Throwing away revenue?
It might not make sense in conventional business, but don’t tell that to crypto entrepreneurs. Indeed, for some projects, economist Joseph Schumpeter’s notion of “creative destruction” is taking on a literal meaning in that they’re actively destroying their own money supply – and generating value for investors in the process.
It’s turning out to be an unexpected benefit of the initial coin offering (ICO) model, whereby startups and projects fuel and fund their projects with a scarce digital asset they create. In short, these projects can use the token to price their services, and then strategically alter the economics of the money supply to which they have a direct relationship.
To that end, burning tokens, or destroying the cryptographic keys to these assets so they can’t ever be recovered, has proven to be a selling point for investors, with ICO white papers finding projects promising they will destroy new tokens as they return to the issuer as earnings. Essentially the ask is, if you buy our token now, these companies promise potential backers they’ll trash them as they earn them back.
However unorthodox, one thing is clear: speculators appear to love the model.
Take Switzerland-based Eidoo, which just announced that it was burning 1 percent of the total supply of the EDO tokens it created when it did its ICO in November.
Its latest blog post reads: “The excellent news is that we will destroy 920,000.00 EDO tokens starting from August 31st. This means that we are going to permanently remove one percent of the total supply of EDO tokens.”
Sure enough, EDO’s price spiked nearly 40 percent shortly after the post above came out.
For Eidoo, this means it earned the tokens it created back as revenue from helping startups to run ICOs on its app. But since it isn’t going about this process alone (the company says it has 200,000 users eager to get in on more sales), it’s jettisoning a full half of the money it brought in by burning the tokens.
The twist is, Eidoo is a major holder of EDO tokens, meaning it’s a win-win for the company and investors.
As Eidoo’s Amelia Tomasicchio told CoinDesk:
“Burning 50 percent of our revenue is not really creating any loss for the company itself, but it is creating value for the entire EDO token holders.”
A new direction
Sure, there may not be guarantees that Eidoo’s model will work in the long run, but industry insiders argue counter-intuitive practices like this come with the territory in eras of financial experimentation.
“This is a 1.0 attempt to manage how an economy would work,” author, investor and crypto startup advisor William Mougayar told CoinDesk, adding: “They all want to play Fed Reserve Chairman or Chairwoman.”
Mougayar said he expects more companies to handle their crypto finances in creative ways, which doesn’t mean that all the ideas are good. Destroying part of a company’s revenue may seem disconcerting, or even signal to consumers that it is over-priced.
As Mougayar said, it’s a pattern that can never work for a company that isn’t delivering a service in demand.
“This model has been adopted during the recent months by a variety of projects in the space, however, Eidoo has been quite unique in burning so many tokens in such a short timespan – thanks to a very high revenue coming from the service usage of the recent months.”
Founded in 2016 to make crypto easier and more mobile friendly, Eidoo started burning early on. After its $27.9 million ICO in November left a little over 9 percent of the tokens designated for the sale unsold, it burned them, as it had promised to do.
The burning continues later this month, and so far, it’s winning the project attention.
“Projects burn their own tokens to remove them from the market to demonstrate consumption – as a result this creates further scarcity, thereby affecting the market cap, and arguably is a form of price manipulation,” Lisa Cheng of the Vanbex Group, a blockchain services company.
Follow the exchanges
But Eidoo’s upcoming burn won’t be the most significant instance in recent memory, as crypto exchanges that have launched their own tokens have most readily embraced the model.
In July, Binance burned 2.5 million of its BNB tokens (which it uses for discounts on its exchange) worth approximately $30 million, according to a blog post (that’s more than the whole market cap of all the EDO tokens). When it created the token, the company committed to burning 20 percent of its token profits each year.
Even more aggressively, they say they will do it up until they’ve gone through half the BNB token supply.
Still, there’s utility beyond the depreciating supply. The Binance token has been used to lower the cost of transactions for users, helping to bring more people onto the platform, as Mohamed Fouda explained in a recent Medium post about why exchanges are launching tokens. Effectively, they leverage their large volume to drive up the value of their stored supply of tokens, offloading revenue to token appreciation.
But it only works if people want to come. Mougayar gave the example of a tavern.
“If I bribe you with a free beer, you may come once,” he said, but visitors that don’t like the place won’t come back. Similarly, a company that uses a token to provide early discounts to bring people in still need to deliver a strong product.
The idea is spreading across exchanges. KuCoin is using 10 percent of its profits each quarter to buy back and burn its own tokens.
Even Eidoo will launch its own decentralized exchange or “hybrid exchange” in a few weeks, with plans to use EDO there as well.
But while buybacks and burning can boost price, it could present other problems for projects.
Eidoo calls its token a utility token. “The way a given token works defines its very nature. Regulators themselves are already doing a good job trying to define the different categories of tokens which are being used today,” Tomasicchio wrote.
U.S. regulators, though, have indicated which category tokens with burn functions fall into.
“I would caution those exploring this concept to check with their jurisdiction as the recent SEC announcements have been quite clear that burning tokens would constitute the actions of a security,” Cheng wrote.
In particular, she looked to the Munchee decision from last year, in which the U.S. Securities and Exchange Commission (SEC) specifically pointed to the company’s promise to destroy tokens as an example of increased value “derived from the significant entrepreneurial and managerial efforts of others.”
It is well established in equity markets that buy backs are a way to support the price of a stock. If a company has cash reserves and flat growth, as Apple has had from time to time, it can be a way to keep the mass of its investors loyal by stabilizing the stock price.
We have seen this pattern come to crypto as well. U Network recently did a buyback to power its growth effort. Going further and burning is adds complexity, but the SEC appears confident it can draw a parallel to what token issuers are doing with examples from equities markets.
“I’m not sure this will stand the test of time,” Mougayar said.
“The sky is not the limit.”
Bitcoin in fire image via Shutterstock.