Why we need a treasury function in cryptocurrencies?

  • Shaun Conway, Founder and President at ixo Foundation

  • 26.07.2018 08:00 am
  • undisclosed

So far, not much has been written about treasury functions in the context of cryptographic utility tokens. However, as the distinctions between different classes of utility and security tokens becomes more defined, it will become a more important topic of discussion, research and experimentation.  

Treasury management is relevant to any entity that issues a controlled-supply utility token.
Whether this control is exercised through a centralised treasury function, or we see decentralised treasury mechanisms being effectively deployed, the token issuer must take some responsibility for making the market around their utility.

After all, the alternative is that external market-makers, such as centralised exchanges or crypto-whales make the market for their own speculative purposes. This externalises risk and contributes to destabilising market practices, such as shorting and pump-n-dumps.

All token issuers should be considering how they can follow a sensible and responsible approach that controls the dynamics of supply and demand while necessary and then lets the market take over when appropriate. It is here that treasury functions will play a crucial role.

Why treasury management matters

Tokenised utilities include blockchain networks and decentralised applications offering services that are built using the capabilities of these networks. Within tokenised economies, cryptographic tokens represent the rights of use and rights of access that must be made available to the users of the network, including the users of decentralised applications.

The tokens must mediate value flows from users to providers of the utility. Further value flows can include payments between service providers in the network and payments to third-party services that are required to operate the network or add value to the utility. This all requires sufficient liquidity to ensure that users can acquire tokens to make use of the utility and that utility providers can exchange the tokens they receive for general-purpose currencies in order to get paid.

Unlike when an existing utility is tokenised in order to expand its global operations or build on an existing network effect, when a new utility is introduced, it has neither the network effect nor global operations in place.

ICOs are a controversial mechanism for launching these new tokenised utilities, by distributing tokens to a crowd that can bootstrap a network of users, generate market demand and provide operating capital. 

In this situation, liquidity is generated by pre-selling the utility that will be delivered at some point in the future. How and when the capital raised is deployed to build and fulfil the demand created through the distribution of tokens will determine the cost of this capital to the utility provider. 

Creating liquidity beyond the immediate capacity of the utility provider can be perilous though. If the full number of tokens sold at a point in time can immediately be used to access the utility, then no excess liquidity is created. However, if more tokens are sold than can be used, the excess liquidity is hazardous because the proportion of tokens bought by the crowd without any need to use them in the immediate future represents pure speculation. 

This can raise expectations of financial returns that the utility provider is not in a position to deliver. If they can make the token more mainstream and establish a marketplace, demand for the utility will increase. Each degree of network growth, compounding with utility, has an exponential power effect on the value of the utility. 

More specifically, as the value of the utility increases, so should the price of the utility token and, as use of the network increases, so should the supply of the utility token.  

However, optimising the ratio of a utility token’s price to its supply is not straightforward and requires carefully managed liquidity. This is a why a treasury function is so important.

Smart contracts as a solution

Market-making smart contracts are a promising mechanism for establishing a decentralised, autonomous treasury function during the long-tail phase of building liquidity for a utility token.

This works by algorithmically determining the prices at which a smart contract sells and buys tokens without counter-parties. Think of this as an autonomous token-dispensing machine that sells tokens and offers refunds for unused tokens. The sale price is a ceiling and the refund is a floor limit. Token-holders are not forced to use this mechanism and can freely choose to make their own independent trades within the marketplace. 

However, if the token supply smart contract is well-designed to price the token dynamically and according to the intrinsic utility value and market demand, this can provide the right levels of liquidity whilst the utility and its marketplace are becoming established.

Beyond this long-tail phase and once the utility becomes well-established with high demand for use, liquidity should no longer be an issue. At this point, the free market should determine the token price of the digital utility in the same way as the unit prices of traditional utilities, such as energy or communications, are determined by the marketplace.

But whatever mechanism they use, it's important that any token issuer considers the role of a treasury function for the long term good of a project.

Other Blogs