Value-Leaking Protocols and Security Tokens

The creation, accumulation and exchange of value via protocols is one of the most important attributes of the crypto ecosystem. From fat to thin protocols, the dynamics of crypto-networks are centered on the transferability of value across different parties and those dynamics permeate into higher level components such as DApps. Security tokens are, arguably, the first group of blockchain protocols that have bypassed the value creation architecture of public blockchains. In the current generation of security token solutions, the protocol layer captures little to no value which creates an increasing friction with the underlying blockchain layers. I like to refer to this dysfunctional dynamic as value leaking protocols and I think is one of the biggest existential challenges to the security token ecosystem.

Joel Monegro’s Fat Protocols thesis became one of the seminal papers in the first generation of blockchain applications. If you read this blog, you know that I disagree with many of the premises of the fat protocol thesis and I’ve written several papers refuting some of its core ideas. However, I would be the first one to acknowledge that there is an important subset of the fat protocol ideas that have held true across the evolution of the blockchain ecosystem. One of those foundation ideas state that, in blockchain applications, the protocol layer will accumulate some form of value. I explicitly state “some form of value” because I think that the idea that the lower protocol layers will accrue the biggest value is highly questionable and technologically and economically flawed. From that perspective, the different layers of protocols enabling a DApp will capture value in distinct but correlated ways. For instance, the value created in an utility token transfer has some correlation with the value captured by the ERC20 protocol which has some correlation with the value created by the Ethereum network.

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