Some stocks are literally tokens off the blockchain, and some tokens are literally stocks on the blockchain. They both represent a proportionate ownership in a project or company. So, what distinguishes new crypto traders from new stock traders?
According to the US Securities and Exchange Commission (SEC), an investment contract exists when money is invested in a common enterprise with a reasonable expectation of profits from the efforts of others. Some coins and tokens pass the Howey test and are classified as securities.
Cryptocurrencies like Bitcoin BTC that primarily serve the purpose of replacing fiat currencies are regarded as commodities. In 2017, then-SEC Chair, Jay Clayton warned cryptocurrency exchanges, said that many of their products were likely securities and thus required registration under federal securities laws.
It is a universally accepted principle that before committing funds to any market or asset, one must first study and understand it. What is not specified is the study approach, a comprehensive list of factors to consider, and where to obtain the information.
Stocks are traded in mature markets that have been in existence for more than 100 years, whereas crypto tokens are relatively new, having been in existence for just over ten years. There is a vast body of literature on stock trading and best practices that has stood the test of time, whereas the literature on the crypto industry is a chase after a rapidly changing environment full of innovation and growth.
To get started in the stock market, new investors frequently read books, take an online course, study stocks at a tertiary institution, or work as apprentices. There is plenty of information to help with the dos and don’ts. Most beginner traders in cryptocurrency lack the proper structure for studying and understanding the blockchain world before investing. This results in a trial-and-error approach to learning in which many cryptography beginners make mistakes that novice stock traders do not frequently make.
I acknowledge that some institutions, authors, online creators, and exchanges have created blockchain-focused curricula to help newcomers understand the scope and nature of cryptocurrency projects before investing. However, every couple of weeks, a new innovation in the blockchain world emerges, rendering previous educational content outdated. This is a good type of problem to have, but it has some drawbacks.
Newcomers to the stock market will frequently study the sectors, break down the industries within the sectors, weigh the performance of such industries, and identify individual stocks with the best chance of outperforming their respective benchmark indices.
The crypto market is maturing, and various sectors and/or industries, such as privacy coins, DeFi (decentralized finance) tokens, exchange coins, NFT (non-fungible tokens), metaverse tokens, fan tokens, and stable coins, are rapidly distinguishing themselves. Before investing, new cryptocurrency traders should understand the scope and nature of these classifications.
The profitability of the company in which they are investing is an important consideration for new stock traders. It is common knowledge that inexperienced crypto traders do not view a centralized crypto project as a company and thus overlook its profitability. For example, what is Decentraland’s MANA profitability? How much value is created, and how is it distributed to token holders? I might have an answer for Decentraland, but I can’t say the same for the vast majority of other coins.
The process of creating a crypto token is similar to that of registering a business or company. Its initial value is equal to the founder’s total net assets invested. The company’s future value is determined by the results of its operations and additional capital injections. This means that when a cryptocurrency founder creates a token, they are creating ownership blocks that they can sell or distribute to the community. The value of the token project immediately after token launch is equal to the total value invested by the founder and new token owners.
If a token meets the Howey test, meaning it involves people investing money in the token project, there is a common enterprise, and there is a reasonable expectation of profits derived from the efforts of others, it qualifies as a security and should be registered under securities laws.
If, after the initial token offering, the token founders allocate themselves a significant share of the total tokens available without contributing value, the value per token to the new buyers will be lower than the amount they purchased, which is arguably fraud. However, if the founders can back up their allocation with work done or proprietary assets contributed to the project, it may not be considered fraud.
Tokens should be treated in the same way that a new investor or angel investor would want to know the company’s bottom line and earnings history before investing, in my opinion. It would be appropriate to investigate what the crypto project does to generate value, quantify it, and speculate on the project’s future growth.
This approach would assist new crypto traders in avoiding purchasing tokens designed to defraud them. Of course, there are other factors to consider, such as contract audits and founder experience and track record, but using the above-mentioned approach would help filter out many crypto projects that frequently defraud new investors.
I agree that not all registered firms make or intend to make profits. There are blockchain-based tokens whose purpose is not profit, just as there are charity organizations, non-governmental organizations, and religious organizations, among others.
Tokens are commonly divided into three types: utility tokens, asset or debt tokens, and payment tokens. Asset or debt tokens are frequently regarded as a stake in the same way that holding a share is. Utility tokens serve as a gateway to digital applications, services, and ecosystems. Payment tokens serve as currency. A token can be a utility token, an asset token, or even a payment token.
When stock traders analyze a stock, they take into account the fundamental factors that may affect the stock’s demand and supply, such as market share, competition, consumer trends, and daily active user trends. Newbie crypto investors should take a similar approach, taking into account a token’s market share, competition, and changes in the number of daily active users.
To summarize, considering a token’s business model, financial health, profitability, and user growth rate may go a long way toward ensuring that newbie token investors do not fall for scam projects, as stock traders do.