Bad investment logic: “Utility token price will increase over time due to growth of the network so I’ll buy it now as an early adopter.”

Less bad investment logic: “Utility token price will increase over time, but only if it actually has utility (the speculation will eventually dry up).”

Better investment logic: “Utility token price will increase during speculation, but fall a lot even if the project has utility because (a) speculators will sell and (b) increased liquidity (from instant decentralized exchanges) will put downward pressure on token supply and price.”

Yikes.

Better, but not what people hoped

Vitalik Buterin explains how it’s supposed to work:

One kind of token model that has become popular among many recent token sale projects is the “network medium of exchange token”. The general pitch for this kind of token goes as follows. We, the developers, build a network, and this network allows you to do new cool stuff. This network is a sharing-economy-style system: it consists purely of a set of sellers, that provide resources within some protocol, and buyers that purchase the services, where both buyers and sellers come from the community. But the purchase and sale of things within this network must be done with the new token that we’re selling, and this is why the token will have value.

In reality, utility tokens are going to be less valuable that proponents claim.

Let’s assume best-case scenario. You’re holding utility token X that lets you purchase a product or service that people actually want. As soon as the price starts to flatten out, many of the speculators who do not actually want to use the tokens will sell them. This causes an initial price fall.

Now, the holders of the token are mostly people who are actually transacting with the token. There’s a couple ways that this might play out. One is where utility tokens are illiquid; they cannot be easily and quickly exchanged within transactions. You would have to hold a balance of all the tokens you plan to use. While there’s less downward pressure on the price, there would be more price volatility. More people are holding the token, there are fewer tokens in circulation, there are fewer trades, which means that it takes less volume to move the market of the token up or down. The second scenario is where utility tokens are abstracted away from the end-user experience. You’d able to use any stable currency (e.g., USD or some stablecoin) to purchase tokenized products. Behind-the-scenes, your money is sent to a decentralized exchange, traded for the native utility token which is then used to complete the transaction. In this scenario, there’s downward pressure on the price of the utility token since people do not need to hold those tokens (less saving means more tokens in circulation means lower prices) and greater price stability since the large number of buy/sell orders absorbs market fluctuations.

The market will likely move towards the latter scenario since the decentralized exchange technology is coming, and the majority of users want increased liquidity and price stability (only the subset of users that bought early have a vested interest in the price remaining high).

To be clear — these market dynamics (if true) do not imply that utility tokens are bad. Giving early supporters / evangelists a stake in the future growth of a network (even if they need to sell early in order to benefit from that stake) is an incredible driver of network effects and a serious enabler of disruption and innovation when competing against natural monopolies is harder than ever.