Ilya Oskin

Speed Running Financial History, Part 9: The Value of a Token is What it Does Building for Votes vs Building for Weight > “In the short term the market is a voting machine, in the long term it’s a weighing machine.” VOTING MACHINE: What this means is in shorter timeframes, price is largely a product of traders trying to buy something for $1 and sell it for $1.04. It’s not so much fundamentals that drive price action, but headlines, liquidity, and whatever the hot narrative is. Why’d the price go down? More sellers than buyers. This is how traders see markets. They look at things like open interest, volume, charting patterns, etc.. Focusing on mechanical metrics that make number go up or down near term. They’re trying to anticipate supply/demand dynamics and sentiments that inform price oscillations, they don’t care about the cashflows or success of the underlying company. A prop-shop or high-frequency trading firm doesn’t see a stock as a company, they see it as a series of letters that correlate with other series of letters that it can arbitrage, scalp, etc. to extract trading profits. Flows, speculation, and perishable information inform shorter timeframe, these are market “votes”. If you’re accommodating traders, you’re building for votes. This is high-time-preference asset allocation. WEIGHING MACHINE: An investor sees a stock as a company. This means he looks at fundamentals like cashflows, revenue growth, margins, etc.. Information related to value creation and the core business are how capital allocaters understand the world. You are investing in the prospects of the company, not trading it because you think the RSI chart is due for a reversion. The market can vote quite irrationally over short-to-medium timeframes, but ultimately it’s the weight of the asset that matters: why is this thing actually valuable? Eventually, this question is harshly answered. You can play financial-engineering games and run coordinated pumps for a bit, but when the music stops the raw utility/value of the asset becomes its price. This is market “weighing”. If you’re accommodating investors, you’re building for weight. This is low-time-preference asset allocation. For the most part, people build for votes in crypto, and the flighty, trendy pump mentality reflects it. They vote, not invest, based on how they think others will vote week over week, monthly, “narratives”, etc.. However, value creation and capture is not optional if you want to provide long-term returns and exist beyond quarterly trends. DeFi must build for weight, and have assets that act as scales for the beefcakes we’re becoming. “Price is what you pay, value is what you get.” ------ The Three Kinds of Weight-Bearing Assets If a project issues an asset and it doesn’t track the performance or growth of the business, what they’ve created is either a completely separate product, or a poor vehicle for value capture. There are three core kinds of weight-bearing assets, and they’re valuable for different reasons. A CLAIM ON RESOURCES: The asset exerts a claim on cashflows and resources of the business that issues it. Traditionally, this is understood as stock/equity. It’s a form of permanent capital for the company, since it’s not something the issuer needs to repay. This asset is valuable because you believe the claim on resources you can exert with it, proportional to your ownership, will increase over time. This asset gains value as the claim on resources does. Its weight comes from the cashflows, either now or in the future, of the underlying business. A COMMODITY: Like ETH or oil, it’s valuable because it lets you do something that has productive utility. Oil lets you drive around, ETH is the oil of Ethereum. Corn fuels your body. You buy it because you want to use it. Demand for their consumption is reflected in their market price. You don’t just buy them once, you must keep buying them to continue receiving the benefit. Its weight comes from the demand to consume and use the resource. A DEBT: Any asset that owes the holder principal plus typically interest is debt. Debt is defined by its temporal nature, it’s non-permanent capital; meaning it has an expiration date where repayment occurs and the debt is extinguished. Its price can fluctuate in the interim based on interest rates and default probability, but its value remains static. Its weight comes from the principal and interest payments. If it’s not any of these assets, it’s either a meme or a derivative of them. If the asset only lets you vote, and does not facilitate a claim on resources, it’s a governance meme. You must be able to commandeer resources with an asset for value to accrue to it. Governance abilities are a positive, and usually necessary characteristic, but a not sufficient one. WHAT ABOUT DERIVATIVES? Options, futures, and other derivatives are not weight bearing in and of themselves. They merely track the performance of weight-bearing assets. They’re ways to speculate on one of the three core asset classes. For example, an option is a way to bet on/hedge future stock prices. Futures are a means to purchase or speculate on commodities. Credit default swaps let you speculate on or hedge bonds, etc.. Derivatives are…. derivative. Their value is predicated on the asset they’re tracking being worth something. They’re not independently valuable. A possible fourth weight-bearing asset class: Capital assets like real estate, cars, factories, etc. are productive assets owned to generate cash flows or for their utility. They’re quasi commodities in a way. All physical capital assets are built using commodities (thus their price is partly a derivative of the commodities that go into them), with a premium applied for the labor to assemble them. If you wanted to consider them a fourth weight-bearing asset class, I wouldn’t object. You could view capital assets as non-fungible commodities: eg a 2020 Toyota Camry is fungible with another 2020 Camry, but cars are not fungible with each other. Same for houses, cellphones, etc.. And they’re still subject to the scarcity and demand laws of commodities. You need both demand and scarcity for a commodity to gain value. On Currencies: These have value based on the access they provide to one of the three core asset classes listed above. Currencies are a claim on the resources of a nation. However, I think they’re much closer to national giftcards than they are equity, as explained in Part 7 of this series. And… that’s kind of it. I’ve seen crypto tokenomics stuff that tries to dress up value accrual for tokens to be this byzantine thing, like you’re engineering something for SpaceX. You’re not. If you can’t explain it simply, you don’t understand it well enough. The more complicated it is, the more likely the value capture will be poor. Bolting a derivative onto something does not change the fundamental nature of the base asset. Layers of complexity and financialization can put makeup on a pig, but eventually it’s the pig that matters. Derivatives create volatile, voting-based ways to speculate or hedge. And I'm not aware of a single asset in financial history that's valuable just because it lets you vote on something. The asset must have teeth, and those teeth must be able to eat resources. An asset with only governance abilities is like a mouth with only gums. More on this soon. CLOSING Does it exert a claim on cashflows and resources? Is it intrinsically valuable with both demand and scarcity, like a commodity? If the answer to both of these is “no”…. when the weighing machine kicks in, it will not be kind. Eventually, everything gets put on the scale. You are building for votes when you focus on derivatives, financial engineering, or think the price will go up for any reason not related to cashflow claims, or scarcity and demand. You are building for weight when you focus on value creation and capture, or the utility of the asset. DeFi will build for weight, because it doesn't have a choice. A new mechanism to impose weight-gaining financial behavior coming soon... Link to blog in profile