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Protocol Tokens – Good for Investors, Bad for Business

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Anyone who follows the ICO process with interest, will be aware that many startups have been rejected as a result of being considered to not be a protocol token. The theory of protocol tokens is that 90% of the value of any blockchain network is centred in the protocol layer of the network, which is accessible by a token that can interact with that network. Protocol tokens are extremely popular in ICO’s as they allow investors to buy into startups early with the anticipation of seeing gains similar to those previously seen in Ethereum and Bitcoin.

However, although protocol tokens are popular amongst investors, the benefit they have to the companies is less positive. One of the reasons for this is that the development of protocol tokens requires a level of expertise that is not necessarily appropriate for every company, for some of the following reasons:

  • Technical Risk – The creating of a protocol requires deep expertise in cryptography, open-source software, economics and game theory. There is not s surplus of individuals with these levels of expertise in the world.
  • Business Risk – The value of protocol tokens is directly related to the value of the company behind it. Therefore, protocol tokens can take up to a decade for the market cap to reach the expectations set out by the company.
  • Execution Risk – The sheer demand for cryptocurrency developers means that hiring a team with the necessary experience and expertise to execute such a project is challenging.

Although these risks should not deter businesses from issuing protocol tokens, it is recommended by some commentators that the tokens should take the form of ‘reward-type’ tokens that can emphasise existing business models, which allows the company and the investors to remain in sync with each other, giving the company time and space to grow at sustainable levels.

Technical Risk

There are very few blockchain developers on the market for new roles that have the level of expertise to create such protocols. With blockchain only becoming mainstream in recent years, there have been no college courses or textbooks to assist developers, who had to learn everything from scratch, often using archaic tooling. In addition, there was significant controversy associated with blockchain (and especially Bitcoin) during its formative years, meaning that few were willing to take a risk in a technology whose future was uncertain. As a result, there is a small number of experts that can build the necessary layers for developing on blockchains, and many of these are following their own visions for the platform.

For that reason, it is not easy to build a team, either in-house or remotely. Instead, it would involve the inner protocol of the business to first be synthesized finely, allowing the various stakeholders to the business to interact with each other, as well as with the network resources involved in the business, and the mechanism design that joins the dots between all of the business. A set of remote developers will not be able to acquire the inner knowledge of the business within a blockchain environment, especially once it is being communicated indirectly through a layer of middle management, potentially to an overseas time. Protocol tokens require a standardisation of concepts before the development of such tokens for an ICO is successful.

Business Risk

The development of a protocol token requires significant attention and resources, and therefore the development of such tokens will require such attention and resources to be diverted from the core business model. Most of this attention will come from business executives that are more concerned with the marketing, branding and business angle of the protocol, rather than the technical angle, which can result in confusion and unclear ambitions.

Many of the initial successful businesses developed on the blockchain have been created by teams with deep technical expertise, with the non-technical ones often being spin-outs of these technical companies. Therefore, history would suggest that non-technical involvement in protocol development remains low in comparison with the importance of technical involvement.

Rewards Token?

The downside of reward style tokens is that, at present, crypto investors are still on the lookout for fast and large gains. However, an established business does not need these huge percentages of gains to be built into their company, but instead a sustainable level of gains. However, the value in a protocol token is that it can incentivise parties to invest in a network that it otherwise would not have done. For example, Bitcoin miners are incentivised to provide computer power to mine Bitcoin in exchange for Bitcoin, whereas Bitcoin users are incentivised to use and hold the Bitcoins due to low fees and increasing prices.

Adding a tokenized layer to an existing business model can be a low risk and high-return way to increase revenue from existing business models without dismissing the relationship with existing investors or dismantling existing business models. Performing this tokenised layer through a centralised model ensures that companies remain in control, and allows companies to remain available to later list the token on n ICO. Protocol token sales can be undertaken at a later time, when the levels of risk are not at the level that they would be when trying to entwine an existing business model with a protocol layer.

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