Understanding Token Velocity

By Kyle Samani
There are a lot of variables that that impact the valuation of a token. The primary
ones are:
Why is a decentralized protocol superior to a centralized alternative?
Why is a particular protocol superior to decentralized alternatives?
Total addressable market - if the protocol fulfills its vision, how much commerce
can it power?
How strong are the network effects?
Quality of team
Progress - how far along is it?
Token velocity - will people hold onto the asset, or will they sell it immediately?
Velocity is probably the least discussed of these, and the hardest to understand.
In this post, Ill dive into velocity and provide some examples. Ill conclude by
reviewing how teams can engineer lower velocity into their protocols.
A High Velocity Example: Ticket Issuance
Ticket fraud (literally reprinting and selling the same ticket multiple times) for
live events is a huge problem. Theres a reasonable case to be made that tickets
for live events should be issued on blockchains. If venues come to accept
blockchain-issued tickets, this solution should stomp out 100% of fraud. You cant
double spend blockchain-based assets.
Issuing tickets on blockchains can bring other benefits (e.g. disallow resale,
profit shares on resale back to venue, capping resale amounts, etc.)
I love this use case for blockchains. This use case unlocks a lot of value: no
fraud, reduced scalping, reduced fees to middlemen like Ticketmaster/Stubhub.

But I dont own, or plan to own, any cryptoassets that are trying to solve this
problem. Why not? Because these tokens will have a high velocity.

There is no reason that I, as a full time crypto investor, want to actually want to
hold Aventus, Ticketchain, or Blocktix tokens. But I think that in time, many
people will want to use these tokens. Ill use Aventus as an example below, but I
dont mean to pick on Aventus in particular. Everything below is generally true of
Ticketchain, Blocktix, and many other cryptoassets as well.

Consumers generally want to pay a price denominated in USD (or maybe in the future,
ETH or BTC) and get their tickets. They may purchase Aventus tokens as part of the
process to acquire blockchain-issued tickets, but Aventus will just that: a small
and temporary step in the process. Consumers will generally not hold Aventus tokens
for more than a few minutes at a time because they have no incentive to.

Venue hosts wont care to hold these cryptoassets either. Venue hosts care about
generating profits denominated in the currency of their choice, likely USD, or
eventually BTC or ETH. After consumers trade Aventus tokens for concert tickets,
venue hosts will trade Aventus tokens for their preferred currency.
This process is shown below. In this example, Im assuming that all parties prefer
USD as their reserve currency. This diagram would still hold true with another
reserve currency such as BTC or ETH.

This creates an interesting dynamic in which the people who get paid in Aventus
tokens dont actually want to hold Aventus tokens. The moment they receive Aventus
tokens, they will sell them to someone else who wants to buy different concert
tickets, or a market maker (who will sell them to someone who wants to buy concert
tickets).

Even if Aventus becomes the global standard for ticket issuance, no one will want
to hold Aventus tickets. BTC, ETH, and/or USD denominated trading volume for
Aventus tokens may skyrocket as Aventus becomes the global ticketing standard, but
the price wont actually go up much. Everyone who buys into Aventus will sell their
Aventus immediately.

The only people who will profit from the success of rise in trading volume of
Aventus tokens will be market makers who provide liquidity for those entering and
exiting the Aventus market. This is not a bad thing. As asset pairs increase in
volume and become highly liquid, bid-ask spreads will collapse to near 0%, which is
good for consumers and venue hosts. Market makers may take a few basis points, or
even a few dozen basis points, but not more than that. These fees are certain to be
lower than credit card fees.

To be clear, in this proposed future venue hosts still win by cutting out scalpers,
and consumers win because of increased fraud protection. But coin holders dont
really win since the price of the coin wont go up enough to justify the risk of
investment.
The analysis above doesnt imply that Aventus should be worth near $0. This
analysis assumes no speculation, which will never be true. Also, if volumes
increase, its natural that some people will buy and hold the asset simply because
increases in volume typically correlate with increases in price in crypto land.
Insiders will also hold shares. However, this limited number of market participants
will not be sufficient to counteract the market forces of high velocity, especially
in the absence of massive speculative value.
Quantifying Velocity
Velocity = Total Trading Volume / Average Network Value
Velocity can be measured over any time span. For standardization purposes, well
measure it annually.
We can say that an asset has a velocity of 0 if, over the course of one year, no
one buys or sells the asset. The lack of liquidity would cause the asset to trade
at a discount to intrinsic value. Assets need some velocity to achieve intrinsic
value. This is known as the liquidity premium.
Lets say Bitcoin has an average network value of $1B over the course of a year.
Bitcoin would have a velocity of 1 if $1B worth of Bitcoin trades over that period.
In the last 24 hours, there were about $1.5B of Bitcoins traded on exchanges. This
excludes OTC volumes, which could be significant. The network value of Bitcoin is
about $70B. This implies an annualized velocity of $1.5B * 365 / $70B = 7.8x
(ignoring OTC).
By non-crypto standards, this is an extraordinary velocity. Equities as a whole are
worth about $70T and trade about $70T annually. Amazingly, Litecoin has an even
higher velocity than Bitcoin.
(Note, this rudimentary analysis implies that crypto prices will continue to rise
as institutional capital converts from fiat to crypto. In comparing crypto
velocities to equity velocities, institutional capital tends to hold equities on
average longer than current crypto holders hold crypto. Given how large the
disparity is between equities and crypto velocities, its likely that crypto
velocity will decrease as equity capital transitions to crypto capital.)
Its difficult to say what future velocities should or shouldnt be. We can look to
things like equities, commodities, and retail, but cryptoassets are different. Its
difficult at this stage to confidently say what normal velocity ranges should be.
How Protocols Can Reduce Asset Velocity

