How to invest in Cryptocurrencies - A model of value capture in decentralized application ecosystem

The scale of investments raised by Initial Coin Offerings (ICO) has generated a debate on how to value Crypto coins and what ICO’s to invest in. We first present a contrast against traditional monopoly platform to highlight the potentially revolutionary benefits of decentralized Proof of Work (PoW) crypto platforms. A monopoly investor profits from collection of transaction fee revenue (Operational Value) in every period while a PoW investor extracts a one time Turnover Value by sale of tokens. Unlike a monopoly, PoW’s Turnover Value driven revenue mechanism does not incentivize investment in platform quality. PoW’s potential to expand user surplus by banishing monopoly control over transaction fee is diluted by a low investment in platform quality. Proof of Stake (PoS) which promises to eliminate PoW’s wasteful puzzle solving turns out to instead raise the fees for users. From an investors point of view PoS allows monetization of both Operational Value and Turnover Value, thus a preferable alternative in most cases. PoS platforms, as a middle ground between PoW and monopolies, are best bet to disrupt existing monopoly intermediaries.

We further assess partition of value between decentralized protocols (Bitcoin, Ethereum, EoS) and applications (Augur, CryptoKitties, uPort) on top of them. Our model supports the Fat Protocol hypothesis i.e. larger value capture in protocols. We independently show three contributing factors - first mover advantage in setting platform design by protocol investor, Store of Value characteristic of protocol tokens and direct network effects. We also present empirical evidence in the form of two prevalent phenomenon - Ecosystem Funds and Protocol Forking. Investors looking for the Amazon’s and Google’s of the decentralized era must look to high quality Proof of Stake protocols with a vision to either create or subsidize creations of applications.