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 allocators 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.

We 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

Throughout financial history, there are three core weight-bearing assets, and they’re valuable for different reasons.

A claim/control on resources:

The asset exerts a claim or ability to control cashflows and resources of the business that issues it. Typically this is understood as equity. It’s a form of permanent capital, since it’s not something the issuer needs to repay. This asset is valuable because you believe the resources that can be claimed/controlled by it will increase over time; it reflects the value of the resources it owns. Its weight comes from the cashflows, either now or in the future, of the underlying business.

A commodity:

Commodities are valuable because they let you do something that has productive utility. A good heuristic for a true commodity is if its market price were $0, it would still be just as useful.

Heating oil works regardless of its price. Oil lets you drive around. ETH is the oil of Ethereum. Corn fuels your body. These all do their thing independent of market pricing; this is what true intrinsic value looks like. They are bought and used because they are intrinsically useful. Demand for a commodity's consumption is merely reflected in its market price; the market does not dictate its utility.

And 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. Scarcity and demand must be present for the price to maintain and rise.

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 principal 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 in the principal and interest payments it will make (assuming no default). Its weight comes from the principal and interest payments.

To be more literal, debt is fundamentally a cashflow swap. We could also describe this weight-bearing asset class as an obligation of cashflow swaps if we wanted a purely functional description.

All other assets that exist are derivatives of these three core asset classes. If it’s not any of these assets, it’s a meme. 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 and control resources with an asset for value to accrue to it. Governance abilities are a positive and usually necessary characteristic, but a not sufficient one for value accrual.

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, or are predicated on them. Derivatives are ways to speculate on one of the three core asset classes.

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 credit risk, etc..

Derivatives are…. derivative. Their value is predicated on the asset they’re tracking being worth something. They’re not intrinsically valuable (a granular deconstruction of what ‘intrinsic value’ means found here). They’re not independently valuable, they’re valuable because of the core asset class they deliver.

For example, if I create a futures market for beach balls, I’ve done nothing to impart value to beach balls, I’ve just created a way to speculate on them. There may be more trading (voting) happening because of my beach-ball futures, maybe even a beach-ball pump! But there is no weight (value) accruing to the beach ball because of my futures market. The nature of the beach ball is unchanged; it’s not a commodity, it’s not a claim on cashflows, and it’s not debt. Which means eventually, the futures will reflect that. Everything in its right place over a long enough timeline.

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.

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 poorer the value capture will be. 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 is valuable solely 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; Salutary is built to address this systemic shortcoming in DeFi.

There is currently no way to invest in the fundamentals of a business in this industry, because the tokens aren’t any of the aforementioned three core asset classes. The absence of value accrual for DeFi tokens is not difficult to understand once you comprehend the nature of what something must be, and do, to sustainably be worth anything. Gas tokens are the only investable asset class in this entire industry, because they are actual commodity-type assets that accrue value consistent with the use of the entity (blockchain) that issues them.

Does it exert a claim or control over cashflows and resources? Is it intrinsically useful with both demand and scarcity present? 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 genuine utility of the asset.

DeFi will need to eventually build for weight, because it doesn't have a choice. A mechanism to impose weight-gaining financial behavior coming soon. The value of a token is what it does; Salutary tokens… do things.