Crypto exchange tokens

Summary

Focus

Crypto exchange tokens are blockchain-based assets issued by crypto exchanges. These tokens may promise holders discounts on transaction fees and access to certain platform services. They are a major source of funding for crypto exchanges, and at times their combined market value has exceeded US$ 100 billion. Crypto exchange tokens have also been at the core of some of the biggest disruptions in the crypto industry. For example, the exchange token FTT played a central role in the collapse of the FTX platform. Despite the importance of crypto exchange tokens, little is known about their valuation and how their prices are influenced by buyback pledges from the exchange.

Contribution

We derive formulas for the exchange rates of crypto exchange tokens. Our model incorporates key aspects of both the demand and supply sides of this market. On the demand side, we model user demand for crypto exchange tokens as well as demand from (speculative) investors who hope for price appreciation. On the supply side, we include the exchange's pledge to buy back tokens. The environment also captures dynamic aspects, including the potential future growth of the trading platform and the risk of the exchange defaulting on its promises to offer discounts and to buy back tokens (as was the case with the FTX-issued FTT tokens). Our analysis also considers strategic actions by investors to manipulate the price of exchange tokens by restricting their supply.

Findings

Buyback pledges increase the amount raised by selling tokens. However, the additional amount raised is always less than the discounted cost of the buyback pledge. Buyback pledges can also be exploited by large investors, or coordinated groups of small investors, to the detriment of the platform owner. For both of these reasons, buybacks would not be the preferred form of funding for platforms, and their existence should be seen as an indicator of capital market restrictions faced by platform developers or other frictions.

Abstract

Crypto exchange tokens are an important funding source for centralized crypto exchanges, and they have been at the core of some of the biggest disruptions in the crypto industry. We develop a tractable model for the exchange rates of crypto exchange tokens that incorporates user demand, investment demand, and commonly observed pledges by exchanges to buy back tokens. We derive closed-formed solutions for the valuation of exchange tokens and the time required to fulfill the pledge. Buyback pledges increase the amount of funding raised by selling tokens. However, the additional amount raised is always less than the discounted cost of the buyback pledge. Future price manipulation by investors can further increase the cost of the buyback pledge.

JEL Classification: G10, G12, G18

Keywords: asset pricing, cryptocurrencies, exchanges, market manipulation