Token Buybacks: Design or Despair?

Friday, November 9, 2018

Similar to stock buybacks, token buybacks involve a cryptocurrency project buying back its tokens from existing holders. We’ve come across a number of examples and have divided the token buybacks into three categories:

Buybacks Instead of Dividends

Some projects have explicitly mentioned buybacks as a core feature of their business and token economics. The best examples are the successful Asian crypto exchanges (Binance, Huobi, Kucoin) and their respective exchange tokens (BNB, HT, KCS).

These exchange tokens have three functions:

  1. Medium of Exchange / Trading Fee
    Token holders can choose to pay their trading fees in tokens.
  2. Discount Mechanism*
    If token holders pay the trading fees in tokens, they receive a discount on the fees.
  3. Buyback Rights / Periodic Payouts
    The exchanges pledge to use a percentage of revenues/profits for buybacks on a regular basis.

Given the large volumes and revenues generated by these exchanges, the token buybacks have been substantial with Binance and Huobi returning more than $30M back to token holders.

Projects with pledged buybacks

ExchangeQuarterly20% of profitsBurn~ $30M
ExchangeQuarterly20% of RevenuesLocked in Reserve~ $35M
ExchangeQuarterly10% of ProfitsBurn~ $1M
Asset mgmtContinuousVariesBurnN/A

After the buyback, the tokens are burned by a smart contract and/or deposited into a wallet with no private key. As a result, the profits used for the buyback should – theoretically speaking – be fully captured by token holders. In the words of Vitalik – the token’s value is “backed by the future expected value of upcoming fees spent inside the system”.

Or, put simply: the tokens are similar to “traditional” equity because the buybacks ensure that token holders receive (part) of the profits created by the project – just like dividends paid to shareholders**.

Buybacks to Correct Token Allocation

One of the biggest challenges of cryptocurrency projects and ICOs is the initial token allocation. Many projects reserve a fixed amount of tokens to incentivize future partnerships, developers etc. A potential outcome of this “one shot allocation” challenge is that there aren’t enough tokens to hand out a few months/years down the line.

That’s why a handful of projects have started buying back tokens in the secondary market to mitigate this issue. Some examples:

Aragon: The well known DAO project Aragon has been buying its token on a regular basis and has published quarterly reports and guidelines.

Pundi X: The crypto payments and point of sale project Pundi X reported buying ~2000 ETH worth of tokens in June to be put into a partnership reserve.

Buybacks as a Signal?

While the first two categories of buybacks are predefined and/or strategic, the last category involves opportunistic buybacks. The cryptocurrency “bear market” hasn’t been kind to most projects, with some tokens trading 75% below their original sale price.

As a result, some cryptocurrency projects have started buying their own tokens stating that they believe their project is undervalued:

  • DeepBrainChain: an AI and data platform that raised $12M, announced a buyback of 40 million of its own tokens in March (~$1.6M) because “the current value is underestimated”. The token has declined 65% since…
  • TokenPay: a banking and merchant payments platform that raised $23M bought back 810,000 (~$2.4M) in June stating that they “firmly believe that today’s market value of TokenPay is extremely undervalued”. TokenPay is trading 60% lower now…
  • CPChain: an IoT platform that raised $30M in an ICO announced a plan last week to buy back 13% of its tokens (~$2.5M***) over the next few months. These tokens are not burned, and CPChain explicitly mentions that this decision “will allow the CPC token to retain value by being removed from current market conditions”.

At face value, buybacks can be a positive signal. A team believes its project is undervalued and is confident that they will deliver. But you could argue that what’s missing from the equation is the founders purchase more tokens, instead of just using the project’s treasury. Just take a look at Elon who can’t get enough of Tesla stock…

What’s more plausible in our opinion is that these buybacks serve as proof that the projects raised too much during their ICO, are failing to develop anything useful, and don’t know what to do with their cash balances…

We’ll keep monitoring this area more closely to collect more data, but feel free to send us examples if you come across them!

Additional Notes:
*Discounts: An additional function of the discount mechanism is that incentivizes the holders to pay with the tokens, making the tokens a (substantial) part of revenues. The exchange can can simply burn some of the tokens it received as trading revenue, instead of having to conduct market transactions to buy back the tokens.

**Many projects have shied away from dividend-issuing tokens because of regulatory reasons (dividends = equity = regulation) and/or infrastructure (you need a central trusted party to issue dividends).

***Values estimated using closing prices on the day of buyback announcement