As an investor in two blockchain analytics companies (visit Panda Analytics and Elementus), I am very optimistic about the cryptoasset space as a whole. However, I have found the industry heavy on overvaluation of assets and light on data and fundamental analysis. The most obvious area of this overvaluation that I have observed has been in the space of utility tokens — digital assets that are proposed to provide access to services but lack intrinsic value beyond their use case.

Investors have bid up the price of many utility tokens over the last year. I think there are two main reasons for this. Many investors have not thought through what utility tokens really are, how they will be used, and what they should be worth. Also, I believe that investors are using utility tokens as stores of value. Many think a portfolio of utility tokens is similar to a rare wine collection, where the wine is not consumed by the investor, or an antique car collection where the cars are not driven by the investor. I hypothesize that investors are using (and probably misusing) utility tokens as stores of value.

Blockchain is a major innovation. Combining an append only public database with a crypto currency will lead to applications and services that are difficult to imagine today. However, current pricing of tokens requires considerations beyond an appreciation of the future potential of blockchain technology. Factors such as the depth and cohesiveness of the core team must be considered, as well as technical feasability and community acceptance. The market value of some utility tokens without a functioning app is remarkably large. I think most investors believe that this indicates unsustainable “bubble” valuations that are vulnerable to a steep decline.

Most observers would agree that the market prices of tokens are overvalued. The question is why? During the dot com bubble of the late 1990s, start-up companies IPO’d with little more than a business plan. Then, as now, investors quickly appreciated the potential of a new technology. Investors were, however, at a loss to correctly value those new companies. In the post Global Financial Crisis world central banks have created $34 trillion of liquidity for monetary stimulus and to fund budget deficits. Investors seek store of value alternatives to fiat currencies, which are under constant threat of debasement. They appear to be willing to try everything from gold to bitcoin to utility tokens in order to manage and grow wealth. The need for reliable stores of value is justified and a historical perspective of monetary policies suggest that this need will intensify.

Government budget deficits used to be a product of wars. However, after the termination of the Bretton Woods accords in 1971, currencies became de-coupled from the gold standard. As a result, governments were able to issue debt and create money without the constraint of a linkage to a hard asset. Deficits became permanent and government debt grew as a percentage of GDP. See Figure 1 below.

As we saw vividly during the Global Financial Crisis, the response of central banks to a financial crisis is monetary stimulus through “quantitative easing.” This is a technical way of saying governments issue more sovereign debt, and print money by having central banks purchase sovereign bonds on the open market. One problem with this approach is that levels of sovereign debt remain very high at the end of a crisis. This has reduced the ability of central banks to use this tactic during the next crisis. This cycle of high levels of debt and liquidity creating imbalances makes the economies vulnerable to a future financial crises.

As a consequence of this monetary policy, the amount of total debt relative to GDP is higher at the beginning of each recovery than it was at the beginning of the previous recovery. This creates conditions that make economies vulnerable to the next crisis. Imbalances are not only created in response to financial crises. For decades, the U.S. has run persistent budget deficits. Except for 4 years of small surpluses between 1998 and 2001, the US has run an annual deficit every year since 1969. Other developed economies exhibit a similar pattern. Japan has run annual budget deficits since 1966, and France since 1993. The UK has run a deficit 24 of the last 26 years.

Debt, central banks, and fiat currencies not backed by gold allow a cycle of continued and ongoing inflation and currency debasement. See Figure 2 below. The resulting asset search has bid up the price of many asset classes and utility tokens appear to be no exception. However, while I sympathize with investors who seek havens from fiat currency debasement, I am afraid that utility tokens are a poor choice. The reason why returns to the importance of fundamental valuation of utility tokens.

Figure 2: Global median inflation series since 1209 (left) and 1900 (right)

When the 90’s bubble burst, technology sector valuations were impacted the most as value from new business models failed to materialize. While it is difficult to predict when this realization will occur, it is reasonable to suggest that utility tokens are only worth a small premium over the marginal cost of the goods or services that represent. They will have value, but this value will inevitably be tied to a use case. It’s like the difference between taxi medallions and gold as a store of value. Technology stocks did not store value, and these tokens are unlikely to as well.

Some utility tokens may be able to graduate from a means to utilize a good or service to a store value similar to gold or fine wine. However, most utility tokens will be unable to make this transition, and those will end up trading at a discount (think of retail gift cards trading at a discount to face value). In the wine market, a very small fraction of wine has appreciation potential. The market requires both scarcity and investors that believe that wines produced by certain vineyards are qualitatively superior. The superior vineyards also have limited production. In addition, a portion of rare wines are consumed each year. These features are difficult to replicate in utility tokens.

The conclusion for investors should not be against utility token investing as a whole, but to advise general caution and fundamental analysis in utility token investments. Asset pricing could remain high in the short-term, and utility token use cases that will develop in the long term. Waiting for a further correction, finding exceptional opportunities, or investing in an index and rebalancing periodically are the best ways to achieve both a store of value and long term appreciation.