Let’s start with an example. According to the Court Examiner’s Report, the (now bankrupt) crypto lender Celsius spent over $500 million buying back its token CEL, for which it had only received $32 million during the ICO. According to the same source at least $75m of the $500m was upper management dumping their tokens. That would have been a horrible deal even if the company survived.
But while the CEL token was probably not the reason why the company failed (BlockFi failed too and didn’t have a token), the token was in many ways toxic for it. That is by no means specific to Celsius. Below is a list of ways having a token harms every project that has one:
- The most obvious one — due to the US regulators’ overreach, token sales to US citizens puts the company into permanent danger of being investigated for breach of securities laws.
- In the absence of tradable shares, company tokens assume some functions which shares normally have in the stock market. Namely, they are seen as a health gauge for the firm. As per the Efficient Market Hypothesis, share price is assumed to incorporate all the publicly available information about the company and its prospects. If there are good news, share price rises, if the share price is falling it must be because something bad happened, or is about to, and the insiders are dumping.
When the company’s token is falling more than the market in general, the market assumes bad things are happening with the company. This happened with CEL and was one of the reasons why the company was spending its scarce resources defending the price of the token; it was aware of its signalling function. (Preventing a sharp drop of token price is especially important for the type of company that is vulnerable to bank runs, but not just those.) - The token pits insiders against the unsuspecting public (huge information asymmetries there). Insider trading is inevitable. Even when the odds of it being prosecuted are low, the setup is morally problematic.
- The token allows investors to get out early by dumping on the public, and if the public is not there to buy, on the company itself. It thus reduces the incentives for investors to be long-term committed.
- The token distracts employees who are inevitably constantly checking and discussing the token price, and whose mood and job satisfaction can also fluctuate wildly with that price.
- It distracts the company itself because it has to figure out things like market making (a paid service that is very expensive and extremely hard to get right), exchange listing (a large lump sum payment), and so on, instead of focusing on its core business.
- It incentivizes the company to mark-to-market the tokens it has in treasury, artificially inflating its balance sheet, creating a moral hazard (the management can take on more risk because of the strong balance sheet).
- It creates a bunch of fanatics in Telegram rooms that constantly complain about the token price, even if it is rising but not rising fast enough. These are dubbed “The Community” and are in reality as much a burden on the company as they are a marketing tool.
The list just never ends. A token is like fire, a good servant but a terrible master. It can raise funds, spark interest and ignite early adopters, but it threatens to consume the whole enterprise and burn it down, which happens more often than not.