How You Perceive Everything

ICO fundraising involves creating perceptions, not blockchains.
And for that, you need a hype machine.

The ICO Hype Machine

With ICO prices determined outside active markets and based on incomplete or misleading information, the hype machine itself has become the new source of work that must be performed for a token to gain value. But there is little value for the token issuer in continuing this type of work after the ICO. And besides, they shouldn't.

The work that needs to happen after the ICO is the development of the promised platform.

Delivery on the pre-ICO promises is what will give any ICO tokens value in the end. Unless that work happens, unless the promised services start being delivered, the value of Ethereum and other cryptocurrencies will continue to drop as the bubble of each ICO's promises gets popped.

“But wait,” you might say. “My tokens went up! I made a pile of loot off the AmazeBalls ICO!”

That's super, but your pricey ICO tokens may still be inflationary. Inflation is marked by rising prices and falling value. Price and value often take time to meet up, and the economics of ICO token distribution don't help matters.

“Pure POS”

Tokens created on the Ethereum network exist as "pure POS" tokens, regardless of whether the Ethereum network is POW or later becomes POS. By its nature, a pure POS token—one where the total supply of tokens exists from the outset at its creation—experiences 100% inflation in its first block.

The inherent value of a pure-POS token at its outset is practically zero. No work was done to acquire it, and no demand exists for it. If its purpose is fundraising, the issuer will need to distribute it to funders at a price higher than zero. The token issuer wants to exchange the present zero value of their new token for the present positive value of another, like ETH or BTC. The issuer wants to exchange their worthless new money for valuable old money (and maybe even solve that "worthless" part along the way).

Pricing a worthless token higher than zero requires switching present value for perceived future value. The work of raising the token price ICO fundraising involves creating perceptions, not blockchains. And for that, you need a hype machine.

Coinbase Rot

In an information-dense post comparing POW to other consensus mechanisms, Paul Sztorc discusses the “coinbase rot paradox”:

A lower “% of the total tokens” released today would seemingly decrease the block’s MR (the number is smaller). Yet, by releasing more %-coins in the future, the money ‘rots’ slower, and therefore this money-type is more valuable (the quality is higher), increasing MR.

“Decreasing the quantity of coins released in each block, actually increases the total economic value released in each block. Premining all of the coins encourages work across blockchains. ...The 100% premine itself constitutes a huge MR at time=0, and it will be fought over like any other MR. The MC=MR problem has been concentrated into a single tiny block, and spread sideways across multiple blockchains."

"Marginal rent" (MR) is the profit margin that the holder of a resource can extract in return for access to it. Rents are unevely distributed in an economy, and over time they fall to zero, the equilibrium point where MC=MR. ICO issuers are able to extract economic rents from participants because ICOs are not, at their core, a peer-to-peer economic model. ICO investors are subordinate to the ICO issuer to the degree that investors want the tokens, because the issuer has all of them immediately.

The quantity, timing, and method of distribution for any new form of money drastically shapes its effects on the monetary system as a whole. The work has to happen. Paraphrasing the next point from Sztorc, pure-POS tokens encourage accelerated rot (ie, inflation):

With money, “what other people own” affects you; when money is offered to someone else, your purchasing power decreases. It is as if some of your money has ‘rotted’ away. It is precisely because uniform changes are meaningless, that non-uniform changes are meaningful.

If you work hard all day, and are paid $100 for your work, and someone else prints $100 for no effort, you have a diminished willingness to accept $100 for tomorrow’s work. You care about the “% of the money supply” that you just got.”

So if you have any money, the creation of new money affects you, whether you have any of the new money or not. Adding new money more slowly over time, or more evenly across participants, reduces its inflationary effects.

Pure-POS tokens, like we see in ICOs, have the exact opposite qualities. By their nature, the entire supply is created instantly and assigned to a single account holder. This sets the stage for potentially horrible inflationary effects, like the effect that the recent wave of ICOs has exerted on the price of ETH and BTC and other cryptocurrencies.

(FOMO - FUD) = $ICO

A project with more hot air than real support is doomed to fall back to earth, not unlike the balloons for the ill-fated Skyballs crowdfunded campaign for cancer-awareness. The project’s inflated value crumples to a sagging, oversized sack with a whole team of people trying to pack up the pieces and move on (aka bagholders).

Skyballs was unable to meet its fundraising goal on IndieGoGo. With just a moderate investment in a hype machine, an idea like Skyballs might raise $100 million via ICO.

The market for a new token is shaped by advertising campaigns, "forward-looking" statements, and the false urgency of blinking timers and convoluted bonus deadlines. Investors in an ICO must attempt to evaluate, or more accurately, to price the future value of these current promises, with nearly no other information to go on.

Often the best indication of near-term price movement is found in the hype machine – the effort spent by developers and other investors to drive interest, build expectations, and increase the perceived value of the tokens in the ICO. Developers talk to the media, white papers, YouTube videos, it all starts happening! Excited investors who want to be a part of the next big thing express their enthusiasm, and skeptical investors (or competing projects) express their sometimes-valid doubts. FOMO builds, and FUD

It is this hype machine – press releases, advertising, forum and Twitter posts, slick websites with pictures of tall buildings, and above all, a countdown timer! – that drives the perceived value of the tokens before the ICO.

After the ICO, the now-funded team must deliver on the promises that they made via the hype machine. To the degree that they fulfill the promises that investors expected, they are creating value. That value – the value of whatever functionality was promised – supports the token at that point, and it is no longer borrowing the value from other blockchains.

Inflation not only increases the level of prices, it also distorts relative prices.

The token ICO price is a function of investor expectations (the perceived future value of the token, as ). As time goes on, the market goes through a tumultuous period of valuation where perception is replaced by reality.

It is in this space - the price difference between perceived value and real value - that failures destroy (and scammers steal) the real value borrowed from other blockchains.

The collective value spent on ICOs has effectively been loaned out by ICO participants, who traded real value (ETH or BTC) on perceived value (some promising new token). Some of these projects will add useful work to the world, and some will not. The ones that do not will suppress the price of the blockchains that funded them – entirely through the inflationary effect of printing worthless money, even if this time it was a crypto-token.

More reading:

• Cross-Chain Inflation: ICOs are IOUs, an article by me
• Microfoundations and Macroeconomics: An Austrian Perspective, a book by Steven Horwitz