After reading the following post from Vitalik I want to express my own opinion since I mostly disagree with his views. I have a lot of respect for Vitalik which is obviously a very intelligent person but also a person of integrity (few people would criticize something if they can benefit from it).

Here is the post in question: http://vitalik.ca/general/2017/10/17/moe.html

To make a long story short my understanding of his article can be summed up with the idea that on a theoretical level a “marketplace” token (a token that is required in order to operate on a marketplace) should have a theoretical value close to 0 and that the value is derived exclusively from market inefficiencies (like for example low velocity of money, exchange fees, etc.)

On a theoretical level it makes perfect sense, the idea being that people should go in and out of that specific token in order to use it and immediately exit to their favorite token for longer-term holding. His assumption is that if no one holds the token the value will tend to 0.

Let’s make an example with a metaphor. Let’s assume a tourist visits a foreign country, in that country he can only spend the local currency so he will have to change his dollars for the local currency. He will then use the local currency to buy goods and services and when it’s time to leave he will convert the local currency back to dollars. We are of course assuming that his favorite currency to hold is the dollar and he has no interest in holding the local currency of that country.

Let’s take the example one step further, let’s assume that the country where the tourist is going has a very high inflation. In that case Vitalik analysis is completely right, you would try to hold that currency as little as possible because you know that it’s value is always going to drop. But what if instead you expected that currency to have some potential? Maybe there are rumors that they just found oil in that country? Or every year more and more tourists are coming? You could assume that this currency could perform better than your local currency and keep some money into that (it doesn’t have to be all your assets, could be a very small percentage).

Of course the main difference between local currencies and most tokens is that since the supply is limited you have a real chance for appreciation (unlike FIAT money).

Another assumption that Vitalik makes is that people are rational. This is of course not true and is not something that is going to change with time. People have been buying lottery tickets since forever even if they realize that the odds are against them.

If you assume that a certain percentage of people are going to be irrational (even if it’s like 1%) then you have to keep into account their behavior. Some people will “irrationally” decide to hold that specific token. Knowing that some people will “irrationally” hold that token other people will buy it if the price is low enough that they think they can make a profit from the “irrational” buyers. A similar behavior could be for example investors deciding to buy shares of the company that issues lottery ticket. Is it an irrational behavior to buy shares of the lottery company knowing that there will always be someone irrational willing to buy the tickets?

To go more into a specific example the price can never reach 0 by definition as if it hypothetically reaches 0 someone will buy all of them for 0, expecting that someone will try to buy them maybe at $0.01. But expecting that, someone may buy before at $0.02, and expecting that someone may buy before him at $0.50, etc. that’s why it’s impossible to “catch” a minimum because if someone thinks this is the minimum he would buy just a little bit above that price.

However there is more to it, not only there is no reason for the price to reach 0 but also there are reasons for which the token may become valuable.

The 1st reason is diversification, if something works well and you believe it’s useful you may just keep some of it as diversification. If you often travel to a foreign country you may decide to keep some of that currency with you rather than always converting it back. If you often use a specific platform you may decide to keep some of those tokens as diversification. Let’s say someone has dollars but often travels to Europe. He might decide to keep some of his money in Euro instead of keeping everything in dollars.

On top of the diversification you have to add also the speculative element. In general it’s well-known that markets are irrational and switch from extreme optimist to extreme pessimism. Take the example of gold, during the dot com bubble gold was considered completely useless and the price was very low. Many years after however it had increased many fold because of the financial crisis, and after reaching peak optimism it also crashed again. It’s useful for people to have a basket of potential options they can use in order to diversify their portfolio. Some allocators would try to optimize their portfolio by selling the assets which have risen a lot in value and buying the one that have dropped a lot in value expecting that everything will revert to the mean.

So far I’ve been addressing exclusively speculative elements however, so it’s possible to argue that there is no fundamental value in marketplace tokens.

However the paradox is that the fact that those tokens have no fundamental value is exactly what gives them value. I will try to explain this better.

Gold, just like BTC and ETH have no fundamental value, in the sense that they do not bring an income unlike a stock or a bond. However the fact that they are not backed by anything is also what gives them strength because their value is less influenced by outside factors. People could decide to use shares of Google as a medium of exchange, however the value of the shares could potentially vary significantly based on the quarterly earnings reports of Google, as Google has value only as long as the Google Corporation produces revenue. If the Google Corporation goes bankrupt all those shares are worthless.

Gold, BTC, ETH, etc. instead never go bankrupt. That’s the key difference.

When everyone thinks it’s over for gold, or for BTC, etc. the price drops significantly but never actually goes to 0, it’s never “completely over” as since those assets cannot go bankrupt they may just recover in the future. Anticipating a future recovery some people may just buy accelerating the recovery itself as a self-fulfilling prophecy.