There are a few ways a protocol can reduce the velocity of its associated asset:

1) The first mechanism to reduce velocity is to introduce a profit share. For

example, Augur ($REP) tokens pay out coin holders who report event outcomes to
resolve prediction markets. $PAY holders get paid as consumers transact using TenX
cards. A dividend-like mechanism reduces token velocity because, as the market
price of an asset decreases, its yield increases. If the yield becomes too high,
market participants seeking yield will hold the asset, lowering velocity.
Also, a dividend stream makes a token easier to using a traditional discounted cash
flow (DCF) model. Side note: check out our recent Augur analysis and valuation.
2) The second way a protocol can reduce velocity of its asset is to give token
holder influence over the future of the protocol. This is typically handled via a
one-token:one-vote mechanism. The theory is that stakeholders in the ecosystem will
be unwilling to sell their coins because they have a vested interest in the future
of the ecosystem and want to have some influence over the future direction of the
protocol. This sounds nice in theory, but Im dubious of this claim in practice.
Token-based voting is appealing to many because its analogous to democracy. But
voting on protocol governance is unlike voting on elected officials in one
important way. Its easy to sell cryptoassets and move wealth elsewhere. You cant
easily move in and out of a given democracy (possible, but high switching costs).
If you disagree with the future direction of a protocol, you always have the option
to leave that democracy at will for near $0 cost.
Moreover, for a protocol that becomes even moderately successful - lets assume a
terminal network value of $200M - a token holder would have to hold $5-10M worth of
tokens before her vote would move the needle. Even then, the movement would be
small. The ability of any given token holder moving the needle decreases as network
value increases.
3) A third mechanism to reduce velocity is to build staking functions into the
protocol that literally lock up the asset. This includes proof-of-stake based
staking, although this alone shouldnt reduce velocity too much. But extended
staking mechanisms can reduce velocity further. For example, Numeraire requires
data scientists to stake their NMR tokens for 30 days to compete for prize pools.
This staking by definition reduces velocity since the tokens are illiquid while
staked. Moreover, in the case of Numeraire specifically, the amount of NMR staked
is a function of the data scientists conviction in herself and amount of money the
data scientist believes she can win.
4) A fourth mechanism is what Ill call the network utility expansion mechanism.
This applies to decentralized cloud protocols such as Golem, STORJ, Sia, Filecoin,
and Maidsafe.
Since token supply is fixed, each token can purchase a defined percentage of total
capacity of a network. Overtime, if a protocol is successful, the capacity of these
networks will grow as more people seek profits and rent out underutilized assets.
Therefore, each token will be able to purchase a larger absolute amount of total
compute power / disk space. Although price per CPU cycle and KB are always falling,
markets have generally shown an appetite for ever increasing amounts of both. Its
therefore likely that those who own access to these networks will hold their
tokens, reducing velocity.

5) A fifth mechanism is to become a cryptocurrency (this is a similar, but

different lens on #4). This is non trivial. If people start holding a currency so
they can purchase goods and services at a later time, velocity is by definition
reduced.
Today Bitcoin is the reserve currency in crypto land. But other cryptocurrencies
are emerging. For example, lets examine distributed VPNs like Mysterium and Mesh
Labs (no website yet).
Mysterium is a distributed VPN. The basic problem Mysterium solves is one of trust.
Centralized VPN services are not safe. As a user, you have no idea what the
centralized VPN is doing. You could setup your own VPN on AWS, but this is not
something most users can do. Mysterium aims to solve this problem by decentralizing
the VPN host across many computers. Tor has done this for years, but Tor relies on
altruistic hosts, which limits the number of hosts and reduces speed for the end
user. Mysterium is effectively Tor with a token.
The kinds of users who would act as hosts on the Mysterium Network are also the
kinds of people who would want to use Mysterium as they traverse the Internet. As
Mysterium hosts accrue MYST tokens, theyre unlikely to sell them since theyre
going to use them again in the near future. This reduces MYST velocity.
Conclusion
Velocity is one of the key levers that will impact long term, non-speculative
value. Most app coins like Aventus dont provide a compelling reason for coin
holders to hold the token long term. Absent speculation, assets with high velocity
will struggle to maintain long term price appreciation. Protocol designers will be
well served to incorporate mechanisms into their protocols that encourage holding,
not just usage.
Confidential
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