Cryptocurrency Supply & Adoption
How Utility Drives Value Through Demand
With the rise of deflationary currencies, as blockchain and cryptocurrency took the world by storm, a common question that is on the mind of many is: What is the right amount of currency supply? As one of the key aspects of a deflationary currency is its scarcity, it is naturally important to find the right balance between having an asset scarce enough to multiply its value, while at the same time having enough units for its universal adoption.
A Place for Every Crypto
Not all crypto is made equal and a custom-tailored approach per type (coin, utility token, security token) and per project is likely the best way to resolve this question. Out of the three types, however, utility tokens are by far the trickiest and most interesting to explore in that sense, as their primary purpose is not in serving as a store of value, or means of transaction within the existing financial system, but rather to power a specific set of tools in a closed loop, which we can call an “ecosystem” for easy reference. What makes it a particularly interesting example to look into is that this ecosystem has its own internal currency cycle, in addition to its link to external financial systems, such as fiat, or other digital assets.
Utility, Adoption & Scarcity
Considering the speculative aspect of cryptocurrencies, what many people have a hard time grasping is that without utility there is no value and thus no adoption. This is especially the case for utility tokens, although it also applies to coins and security tokens.
Looking at Bitcoin, the king of kings in crypto, many people forget that it is not the fact that there are a limited amount of BTC that makes it valuable, but rather the fact that it is an efficient means of payment, above anything else. This is clearly visible right at the start, just by looking at the title of the whitepaper that started it all by Mr. Satoshi Nakamoto himself – Bitcoin: A Peer-to-Peer Electronic Cash System.
Without Bitcoin functioning as a cash system, or in other words means of payment, there is no utility in the asset, as it becomes nothing more than just another digital collectible, which would have never achieved the breakthrough it did, regardless of how scarce it is. In other words, without its utility there would be no adoption and without adoption there is no value in a currency. With no one interested in purchasing and using it, it becomes just another useless item, left and forgotten on a shelf, on a cardboard box in someone’s basement, or the digital equivalent of this.
To further illustrate this point, let me give you some simple examples. If it was scarcity that primarily drove adoption, then setting the total supply to 1 would be the best thing you can do, as it creates the ultimate scarcity, wouldn’t it? Although this might ring true to some, it is hardly the case. In order for something scarce to be also valuable, there needs to be something creating that value. For example, the first original Superman comic book is not valuable because there is only 1 in existence (Nicholas Cage owns it, by the way, in case you are wondering). It is primarily valuable because of the franchise that it started and the many lives that it enriched, rather than its scarcity. Without that, it’s just another piece of paper.
Let’s look at the other extreme – let’s say you draw a smiley face in your own style and there is only one in existence, which makes it very scarce. Despite its scarcity, it would still be worthless in monetary terms as, unfortunately, unless you are a great renowned artist, a few people apart from yourself will care and appreciate its value. Even if it carries emotional value for you personally, this is rarely translated to others in the same way, especially in monetary terms. However, if that smiley face drawing was also signed by Michael Jordan, for example, then it would have value as it carries the signature of a celebrity. It is not the scarcity that creates the value in this case either, but rather it is a means of bringing a multiplication effect, above anything else. Even so, zero multiplied by any number is still zero.
Utility Currency Cycle & Ecosystems
Now that we’ve outlined in simple terms how utility, adoption and scarcity influence the value of a currency, it is time to return to the previously mentioned “interesting case” of utility tokens, as they are a rather non-standard application. As explained in the previous paragraphs, without utility, the supply (or scarcity factor) is irrelevant, in terms of value creation. For utility tokens that value is created within their own specific set of tools, referred previously as an “ecosystem.”
In simpler terms and looking at the business perspective, this can be outlined in the hypothesis that without working tools that a target/focus audience can effectively use to reach its goals, or solve its pain points there is no value to be found in the initiative. Therefore, looking back at crypto, a utility token’s primary purpose is not in speculation, but rather in its flow through the set of tools of the ecosystem that empowers their users, thus generating value through utility. This is an entirely different game in comparison to coins and security tokens, as this motion of “running through” the ecosystem features the unique internal currency cycle, which comes on top of the usual external financial system connections.
This is also the case for Dentacoin – a utility token that powers a new, prevention-focused and blockchain-supported dental ecosystem and thus enriches the daily lives of all stakeholders – all the way from patients, through dentists, to suppliers and manufacturers. As explained previously, even though it can be used for speculation, that is not where its utility lie and a whopping total supply of trillions of coins is not as crazy as it sounds. On top of it, Dentacoin has no decimal places which makes its 8 trillion supply 200 times smaller than the total supply of Bitcoin Units (Satoshis). However, it is not its scarcity that creates the value, but multiple facets that are involved in the generation of that value.
For Dentacoin one of primary value generators is the circulation of the currency within the ecosystem – the more people that are actively using the tools and the currency that flows through them, the higher the circulation within the ecosystem and thus the higher the demand for it. This is widely known as the “network effect” and has been a key growth driver for many recent giants to their current pole position, with Facebook being one of the prime examples. Considering this, it is not hard to understand the correlation that the more and better tools that serve user needs are developed, the better the circulation and the wider the adoption is. This, in return, increases the demand for a currency through the need for participation.
Considering the above, it is clear that closing the currency cycle with well-developed tools and locations, where the currency is used, creates value and thus drives higher adoption. With higher adoption also comes greater demand, and making the currency unnecessarily scarce limits the potential audience that can access the ecosystem through the currency. Therefore, pointlessly decreasing the supply without a good argument (e.g. external factors such as artificially created, negative market conditions) is actually detrimental to its adoption and decreases the potential value that can be generated from a larger user base that can access the ecosystem as demand increases.
Scaling with Demand
In order to prevent such detrimental effects to potential adoption due to unnecessarily scarce units, Dentacoin has implemented a unique distribution mechanism to effectively scale with demand, as more and more users become active participants in the ecosystem in the long run. This mechanism prevents the entirety of the supply being pointless emptied at once on a small user base – which might be expected in the early phases of a project – by using time-locked contracts, programmed to unlock a pre-set amount of tokens each year.
Naturally, it is not always possible to accurately predict the amount of tokens required for each year of adoption, as these values are estimates and the actually used amount is influenced by various external factors. That is why an additional burning mechanic can be implemented to fine-tune these amounts. Should more than necessary tokens are unlocked which are also not likely to be utilized in the following period, a portion of these tokens can be burned in order to minimize the effects of inflation. This approach is aimed at protecting holders’ interests by preventing overinflation, while at the same time allowing enough tokens to remain in circulation and enable user participation within the ecosystem.
It is not always easy to find the right balance. However, with an adequate set of mechanisms to adjust the scales on each side, the difficult goal of finding the golden middle of supply and demand can be reached. Artificial attempts at equilibrium can never match what we see in nature’s perfection but getting as close as possible to it is not something outside of human reach. Considering that a financial system doesn’t have nearly as many variables as there are in the natural world, our woes are far from impossible. All it takes is the right attitude and consideration for everyone involved to successfully balance the scales of the new age of finance.
Also published on Medium.