ICOs have dominated the cryptocurrency industry for the past three years. They’ve been credited with Ethereum’s growth, a new financing model and a gateway to a decentralized future.

But what are utility tokens? Economically what do they do and what value do they add?

Utility tokens have no real utility and that they’re schemes to extract fees on transactions from a decentralized application. These decentralized applications, in turn, have been able to get little or no traction in the market because of the friction introduced by these tokens.

In other words, this article explains how ICOs, despite being championed as vehicles of value creation, actually destroy value. But before we get to all that, we need to define an important concept: rent-seeking.

Defining Rent-Seeking

Rent-seeking is the process of extracting money from a transaction without adding value. The easiest way to describe rent-seeking is to tax some activity without doing anything useful.

Think of a typical government bureaucrat who rubber stamps whatever comes through, say in the copyright office. That person doesn’t add anything but extracts a tax on these transactions by getting a salary.

Why Rent-Seeking is Attractive

Rent-seeking is popular because there’s not much work or risk involved. People like earning in excess of the work they put in. The bigger the gap, the better. This is why so many Ivy League graduates pursue careers in Banking and Finance despite lacking any particular inclination toward those fields. Those fields are rife with rent-seeking opportunities with enormous wealth potential.

Why Rent-Seeking Exists

The existence of rent-seeking is strange, especially in a supposedly market economy. How is it that someone who is a drag on the economy is allowed to exist in an efficient market? Shouldn’t other companies without rent-seekers destroy the companies with rent-seekers in the free market?

Economies based on fiat money funnel new money to preferred groups, who in turn have an unfair advantage over everyone else. Preferred groups use this advantage to build regulatory moats around their industry and create something akin to a monopoly to essentially force everyone to use them.

This is most obvious in government monopolies such as the public education system and government agencies, but it’s also true of large banks, and through them, large companies. Every large bank gets access to insanely low-interest rates which allows them to re-lend those funds on a fractional-reserve basis for a large, no-risk gain.

If those funds get paid back, they make money, and if it doesn’t get paid back, then they get a nice bailout. Those profits, in turn, go to the rent-seekers who feast off of the heads-I-win-tails-you-lose situation.

ICOs, Democratizing Rent-Seeking!

What ICOs have done is formalized the rent-seeking process. A utility token’s nominal value is the utility value, such as being able to place a bet in a dApp. But due to the dApp being restricted by the token, anyone wanting to use the dApp must go through the holders of the tokens.

Instead of using an existing currency, the peddlers of ICOs offer early buyers the “opportunity” to be a gate-keeper for the dApp. In other words, utility token holders are rent-seekers that get to tax people that want to use the dApp.

Ethereum, Rent-Seeking from ICOs

One might point to Ethereum as an exception to the rent-seeking rule based on the fact that it has been the platform of choice for “successful” ICOs. Ethereum has been successful because it’s taxed every such ICO. Anyone who wants to create an ERC20 token has had to transact in ETH. Every ETH holder is able to rent-seek off of those that want to buy rent-seeking opportunities!

Conclusion

The honest way to build applications would be to use an existing currency like Bitcoin, USD or even ETH. Instead, ICOs are creating their own money and enticing early adopters with rent-seeking potential. This is a Ponzi/Pyramid scheme in a different guise.

Utility tokens are rent-seeking vehicles that doom applications to failure. The sooner people realize their economic purpose, the better off we’ll be.