Why crypto-coins have value

Crypto-coins are hot. They are liquid, international, unregulated, and they sometimes rise rapidly in value. They are providing a new source of financing for software projects. What gives value to these apparently worthless number strings?

The trivial case: It’s a claim check for assets or pre-sold products

In the trivial case, crypto-coins represent external assets, like dollars and houses and new widgets and concert tickets. The blockchain just tracks ownership. You can design an “initial coin offering” (ICO) to pre-sell products this way, and get a more liquid version of Kickstarter. However, this type of coin does not increase in value with the size of the community.

The not-quite-legal case: It’s stock

Consider Zrcoin, which advertises “The opportunity to become a shareholder in a production company” (producing cubic zirconium). Represented as tokens, the stock is immediately liquid and tradeable, and it reaches a global market, so it has some advantages over normal, nationally regulated stock. This is probably a legal offering in Russia. It’s not legal in the US and many other countries. Coin holders do not get governance rights, or information rights, and in many cases are offered nothing except a promise. This is more than a legal problem, as the lack of any legal claims renders many of these offerings worthless.

The amazing case: It pays for open source software machinery

Most ICO’s are selling a different type of coin, one that is designed to expand in value as more people use the coin and the related open source software. These crypto-coins are an answer to the question “How do users pay for open source software?” — in particular, software that organizes a distributed ecosystem. Distributed ecosystems are very important. We use them for trade, communication, banking, risk sharing, and innovation itself — the sharing of ideas and code. In these systems, we can organize and innovate at a scale beyond one company. People are doing amazing things using shared software machinery. They use coins to operate the software machine.

If coins pay for open source software, it follows that some things are necessary for a successful coin offering.

• It has to be wrapped into valuable software. For a coin offering to be successful, the underlying software must be first successful at the level of open source software — downloaded and used by a lot of people. This explains why successful coin offerings come from deeply technical software teams, not salespeople and lawyers.
• The coin needs to be important for the operation of the software. The coin is essentially an API key. It won’t add value to the coin to be selling things that do not absolutely require the software, such as marketing or data or certification or membership fees. Buyers of those goods can bypass the related software and coins. Things that are wrapped into software are transactions, governance (who makes decisions about the operation or upgrades), mining (essentially a security resource), and resource accounting. In a pure case, the coin itself, as acknowledged by the software, has value as a medium of exchange.
• The software needs to connect an ecosystem of different players. Some have called this role a “protocol” for communication. The coin pays for the protocol when you interact with outsiders. When you are interacting inside one company, you don’t care about the resource accounting, and the coins don’t have value.

Blockchains are useful in the special case. It’s a big special case. It’s not a platform on the scale of the Internet itself, as some have claimed, but it does give thoughtful programmers a way to create real value at a truly global scale. They just have to figure out how to fit the three points listed above.

Smith + Crown has a summary of type types of things that coins can pay for in the software machine.

• Access — Used as the simplest way to pay for transactions and resources, such as with Ethereum and Ripple.
• Payment rights — a more restricted form of access where users MUST pay for things in a marketplace with the designated currency. This could get annoying and subtract value.
• Governance — Influence investment or development decisions. This sounds like a valuable asset, but Smith + Crown says it’s tricky to deliver.
• Block creation rights — controls the security and growth of the underlying blockchain.
• Contribution — Coins are needed to play certain roles in the network, such as deciding the results of games or contracts. This can be cleverly set up so users make money (actually, more coins) when they perform these tasks.

Thanks to Judah Thornewill for giving me a chance to think about the value of a network for sharing health data.