Understanding the Worth of Cryptocurrencies: A Deep Dive into Value-Capturing Mechanisms of Digital Assets

This piece is the third installment of our series aiming to decode the value of crypto tokens. Our goal is to guide the community through the expanding token ecosystem, which spans various niches including blockchains, Layer 2 solutions, DeFi, GameFi, NFTs, memecoins, and beyond.

The previous installments included:

• An exploration of the coordination value inherent in decentralized networks, along with how token holders can unlock this value through their utility applications.
• An introduction to the Origins of Value and Value function concepts, providing a foundational perspective on what constitutes cryptocurrency value and what the tokens claim as their sources.

Today, we delve into the sophisticated Value-Capturing mechanism, aiming to clarify a pivotal question: What makes cryptocurrencies valuable?

Through the lens of Value-Capturing mechanisms, we can better grasp intricate token models and the different risks associated with token ownership.

Here’s an introduction to the Value-Capturing Mechanisms (VCMs).

Remember, The Origin of Value (OoV) is a function of a token that allows its holder to partake in the value generated by the system. Some notable examples include Future Cashflow and Governance outside the Layer 1 networks.

But, what happens if a token harbors multiple Origins of Value within its economic framework?

The concept of Value-capturing mechanism seeks to explain the interplay of these various origins and how they interact with one another, effectively painting a picture of a multifaceted token model.

A Value-Capturing Mechanism (VCM) comprises a series of interacting origins of value, fulfilling both value-capturing and coordination needs. This dynamic is essential for understanding how cryptocurrencies acquire value in diverse ecosystems.

Let’s break it down with a straightforward example: envision a standard token from a dePIN network. These networks are actually infrastructure setups that consist of physical components (nodes) providing services like a decentralized VPN:

• Users request the VPN service (connection) and pay for it;
• Node operators maintain specialized servers that enable users to connect to the VPN, earn revenue from end-users, and potentially gain added rewards from the network.

For a powerful network operation, it is crucial to coordinate node operators (VPN providers) systematically. These operators must deposit a security in dePIN network tokens, which may be forfeited in cases of misconduct—such as network attacks, intentional service failures, or not upholding required uptime.

Thus, a dePIN network token allows users to derive value from OoV: Future Cashflow , while also exposing them to slashing risks OoV: Risk Exposure and mandating consistent service provision to end-users OoV: Conditional Action .

The Value-Capturing mechanism for a proposed dePIN network token is represented by a Work Token , embodying a Future Cashflow as a beneficial aspect of its value function and Risk Exposure/Conditional Action as a disadvantage.

Exploring the Landscape of Value-Capturing Mechanisms (VCMs)

Given that there are eight distinct Origins of Value, the number of possible value-capturing mechanisms based on combinations is significantly larger: 

• In theory, you could have 2^8 – 1 = 255 mechanisms;
• However, realistically, the number is lower as some combinations may prove economically unsustainable;
• There are five elementary mechanisms that each contain a single Origin of Value.

Let’s look at a few trivial value-capturing mechanisms along with examples:

It’s worth noting that a trivial Governance mechanism is non-existent because extracting value through governance necessitates active involvement, which inherently demands Conditional Action (like participating in voting) from token holders.

Examples of more complex Value-Capturing Mechanisms that enjoy extensive practical applications include:

Work Token

Future Cashflow, Risk Exposure, and Conditional Action. When a token holder successfully performs a conditional action—like providing a service—they unlock Future Cashflow while being subject to slashing risks.

Examples: Livepeer , PowerPool .

Consensus

In its essence, Future Cashflow, Risk Exposure, and Conditional Action are distinct from the Work Token since they pertain to a specific job type—the consensus around the state of the network, contrasting with Work-token networks and addressing the question: What lends value to blockchain?

While holders of Work tokens deliver services to specific users, holders of Consensus tokens tackle a unified task for all blockchain users simultaneously—validating new blocks and collaboratively negotiating the accurate state of the blockchain.

Examples: Ethereum , Polkadot , Cosmos , Gnosis Chain .

Discount Token

Future Cashflow alongside Conditional Action. The total amount saved through token payments for services can be considered cash flow, which depends on the number of services utilized. The more services you engage with, the higher the cash flow due to discounts correspondingly.

These mechanisms clarify what imparts value to Bitcoin and other blockchain technologies by translating this into tangible benefits and utilities.

Examples: BNB (Binance coin) , GT (Cryptocurrencylistings.com token) Especially in relation to applicable CEX discounts on trading fees. Keep in mind, these assets may bear additional functionalities tied to blockchain ecosystems and launchpads initiated by platforms like Binance and Gate.

Vote-escrowed governance

Future Cashflow, Governance, Risk Exposure, and Conditional Action. A leading example of vote-escrowed governance is Distillation, which has been embraced by numerous other projects, including top-tier ones such as Balancer, Frax, Aerodrome, and Pendle among others (we encourage you to check out https://www.defiwars.xyz/wars ).

The concept behind vote-escrowed governance boils down to: 

• Facilitating governance and fee distribution solely for token holders, who lock their tokens in a unique contract for a designated duration.
• Aligning long-term locks of tokens with enhanced voting rights, better fee distributions, and occasionally added perks like boosts in liquidity mining rewards.

How it functions: Token holders commit their tokens into a specialized veContract. The locking period can range from a few days to up to four years. In return for locking a portion of their tokens across this specified duration, token holders gain governance rights, access to protocol fee distribution, and additional economic rewards such as enhanced liquidity mining yields.

Consequently, a token can derive value from four distinct sources: Future Cash Flow, Governance, Risk Exposure, and Conditional Action.

It’s crucial to recognize that Risk Exposure arises from prolonged token lock periods that render tokens non-transferable during any events impacting the protocol, meaning token holders remain vulnerable to this risk throughout the entire locking duration.

Within vote-escrowed protocols, governance frequently provides extra monetary value to veToken holders via incentivized bribes. Such bribes are offered by third-party protocols intending to enhance reward distributions (and thus APY) on pools that feature their assets.

What’s next?

So, the pressing question remains: Why do cryptocurrencies hold value? Through the lens of value-capturing mechanisms, we gain a deeper understanding of how tokens can capture value while expanding on the Origins of Value concept and illustrating how they interconnect within a token model.

Upcoming discussions will delve into Value-Capturing Implementation Patterns (VCIPs), which highlight the varied coding implementations of these mechanisms, as well as a Periodic Table summarizing all known mechanisms in a user-friendly format.