Medium of exchange tokens are based on the same principle, their value may vary but they never “go bankrupt”. Their number is also limited with the consequence than when the price is very low speculators might start buying knowing that when the price recovers there could be significant upside because of the limited number of tokens.

I understand that what I’m explaining is more psychological than mathematical, however markets are ruled by psychology and not by mathematics.

According to Vitalik analysis also BTC and ETH should have no value assuming that exchanges are extremely efficient and no one decides to hold.

However that’s the whole point, someone will decide to hold.

The price of BTC and ETH is not made by the people that constantly go in and out but by the people that decide to hold. Those are people that make the price by reducing the supply. The reason that BTC price is high is because a lot of people decide to hold it as a way to diversify their portfolio.

In some way the criticism that Vitalik is giving to medium of exchange tokens is similar to the criticism that the early BTC holders were giving to ETH, they were saying that the problem with ETH was that it was not a proper currency. However as we saw it actually became one, some people decided to hold on ETH as a way to diversify their portfolio and don’t feel the need to immediately sell the ETH for BTC or USD once the money has been released by some smart contract.

It’s perfectly reasonable for people to decide to diversify their portfolio into “growth tokens” instead of simply diversifying in “reserve of value tokens”. If you perceive that a certain medium of exchange token is gaining traction and you know that the supply is limited it’s reasonable to decide to allocate a portion of your portfolio to it assuming that as adoption will grow more people will decide to hold and the value will increase.

I think the issue here is really about definitions. What defines a “proper currency”? Some people will argue that only USD is a proper currency and everything else behaves like a Ponzi. Even gold itself you cannot actually use it to buy anything, people buy it simply with the expectation that they will be able to sell it later ideally for more than what they paid for. No one really cares about how many grams of gold they have, they only care about how much it’s worth. BTC is similar to gold with the difference that it experienced a very fast adoption which made it a good investment so far for the people that purchased it early on. ETH added a feature to BTC and became popular with ICOs as it was necessary to buy ETH in order to participate to most of those ICOs. But more than the amount of money that is locked into the smart contracts because of the ICOs what gives value to ETH is the people that hold a large amount as a way to diversify their portfolio. Why shouldn’t someone decide to diversify their portfolio by holding a new medium of exchange token which has a limited supply and is still very early in the adoption phase?

You could argue that this behavior resembles a Ponzi as it’s not possible that everyone successfully exits. What Vitalik is trying to say in my opinion is that those market access tokens are zero-sum games, in the sense that if the token value goes to 0 at some point then no value has been created, simply value has been transferred from the early adopters to the late adopters. But that’s true for every investment which doesn’t provides revenue. When you buy a stock even if eventually that company goes bankrupt it may have paid dividends for a very long time and produced a lot of value for everyone involved. But anything that doesn’t produces revenue (like gold) to some extent is going to behave like a zero-sum game (If the price eventually goes to 0 — if the price remains high indefinitely then actual value has been created) where no value is created and people that buy low and sell high are going to take the money of the people that purchased high and sold low. The same applies to purchasing land. However historically people have been holding gold and land forever and usually those always appreciated in terms of FIAT because of inflation. I don’t see any difference between a market access token and gold or land except for the fact that of course if people lose interest in the platform the token value may go to 0. However if the interest keeps growing the price will go up. So my conclusion is that market access tokens behave very similar to gold, BTC, ETH, etc. with the only difference that they have more risk but also more reward for the simple reason that the less adoption there is the more risk that the interest just disappears. However the less adoption the more upside if the adoption increases.

In the next part of the article Vitalik suggest something that he sees as a better alternative, tokens which behave more like shares and are supposed to pay dividends either directly or by buying back tokens. While this could work I personally don’t find it attractive at all. In this context you are basically just dressing a normal company as an ICO in order to raise funds from the public instead of raising the funds from VC. The buyer would most likely overpay compared to the normal market rates that VC use, no due diligence will be performed and no guarantees will be offered to the token holders.

A token which sole purpose is to distribute dividends has to go through 3 hurdles:

– adoption

– revenue

– profit

Instead a market access token only needs adoption in order to increase in value. ETH foundation is certainly not profitable and keeps burning money, however ETH has increased in value over 1000x simply because adoption has increased.

One last comment I want to make regarding Vitalik article is regarding this paragraph:

This is all very nice from a theoretical point of view, but from a practical point of view it’s obviously impossible to predict the rate of return for speculative assets as the price will only depends on offer and demand. The thing is if everyone expected let’s say gold to increase 10% by the end of the year with a confidence level of 100% then the price of gold will get the 10% increase instantly as everyone will discount the future increase. There is really no way to determine which asset is going to outperform another asset, that’s why people diversify and hold several assets instead of just one. So it’s not unreasonable at all to hold some token knowing that the price may go up or down, as this is true for everything else.