A Metaphor for Functional Tokens
Imagine there is a bridge that connects two cities, Atlantis and Bedford, which we will refer to as A and B. These two cities are separated by a small body of water making the bridge immensely useful in travel between A and B. Without this bridge, commuters would have to travel hundreds of miles to go between these cities, but with this bridge, travel is fast and easy. This bridge currently charges a toll of $1 and commuters happily pay this fee every day.
Suppose one day, the owner of this bridge wants to change the way that they operate this bridge. The owner says that the bridge will no longer accept dollars as payment to cross the bridge, but instead will only accept Travel Tokens which are issued by the Atlantis Bedford Bridge Authority or ABBA. Travel Tokens can be used to cross the bridge and are consumed on use. The ABBA decides to issue 20% of the tokens to anyone who wants to buy them at $1 each and will keep the remaining 80% of the tokens. The ABBA also says that the supply is immutable which means no new Travel Tokens will ever be created. Some tokens may be lost or destroyed which takes them out of circulation meaning that the Travel Token is an inherently deflationary currency.
Many people will buy the Travel Token because they need to use the bridge. These people don’t mind since they are paying the same price they were before to use the bridge. Some speculators may also buy the coin because they think that the bridge was so useful that people should be paying more than $1 to use it. They may buy large quantities of the token in order to control the supply and sell them later at a higher price. The Travel Token, however, has not changed. It still can only be used to cross the bridge connecting cities A and B.
Since the Travel Token is needed to cross the bridge, there will always be people who need to use this token and there will be an active market for people who need to buy this token to cross the bridge. These people may be buying the token from the ABBA who sell the token to pay for bridge maintenance or from other people who don’t need to use the token. The token price will fluctuate based on what people are willing to pay to cross the bridge. The token may begin to trade at $2 since that is how much people are willing to pay to cross the bridge.
Now suppose that cities A and B do not have a bridge between them at all. People in cities A and B wish there were a bridge since they need to travel frequently between the two cities, but due to political and funding issues, the bridge never gets built. Despite public demand, the two cities cannot decide on how to fund this bridge.
A savvy entrepreneur comes around and sees that there is massive demand for a bridge between these two cities, yet no one is building one. This entrepreneur realizes that there might be enough people who are willing to pay up front in order to use the bridge later on when it is built. The entrepreneur decides to sell Travel Tokens at $.25 each which will be able to be used to travel between A and B. The entrepreneur sells 50% of the total supply of Travel Tokens to the public in a sale and raises money to build the bridge.
The Travel Token doesn’t yet have any use, but there are many people who want to use the bridge and are excited for the prospect of being able to travel between the two cities. They decide to buy the token early since they think it will be more expensive to buy the token later if they want to use the bridge in the future. They understand there are numerous risks involved in this project that are all out of their control as they have no ownership rights in the bridge. They also understand the bridge may not ever be built or the bridge may have heavy traffic, but they buy Travel Tokens anyways because they think the bridge will change commuter travel between A and B.
Eventually, the bridge is finished and people are very happy with it! The Travel Token now trades on the market at $2 each because the bridge saves so much time for commuters between the two cities. The entrepreneur is happy because they now own a very successful bridge authority collecting lots of Travel Tokens which can be sold back onto the market to pay for bridge maintenance and employee salaries.
Now suppose the bridge has become highly popular and the token price is extremely expensive and now trades at $4. To better justify such a high price of the token, the bridge authority decides to allow round trips on the bridge with a single token. That means that the Travel Token can now be used for 2 trips instead of 1. The token jumps in value because that means each token has more utility, but only to $6. That means that the effective cost of crossing the bridge has been reduced from $4 to $3.
Early bridge backers now hold Travel Tokens that have increased in value. They may use their newfound wealth on traveling across the bridge at a cheaper original cost of $.25, which allows them to use their savings to increase wealth or consumption, or they may find that there are other people they can sell their Travel Token to who want to cross the bridge. The Travel Token has a large market cap, but that market cap is justified by the number of commuters that use the bridge every day. Over 1 million drivers cross the bridge daily each spending 1 Travel Token meaning that there are $4 million worth of tokens being collected by the ABBA every day. The ABBA may choose to sell these tokens back onto the market instantly meaning the market cap of the token stays constant. If the ABBA sells fewer than $4 million worth of tokens a day, the demand side of the token will be larger than the supply and the price will begin to increase. The price will continue to increase until other commuters decide to simply sell their token at a profit and drive the long way around since it isn’t worth that much to them.
Suppose the Travel Token can also now be used for a bridge connecting cities B and C. The supply of the Travel Token remains constant, but the demand has increased causing a positive price increase for the Travel Token. There may be fewer bridge commuters on the bridge between A and B, but the increased number of commuters that come from bridge B and C push the price of the Travel Token higher. The ABBA can reduce the number of Travel Tokens that are consumed to cross the bridge to keep costs down for customers if the market does not appear to be in equilibrium. As the token gains more utility, the price increases which is justified because now a single token can do a lot more than it could before the bridge was even built.