocity

I believe there are two reasons this isn’t true: 1) velocity depends on all coin holders, including market makers, not just end users, and 2) velocity here is not measured by the time between individual transactions (“transaction velocity”), but relative to the market cap (“market cap velocity”).

The first point is simple — if token receivers sell the moment they receive to market makers, but market makers hold these tokens for a long time before another buyer appears, then overall velocity would still be low.

“Market cap velocity” is not the same as “transaction speed”

We originally started with this:

“Velocity = Total Transaction Volume / Market Capitalization

But observe that velocity is defined here in terms of market cap. How about breaking out Total Transaction Volume? Letting total transaction volume = transaction speed * (amount per transaction), we have:

Market Cap Velocity = (Transaction Speed * Amount per Transaction) / Market Cap

Written this way, transaction speed is NOT the same as how quickly the market cap turns over (“market cap velocity”) — a utility token which involves frequent transactions in small amounts may still have low market cap velocity.

Summing it up

The valuation of utility tokens is still largely an unsolved problem, as there isn’t yet any empirical data from tokens with real utility.

However, it’s worth interpreting arguments about velocity carefully - there is nuance in how velocity will play out in a real-world setting. Real velocity is defined in terms of market cap is not real-world transaction speed.

Given a lack of data as well as other still-unexplored areas in token design (e.g. what additional utility benefits do tokens provide - discounts?), the jury should still be out on how to create useful, valuable tokens.