Cryptoeconomic systems must accelerate the development of the real economy to positively impact society.
Despite recent turbulence in the crypto industry, it would be a mistake for society to forgo adoption of crypto and blockchain infrastructure altogether. The technologies created over the last 12 years have the potential to solve problems with existing institutions and to reimagine the way societies organize their financial and political systems.
To achieve this lofty ambition, cryptoeconomic systems must operate in a virtuous cycle with the real economy. Positive real-world value-creation linkages must be created before broader systems will tolerate the adoption of ideas such as self-custody, asset sovereignty and decentralized governance.
Real institutions continue to use fiat. Mortgages and titles are not secured via crypto. Energy infrastructure investment is not organized on-chain. The vast majority of compute and cloud storage is allocated on traditional networks. DAOs aren't coordinating critical segments of the economy. The last crypto cycle built incredible tech stacks, networks, and protocols, but nearly 12 years after Satoshi’s original white paper, none of these innovations have become core infrastructure for day to day activity.
Crypto took some L’s and needs to touch grass to achieve its ultimate vision.
Money, credit, and the advent of financial institutions that allow for the transfer of financial and economic risk have been crucial to the development of human civilization. Money gave humans the ability to trade goods and services efficiently, credit allowed humans to pull goods and services forward through time, and financial institutions enabled efficient risk transfer and investment.
However, as David Einhorn famously described with his Jelly Donut analogy, too much of a good thing can be destructive. Over the past one hundred years, western economies have become over-reliant on financial institutions for economic growth at the expense of innovation. In the US, financial services have gone from 2% to almost 10% of GDP since the end of WWII while per capita GDP growth has fallen by 2% per year.
This backdrop has created the current techno-financial synthesis, a system that exalts those who create the next business software subscription service, creator economy tool, or unused Web3 application. These trend-based investments have received orders of magnitude more resources than many of the industries that bring forth new technological paradigms and accelerate the flourishing of humanity.
Crypto has succumbed to this same fate. Billions of dollars have flowed into the space to fund projects with little tangible impact on the world, a microcosm of the broader phenomenon seen in other technology industries. Much of the ecosystem has become a dopamine casino feeding off the dreams of millions who missed out because they weren’t “early” enough. The popularity of 24/7 perpetual futures exchanges with volumes that approach levels of major global stock markets are no different than 17th century Dutchmen offering 12 acres of land for a particularly pretty tulip bulb.
This is a disappointing state of affairs. The original crypto thought leaders genuinely believed that they created a movement that would fundamentally alter the political and economic substrate of the world. Crypto can still fulfill its purpose.
While we’re not the first to make this point, We have developed a framework for how we think about the value of cryptoeconomic systems and bringing real-world economic value on-chain through a lens that we’ve yet to see discussed.
The overall value of any asset, good or service consists of immediate use value (commodity value), future value, and cultural/brand value.
The value of a barrel of oil is composed of immediate use value, determined by demand from consumers and supply from producers. Occasionally some future value emerges from expectations of future demand and supply changes.
The price of a stock can be represented by its use value, which is its cash dividend value, future value, which is the value of those cash streams in the future, and brand value (think Tesla premium or VCs that want to get in the “hot deal”).
This framework is simple, but flexible. We can expand upon it to account for certain types of value that seem unaccounted for, like governance rights.
If we assume that the value of a bundle of economic and governance rights can be broken down into use values, future use values, and brand values, then governance has high future use value, but low use value outside of instances of immediate value capture. Governance rights are only immediately useful when you can extract value immediately, which is rare and usually malicious.
Crypto-economic systems are unique, value is quantified and transferred through the use of tokens that can also accrue future value from usage of the system. To use the Ethereum network, one has to pay the network in Ethereum and most of those fees are redistributed to users who stake their tokens to secure the network.
Brand value also exists, as we saw during Web3's soaring cultural heights in 2021 - companies like OpenSea and Coinbase exemplified the outsized value accrual to trusted brands. Governance-use and future use-value, however, don’t make cryptoeconomic systems unique.
Governance rights have been present in other instruments for centuries and have rarely been ascribed high use- and future use-value. The below example of the Google Class A (which has voting rights) vs Class C (which has no voting rights) stock isolated the voting premium i.e. how much do people value the ability to govern Google the company:
The above chart shows that people do not place any value on voting at all, unless it comes with immediate use value.
The ability to both pay to use a network and collect benefits of usage of said network by holding a token is what makes cryptoeconomic systems unique and potentially attractive instruments, not the ability to govern them. A system in which overall value is driven by immediate value and where immediate use-value scales with successful adoption and propagation, mechanically results in a higher use-value than existing instruments. Tesla stock has low immediate use-value, you can’t trade Tesla stock in for a car (yet, Elon?) and it does not pay dividends. In comparison, I must use Ethereum to interact with dApps. A legitimate case can be made that the holy grail cryptocurrency instrument encompasses a mix of equity, commodity and money.
However, despite the above advantages, even the most widely used network, Ethereum, seems to look like other existing instruments that are primarily driven by Future Value. There are two primary drivers of changes in future value, either expectations of future cash flows change, or the rate that one needs to “discount” those value streams given the opportunity set of other value streams changes.
The charts below show the returns of Tesla and Ethereum with the discount rate effect removed. Returns serve as a very rough proxy for “value created”, while returns ex-discount rate attempt to isolate changes in future value, giving a rough picture of volatility coming from future expectations for Tesla or Ethereum.
Assets with high immediate value and low future value should not have large differences between the two lines. This is expected for a company like Tesla, which has low immediate value in the form of dividends, but the potential to change the world. For Ethereum, this implies that the immediate use-value of the existing networks is low, unstable and has only been extremely high when the overall system becomes the “dopamine casino”, due to NFTs and on-chain trading.
Said differently, use-value on existing protocols can be thought of as demand for blockspace, storage, and compute. So far, that demand has lacked a meaningful connection to real economic activity. Within this framework, one of the few states that guarantees use-value stability, and therefore robustness to changes in discount rates, is significant value creation from linkages with real world markets or through the creation of entirely new markets. No one to our knowledge has done this at the scale necessary to support the previous aggregate value of decentralized platforms.
It is due to my immense respect for these technologies that I want to make it abundantly clear that the only way to avoid these types of painful periods is to pursue harmonization and synthesis with the existing economic systems. Mass adoption and use value creation will not occur until real-world activity is either brought on-chain or is intricately linked to crypto systems.
We’re actively working on how to achieve the harmonization I suggest above, hence the brevity of this note. Stay tuned for more on what we’re working on and please do reach out with any thoughts or if you want to collaborate on this problem together.
Special thanks to Praxis Team members Aiyappa Bollera, Vita Guttman, and Jackson Engles and future Residents Christian Angelopoulos, Mathew Joseph and Keegan McNamara for their contributions.