Price formation mechanisms for tokens
When we speak about the type of tokens, we are mostly referring to how its price is formed, and maybe maintained, by the token issuer. There are several strategies for price formation. This post aims to provide an overview.
According to the nature of the asset, or asset property, that the token is pegged to, existing cryptocurrencies come typically in 5 flavours: Unpegged Tokens, Utility Tokens, Security Tokens, Stablecoins and NFT.
The more basic category would be the Unpegged Tokens. Unpegged tokens have not any collateral asset, asset property or utility, providing value to the token units. The price of these tokens is based according to purely speculative value, eg memecoins.
A large and heterogeneus category of utility tokens comes next, as foundation for other pegged tokens. Utility tokens typically are valued by the utility, or service, provided to the participants in their ecosystem. Despite they can include some supply manipulation they do not follow a specific monetary policy to maintain the underlying value of this service and price is delegated to market forces. Therefore these tokens are expected to have price fluctuations, i.e. the higher the utility provided, or the number of utilities, the higher the demand and, therefore, the price. The captured utility can be derived from an objective, or intrinsic, value as access (GameFi), action (Play to Earn, Move to Earn, Recycle to Earn), operation (DePIN) or governance (veTokens, DAOs). Alternatively, the utility can also derive from a subjective value, as a payments for a service e.g. network operation (utility coins), defi commision (e.g. exchange, payment or lending).
A Security Token is the blockchain equivalent of a securitized asset traded on the stock market. Similar to traditional securities, security tokens are financial instruments that represent ownership interest in an asset. Their price, yield and any other features are borrowed from the underlying financial asset. This financial asset can be physical (e.g. real state), equity (shares, stocks), debt (short term bonds, HY bonds, US treasuries, notes) or some kind of derivative (e.g. options).
The first tokens in this list aimed to become currency are the Stablecoins. Stablecoins capture the price of an asset formed in an external market and set the captured price into the token. Stablecoins include a stabilization mechanism that aim to maintain the captured price, typically by supply manipulations, either manual or built-in by an Oracle. Stablecoins either can be collateralized by nothing (algorithmic stablecoins), by the asset (commodity, fiat of digital) or by a basket of products equivalent to the price of the assset (synths).
The NFT tokens are not in charge of any price formation by themselves. Instead, NFT tokens grant ownership of the asset to their holder and, therefore, the price of a NFT token is provided by the price of the backing asset. As non fungible tokens, they match one-to-one with the tokenized asset so NFT tokens do not have supply or price considerations. Furthermore NFT can have a different price. Some NFT tokens are created to represent some identity with the purpose of tracking, membership or access. The standard application of NFT tokens are collectibles. We can include souldbound tokens which are digital identity tokens that represent the traits, features, and achievements that make up a person or entity. Other typical applications for NFT tokens are Profile picture NFTs, Event tickets NFTs, Virtual Real Estate NFTs, Music NFTs.
If we look back to the physical world and the literature, Hayek dedicated a few chapters to define how private money should be created. For Hayek, privately issued currency units should be collateralized by a basket of commodities and the issuer should announce the composition of the basket to maintain the price as compromised.
It might be expedient that the issuing institution should from the outset announce precisely the collection of commodities in terms of which it would aim to keep the value of the 'ducat' constant
Finally, the proposal of Catallactic is different to all strategies above despite it borrows ideas from some. Catallactic aims to create non-fiat commodity backed stablecoins capturing the marginal utility of the underlaying asset. For these Catallactic CryptoCommodity tokens, price would be defined by the issuer and price formation delegated to the exchanges where the CryptoCommodity token is traded. As Stablecoins, CryptoCommodities includes an stabilization mechanism in which supply in the exchanges is paired to physical demand of the commodity for the issuer in a period of time.
From the token collection above, only Stablecoins and CryptoCommodities aim to maintain an stable price and, therefore, hold the potential to become currencies.