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On medium-of-exchange token valuations

Vitalik Buterin
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Network medium of exchange token: a token economy in which there is a set of sellers and buyers with purchase protocols and each transaction must be completed with the specified tokens

  1. This is very simple if the sole sellers are the developers of the network. In this case, the developers exchange their product for some agreed upon number of tokens.
  2. It is not quite as simple with a broader set of sellers. After developers build the network, sellers enter the network and sell their goods for some amount of tokens that is greater than the amount required to produce the good.

Key Problem:

  • There must be a continuous stream of willing buyers and sellers. Otherwise, the token will not have value.
  • If we consider the traditional economic definition of the quantity theory of money, MV = PT, we can apply it to a token economy. We see that an equilibrium must be maintained in order for users not to get cheated.
  • Additionally, holding time (in place of transaction volume) is critical for driving token value. Thus, medium of exchange tokens are always at risk of collapse.

How to avoid collapse:

  • Developers must establish token supply sinks (reductions in token quantity over time), which in essence, creates a consistent rather than arbitrary fee for users.
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