Summary

• Currency is the key to unlocking the benefits of trade. Currencies are used to buy things, which means currencies are constantly being traded

• Early stage tech companies don’t go around paying for things with their equity because their equity is a poor form of currency

• Yet, early stage web3 projects are going around paying for things with their native token thinking their native token is a good form of currency

• As a result, web3 projects are exposing their native token to tremendous amounts of sell pressure, destroying value for team members, investors, and their own treasury

• Revenue-share tokens represent a much superior form of currency that can be used to grow TVL without the adverse consequences of using the native token as a currency

A (very) brief history of trade and currency

Power of trade

Trade is the single most important social interaction in human history because of its profound economic benefits. Decreasing marginal returns dictate that people need a diversity of goods to maximize their utility. Further, comparative advantages teach us that producing everything ourselves is inefficient - it makes sense to specialize and produce only what we are optimally efficient at producing, on the condition that we can engage in trade afterwards.

These dynamics apply to people (we aren’t the ones building all our own furniture, making our own clothes, building our own houses, and farming our own food) and to countries (all countries specialize in certain types of economics activities). It is thanks to trade that human civilization has been able to develop into such a sophisticated web of globalized industries and enterprises.

Barter

Barter transactions involve trading goods for goods. They represent the original form of trade. However, barter has one key limitation: the coincidence of wants. Having a trade partner is a necessary but not sufficient condition for trade; both parties also need to also want what the other has. The solution to the coincidence of wants constraint is a central unit of exchange. Something every person will always trade for, so that everyone can always trade.

Currency

Currency solves the coincidence of wants problem.

Currency is the key that unlocks the potential of trade beyond barter. Throughout history, society has used many different kinds of currencies. Seashells, cattle, and gold were all, at one point or another, used as currency for trade among human beings (don’t worry, this post is not about Bitcoin!).

So what makes a good currency? According to the St-Louis Fed, a good form of currency needs to have 6 key characteristics:

1. Durability

2. Portability

3. Divisibility

4. Uniformity

5. Limited Supply

6. Acceptability

Early stage technology companies

When a technology company is born, it has no revenue. Despite not having revenue, the company incurs costs. In order to pay for these costs the company needs capital. But the only asset it has is equity. Can an early stage technology company pay for things with equity?

Inconvenience

The first problem is the lack of price discovery. The company would have to enter into a negotiation with the counterparty every single time it wants to pay for something (imagine having to negotiate with your landlord or AWS on a monthly basis regarding the value of your startup, explaining to them the benefits of the company, how much money it will make, what the exit multiple will be, etc.) Even if those negotiations could happen successfully, they would be followed by diligence and paperwork. Although theoretically feasible, going through diligence and legal agreements with unsophisticated counterparties is not realistic. Ultimately, the lack of price discovery and having to deal with unsophisticated counterparties makes paying for ongoing costs with company equity so excessively inconvenient that we consider it impossible.

Coincidence of wants

The second reason why paying for every cost with company equity is problematic is because of the coincidence of wants constraint. Paying for every single transaction with equity is equivalent to barter. Your landlord (probably) doesn’t want equity in your startup. The only way to convince your landlord to take the equity is to offer it at a huge discount to its intrinsic value. Your landlord will have no choice but to turn around and sell the equity to a third party for an equally discounted price. Eventually, paying for the same costs will require more equity to be sold because of how low the equity is being traded, and so on and so forth. As a result of paying for every cost in equity, you will put a tremendous amount of sell pressure on your equity.  

Is company equity a good form of currency?

Taken together, inconvenience and the coincidence of wants constraint highlight why startup equity is a poor medium of exchange. In other words, company equity is a bad currency. This becomes obvious when comparing equity to the six factors that define a good form of currency:

Early stage web3 projects

A lot of the same dynamics are currently being played out with native tokens today.

Trade via the blockchain is super convenient

The use of the blockchain, a public ledger, greatly facilitates trade for all digital assets on the blockchain. The ease with which digital goods can be traded for an agreed upon price improves all aspects of trading related to the inconvenience problem: blockchain projects can easily pay for costs incurred using their native token because the native token has a price and the transfer rails are extremely efficient (a landlord or AWS would be willing to receive native tokens as payment because they can turn around and sell the token into the market for their currency of choice).

But are native tokens a good form of currency?

Just because using the token is convenient, doesn’t make it a good currency. 

What happens when a DAO or protocol pays for things in the native token? The receiver sells the token for another currency. The constant sell pressure pushes the price of the token down. A lower native token price means the project will have to sell more tokens next time to make the same payment. More emissions lead to more selling, and so on and so forth. While all of these transactions have little friction thanks to the blockchain, the mechanics that result from using a poor form of currency are the same: downward price pressure on the native token.

This adverse consequence is compounded for DAOs whose treasuries are made up primarily of their native token: the constant sell pressure on the native token affects both the value of the protocol and the project’s runway. 

An alternative form of currency

Cinch allows web3 projects to mint ERC-20 tokens that represent specific amounts of revenue-share: revenue-share tokens. For example, a protocol can mint ERC-20 tokens that represent the right to receive [10]% of revenue until $[50]k is paid out, at which point the revenue-share expires and the tokens get burned. 

Revenue-share tokens are denominated in a widely accepted currency as chosen by the project (ETH or other). The ERC-20 format and the price discovery via Cinch’s secondary marketplace make revenue-share tokens exactly as easy to use as native tokens. Taken together, these characteristics make revenue-share tokens a better form of currency than native tokens.

Even better: revenue-share token trading does not affect the price of the native token. The wallets of core community members, investors, and the core team, as well as the project’s treasury, are spared the unnecessary sell pressure associated with issuing native tokens to short-term holders. 

Ultimately, revenue-share tokens give projects a tool with which to grow TVL without the adverse consequences of using native tokens as currency.

Conclusion

Native tokens, like equity for traditional early-stage technology companies, have all the characteristics to be a good form of currency except one: they are not widely accepted.

Many stakeholders that receive the native token want a proper currency they can use across the digital assets landscape, and as such, they sell the native token immediately upon receipt. As the token gets sold, the price required for transactions to clear is reduced, thus requiring more tokens to make payments of the same amount. Although trading native tokens is convenient, native tokens make for poor currency.

DAOs and protocols need an alternate tool with which to reward community contributors, partners, and liquidity providers, that does not harm or lead to selling of the native token. Revenue tokens are the critical tool projects need to reach their full potential.

** **