Value capture describes the way a business, protocol, or cryptocurrency retains a percentage of its revenues.
Misconceptions about value capture abound.
There are two types of mental mistakes people make – biases, utilitarian and teleological.
Utilitarian bias
Peter Thiel summarizes the first in Zero to One:
“Your company could create a lot of value without becoming very valuable itself.”
Thiel compares returns between major airlines, and software companies.
Airlines operate on thin margins. Software companies have marginal cost of replication.
In 2012, airlines’ revenue was $160 billion. Google’s was $50 billion, but at a 21% profit margin, Google was over a hundred times more profitable than the airline industry.
Valuable protocols != valuable tokens
Lack of value capture isn’t unique to TradFi; in fact, it’s more common in free, open-source software.
As an outgrowth of FOSS, cryptocurrency (ironically) also suffers.
Many in crypto assume the tokens of a valuable protocol will necessarily be valuable. Most of the time, developers haven’t considered tokenomics, and there is no relationship.
Teleological bias
Teleological bias reverses causality.
It implies an imaginary force in an incomplete chain of dependencies.
“x is valuable because y depends on it,” where it isn’t a given that y will remain stable.
For example, “BTC must continue to go up because the Bitcoin network’s security depends on it.”
This type of rationalization is a red flag, but quite common.
Financial interest blinds people.
“It is difficult to get a man to understand something, when his salary depends on his not understanding it.” – Upton Sinclair
Labor Theory of Value
The Labor Theory of Value is another example of teleological bias – which describes the tendency to reverse causality to retrofit a set of beliefs.
Early Bitcoiners said Bitcoin derived value proportional to the electricity spent on it.
Things are valued for what they give, not what they take.
Electricity, required to mine BTC, is a driver of costs, not value.
Conclusion: Systemic Risk
These biases are a problem partly because their premises are true.
Cryptocurrencies need to be valuable to secure protocols.
In most cases, they’re not.
Thought is rarely given to what makes a token valuable. Consequently, protocols behave unexpectedly, collapsing and their tokens dropping 99% in bear markets.
The increasing interdependence of blockchains compounds this issue. The cryptocurrency ecosystem is rife with risk.
Thankfully, builders are beginning to notice these risks, and how to deal with them.
Cryptocurrency often likened to Jenga – one block away from complete collapse.
I see crypto as a pyramid.
We’re building one layer at a time. Sometimes we build too high, without laying the previous foundation. Those who build ahead fall from real heights.
But it doesn’t stop those building at the bottom.
Thankfully, people are starting to tune into this.
Each bull market, the cryptocurrency ecosystem builds another layer.
So far, the approach has been to let it settle, see what falls.
But there is a better way.
In the pyramid analogy, tokenomics are the concrete that hold everything together.
By intentional crafting of tokenomics, cryptocurrency protocols can be made to capture value, giving them the economic security needed for a strong foundation.
If you’d like to learn more about tokenomics and how to design valuable cryptocurrencies, check out Tokenomics 101.