When the ERC20 tokens first appeared they took the world by storm. Why? Because they were quasi-stocks, a way to bet on the success of an enterprise without all the hurdles investing in traditional stocks involves.

Billions were sold to investors, trillions have been traded on the secondary markets… without there ever being a satisfactory answer to the question: how do we value tokens? Why do they even trade and have a market price?

Sure, price is always subjective and it is what a buyer is willing to pay. But when it comes to stocks it is clear why the price should rise when the business is doing well — being a shareholder gives you enforceable rights, including the right to a share of the profits. (You can then use discounted cash flows or another method to reason about fair value.)

There are no such rights when it comes to tokens. The issuer has no legal obligations to the investors. It is quite conceivable that the project becomes a success but the price of tokens goes to zero. For example, the team behind the project could simply abandon the token. Even if they do not officially abandon it, they might struggle to find a use (“utility”) for it, and simply do nothing with it forever.

Everyone is aware of this… still, tokens do trade and have a market price. Why?

We have proposed in a separate article that it is because tokens are the tokenized honor of the founders, a bet that if the project becomes a success the founders’ consciences will force them to find a way to connect the tokens with the success.

This seems to be working? The mechanism most projects currently seem to be converging on is token buybacks (and burns). Here is a partial list of projects that are (or were) doing it: BitMEX, FTX, Celsius, NEXO, Binance. There are more.

This signifies a clear trend. All attempts to tokenize shares of stock have so far failed due to regulatory issues. Efforts continue in various jurisdictions but it looks like progress will be hard and slow.

On the other hand, there is tangible progress from the other direction as tokens are becoming more and more stockenized. It is happening slowly and via trial and error.

At some point in the near future, rather than digitizing ancient stock-trading systems and procedures one by one, governments will simply recognize tokens as shares of stock, grant holders legal protections, and force more requirements on issuers.

Interestingly, the market is not waiting for it. Market expectations are already shaping the behaviour of participants in that direction without any threat of (state) force.

The invention described below has been inspired by the latest hare-brained scheme I have read for a project token. Again, it starts with incantations of Utility. Again, a New Vocabulary is invented, of Actions and Rituals that will be performed with the token, decreasing the dreaded Supply and providing the cherished Demand. You are excused to be confused — by that point to confuse you is the point. A religion which is understood without middlemen is a very primitive one.

What if… we cut the crap?

I am smart enough to understand that I am too stupid to really understand tokens. Tokens… have some magical properties, which are perhaps not even penetrable with reason alone.

And yet, with appropriate humbleness, we can reason about some of the underlying forces and emergent phenomena. And perhaps we can think of better ways to accomplish our goals.

Tokens are used by teams to raise funds for a project. They are sold for a price. This is happening even though the price should be zero because there is no legal obligation for the token issuer to ever share profits with the token investors if the project is successful.

Why is the price not zero? Because the market treats the tokens as pseudo-shares of stock. But unlike with shares, where the bet is on the success of the project, with tokens it’s a twofold bet: both that the project will succeed and that the founders will be honorable enough to share profits even though they don’t have to, legally.

Interestingly, when a project has both token and equity there should be a liquidity premium on the token, but a legal premium on the shares.

To summarize: tokens are, in effect, tokenized honor of the founders.

You raise funds. Your promise is: if we do well, you, our investors will do well too. There has to, eventually, be a hard link between profits and tokens. The cleanest endgame would be to convert the tokens into equity, in a jurisdiction, awarding the holders all the benefits and legal protections that come with shares. That may prove hard, even with good intentions, so other ways of paying back investors are being experimented with, most prominent of which is using profits to buy back tokens and burn them. It’s a rapidly evolving area in which we’ll see more innovation, no doubt.

But for each honorable project that tries to make sure their early investors have profited, there are dozens that have abandoned their token, that don’t care, or that run around in circles trying to prop up the token price artificially using mechanism design and supply/demand manipulation, instead of just calling it a share and letting the market price it as one. How do we solve this?

Two steps:

1. We declare project tokens “non/supra-jurisdictional shares of stock”, governed by common-sense understanding of profit sharing and the ancient rules of honor.
   
2. As mentioned, tokens are magical, so we use blockchain magic to enforce this, using Soul Vessel NFTs (ERC-721-SV).

At the beginning of the token offering, the project founders (who can remain anonymous), accept and declare that tokens are shares in the project and that they will fully partake in the fortunes of the project, one way or another. It is recognized that the project may be far from profitability, and far from incorporating and converting to real shares, but it is promised that if there is ever profitability, tokenholders will share in it in the same manner shareholders would. Rules of governance are also established (whether tokenholders can do other things as well).

A special NFT collection is minted. In it, each NFT represents a project founder. The NFT has two states, “locked” and “unlocked”, represented by appropriate graphics (say, a bird in a cage, and a free bird). The birds represent the souls of the founders. They are initially locked, and the only way to set them free is to send an appropriate amount of project token to the NFT smart contract’s release() function.

Effectively, this forces the project founders to buy back (and burn) almost all of the project token in order to set their souls free. To account for things like lost tokens, people who don’t wish to sell, and token price rise, there are two criteria. Either an amount of tokens needs to be burned, or an amount of ETH (USD?) at least equivalent to the amount initially raised needs to be sent to the contract, which will spend them on Uniswap to buy back the token and burn it. A Time Weighted Average Price (TWAP) mechanism is used to prevent manipulation.

What if the project has failed? Well, in that case the token will be cheap and the founders will not have a problem buying back the tokens and freeing themselves. This has an interesting side-effect… by not dumping the token of a rug-pull project, the investors can make it hard for dishonest founders to set their souls free.

The power of this solution is that it uses magic. Typically, you want founders to be doxxed so that their reputations suffer if they behave dishonestly. But we wrote that founders can remain anonymous. The threat of their souls being captured on the blockchain forever unless they behave honestly is a terrifying threat indeed, and a strong incentive for honest behavior.