This article may be subtitled, "Why I hate burns and buybacks".
I've had more than a few debates with people on ethtrader and in various slacks about the value of token burns vs dividends. It all started when Iconomi decided to change their plan from offering a dividend to holders to buying up tokens on exchanges and burning them. So many people lauded the decision; only a minority pushed back and said it was a bad idea. Personally, I hated it.
To understand why, let's step back and discuss investments in general, then stocks, then tokens.
A person invests their money into a person or company with the intention of earning more capital than they started with. Investopedia defines an investment as "an asset or item that is purchased with the hope that it will generate income or will appreciate in the future". Some investors look for cash flow, while others want appreciation or even loss prevention.
Cash flow is often delivered to investors in the form of dividends, especially in the public markets. For private investments, cash payments may be periodically given to investors in non growth companies. On the other hand, growth companies hold the cash and reinvest it in the company, as they replace inventory, acquire new customers, and expand. Growth companies that give cash to investors too early are taking a huge risk, as a downturn in sales may require them to do further fundraising.
The strategy of burning tokens mirrors when companies take excess cash and buy back their stock, reducing the float and increasing the value of each remaining share (hopefully). There's a crucial difference between stocks and tokens here, though: tokens are not securities, and therefore they have no ownership rights. Therefore, if I own 1% of all tokens and after some buybacks and burns I own 5%, I didn't just increase my ownership percentage and voting rights. There's just less tokens to own now.
Seems like something the FED would do, doesn't it?
Of course, due to supply and demand, reducing float should increase the price of the tokens. That's fine if the token has a use that is unique to it: REP tokens are a special token used in Augur, and if you want to be a part of Augur's reporting and rewards system, you must use REP. However, tokens like Iconomi that represents a basket of tokens, without giving ownership, don't really work in the long run with a buyback.
Take this to the logical conclusion: if you were to own a stock, and the company did buybacks for many years, your share in ownership would continue to rise. If it got to the point where you became majority shareholder, you would essentially own the company. Your 51% control would offer you the option to even take it private if you so wished, allowing you to reap the rewards all to yourself.
If, however, a token like Iconomi with no ownership continues buybacks, it may rise in price, but it will give your stake no greater share in the company. You have no ownership. Congratulations, you own a greater percentage of nothing. You can't call a function on your Iconomi tokens that automatically closes your position and credits your account with an equivalent percentage of the tokens held by Iconomi (if you did, then buybacks would make some sense).
Furthermore, in the case of tokens with a specific utility, it drives price increases that will disincentivize people to use your service. Let's use the Golem Network Token as an example (I don't think GNT is proposing buybacks; they're just useful as an example):
The Golem network uses GNT for access to a distributed network of computers that are utilized by customers as an alternative to current technology. Golem provides a commodity: they will compete either on speed, or fees, with the current providers. The reason ICO participants bought GNT was either 1, they intend to use the Golem network themselves and expected GNT to be cheaper then or 2, they believe others will use the Golem network and are speculating on GNT to rise in price because of it.
If Golem did a burn of their tokens, they would increase the scarcity of GNT. That scarcity would drive up the price of GNT. But, the problem here is that removes one major incentive for using Golem-the price. As GNT becomes more expensive, there is a risk that the network effects are reduced, as less people will be incentivized to use it. Also, wouldn't a company like Golem want to use some of that excess cash to market their product and increase sales, leading to more organic growth in price?
Finally, without any regulatory oversight in this space, it is hard to argue that insiders won't have an incentive to front run any buybacks and burns. It's all well and good to say that the market will sort it out-and it will-but in the meantime, frontrunning and other insider trading is too easy to game with buybacks and burns. While my libertarian leaning self says, let it be, I know too well that people get angry and will burn their own house down to get even. Sticking to a well planned dividend/ reward structure helps avoid this.
Again, stock ownership is all about control. Token ownership is, at this point, all about usability. It's an unfortunate side effect of the investor accreditation laws that is preventing tokens from actually being used as securities for new startups. Until actual control and ownership is given to token holders, buybacks and burns are gimmicks that add no real underlying value to tokens, besides driving up scarcity. But one needs to remember that scarcity is not a goal in itself.
Do you think I'm missing something here? Tell me your thoughts below; this is a subject I'm less than 100% certain on and am happy to discuss further.
Tomorrow I'll write about dividends and why I think dual token systems are going to be a huge hit in the crypto space. All of the above is informational in nature and not investment advice. I do not own Iconomi or Golem at time of writing, and don't intend to own them in the near future.
HERO does it right.
A correction, from user followthechain:
"Golem is not a service provider, it's a marketplace of providers and consumers. Providers on the Golem network set their computation price in GNT, so the absolute price of GNT doesn't matter: if GNT appreciates, providers can charge less GNT (to keep the service at the same USD amount). Very short term volatility is bad for this marketplace, but long term price fluctuations don't matter.
So, investors in GNT could very well have no interest in being providers or consumers of computation themselves. They're speculating on the future utility of the network, predicting a lot of value will be flowing through GNT tokens, which have a fixed supply."
one key thing is a company returning excess cash as dividends is an indicator that it has lesser return expectations from new business opportunities. Typically very large big moat companies with stable growth give out dividends for their shareholders who are typically blue chip investors. Companies do buyouts when share price is low and the board feels its a better way to increase stake of existing shareholders.
all iconomi is doing is that it is using part of a very high maintainence fee it charges (3 %) to do the buy back.
Agree-the motivations for a publicly owned company to do a buyback can be varied. Iconomi's are silly.
@protegeaa
Good Post!
Thanks for sharing.
Thank you for reading!
"I didn't just increase my ownership percentage and voting rights. There's just less tokens to own now."
_Agreed. plus they aren't mere ownership rights as stocks are, so burning them would also affect the functionality and acceptability of whatever system their token is used for.
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