Today I'm going to be discussing appcoins; this can be considered a part 1 that will be followed shortly by a deeper discussion of Steem. First, I'd like to refer you to some dependencies:

1. App Coins and the Dawn of the Decentralized Business Model
2. The Golden Age of Open Protocols
3. Appcoins Are Snake Oil
4. On Tokens and Crowd Sales

Introduction

Appcoins are back! The spectacular rise and fall of the DAO has pseudo-legitimized the role of appcoins as both a funding tool and speculative financial asset in the consciousness of crypto-currency developers and investors. 

Appcoins can be loosely defined as application-specific token used to incentivize behavior and/or raise money for the development of the application.

The concept of appcoins have existed for years in the form of casino chips and in-game currency. However, the term 'appcoin' more specifically refers to tokens created on a decentralized protocol. Appcoins can take one of these forms:

1. Altcoin. The appcoin is the token for its own blockchain.
2. Metacoin. The appcoin is a token created on top of an existing blockchain, via a smart contract (in Ethereum) or through a secondary protocol (e.g. Counterparty layered on top of Bitcoin).

Altcoin-based appcoins come with significant challenges including supporting a development team to continually maintain the protocol, mining, and all of the security considerations that Bitcoin has endured and overcome in the past 7 years. This is in addition to any unique challenges arising from major technical differences from Bitcoin (i.e. Turing-complete scripting language, zero-knowledge proofs, proof of work/stake algorithm).

Metacoin-based appcoins leverage the security of an existing blockchain such as Bitcoin or Ethereum to create and transfer tokens. This works by embedding metadata into the blockchain via ordinary layer-1 transactions, which the appcoin’s wallet and application can parse. Sidechains and sidecoins are conceptually similar, but technically different in implementation, and are yet to be released.

Why Appcoins?

Appcoins are typically created for two reasons:

1. Incentives. To incentivize behavior from individuals in the application and mitigate free-rider issues common in decentralized systems.
2. Funding. To fund and reward the developers and early-adopters of the app. The developers and early-adopters of the app are usually large stakeholders of the token. Through a pre-sale of unassigned tokens, money is raised that will be spent developing the app (hopefully). A market value of the token is assigned in the pre-sale, increasing the asset value for developers, early-adopters, and speculators.

Trouble Ahead?

TheDAO has propelled the idea that appcoins are legitimate mechanism for developers to fund open source projects, especially where centralized financial incentive models are difficult to replicate. However, it hasn’t stopped there. The new narrative is that appcoins can be used by any and all businesses to fundraise, promote engagement with customers, and speculate on the value of the business pre-IPO on a cryptocurrency stock exchange.

My initial reaction to both of these ideas is extreme skepticism, bordering on fetal-position inducing terror. 

Appcoins may be a recipe for disaster for developers, consumers, families, the environment, the orbit of the planets… but it just might be the way of the future, for better or worse.

Incentives: Money and Tokens

Hypothesis: the market will reject appcoins if they offer only marginal benefits over money.

Bitcoin is money, and it is better money than government fiat because it overcomes regulatory and institutional friction (among other things). Where there is friction in the movement and use of money, money substitutes are created (i.e. tokens). The three best examples (non-cryptocurrency) I can think of are:

1. Precious metal certificates (paper dollars).  In the case of precious metal certificates and paper dollars - 100+ years ago - people couldn't easily carry small or large quantities of gold or silver. To work around this, trusted institutions kept client and interbank ledgers to record the balances of specie and liabilities, which were easily transferred via bank notes, certificates, and paper dollars.  
2. Casino chips. Casino chips make the movement or large sums of money within a physical location trivial with only a few tokens in hand, and are an excellent example of a location-based platform token. Chips also facilitate rapid handling and processing at various tables/games in the Casino itself.
3. Game coins (e.g. Pokécoins). Pokécoins make the purchasing of multiple in-game items fast, cheap, and convenient by minimizing the number credit card transactions required and corresponding overhead.

In summary, these tokens solve real problems associated with the use of money in the marketplace or within an institution. With this in mind, we must ask this fundamental question for each appcoin:

Is there some technological barrier with fiat dollars or Bitcoin that prevents real money from being used to incentivize behavior within the app? 

If so, is this friction greater than the trouble of exchanging an appcoin for money? Assuming the answer is yes to both questions, any potential buyer of the appcoin should seek out expert independent verification that this is truly the case before spending their money... and I have yet to see an example.

Fundraising: Speculation and Expectations

If appcoins aren't solving some unique technical challenge that fiat dollars or Bitcoin cannot overcome, they will still find utility as a speculative financial asset created by developers to raise funds. In many ways, this may emerge as the 21st century 'stock market'.

Stock in a corporation is comprised of different classes of shares, which are financial securities entitling individuals or institutions an ownership stake, as well as various privileges. The value of the individual shares can rise or fall depending on multiple factors, but are often driven by speculation and expectations on the current and future prospects of the company. The process of forming a corporation and issuing stock is heavily burdened with legal costs and regulatory requirements, and is subsequently a capital-intensive exercise. Even after shares are issued, not everyone can purchase them.

Appcoins bypass this legal and regulatory overhead, allowing anyone to trivially raise funds and buy into the application. Unlike stock, appcoins don't always entitle bearers to an equity stake of the application, but this depends on how closely it is tied to the appcoin itself. Unlike stock, if the application fails, appcoins do not entitle the bearers any claim on assets owned by the application or the developers of the application. However, similar to stock, the price of the appcoin will largely be driven by speculation and expectations on the current and future prospects of the application. In fact the long-term price of the appcoin is significantly tied to the strength of the application's network effect and popularity.

Interestingly, if the application is open source, the following factors may influence the appcoin price:

• Frequency of code commits
• Size and quality of code commits
• Metrics on the application's adoption
• Code contributions by high-powered developers

But is this a legitimate means of fundraising, or have we merely lowered the barriers-to-entry for running a pump-and-dump scheme? 

If the appcoin or the underlying application is attempting to be used a digital currency, it has to compete with the likes of Bitcoin, which has the largest network effect and strongest security of any cryptocurrency... so it's more than likely to fail and be a scam. Moreover, many appcoins are sold for Bitcoin to begin with and build their market price off its exchange-liquidity with Bitcoin.

But what about appcoins that aren't trying to be digital currencies, at least directly? Steem falls into this category, which I will cover in great detail in my follow-up article.

In summary, if you wouldn't buy a penny stock, don't buy an appcoin.

Conclusion

I tend to think that if your appcoin isn't solving some technical challenge that fiat dollars or Bitcoin can't solve, then you're essentially creating a penny stock to pump-and-dump, and your appcoin probably isn't necessary.

One only needs to look at BitTorrent, one of the most successful decentralized protocols, to see that money and speculation aren’t the only ways to incentivize the development, growth and adoption of a project… they're not even the best ways sometimes (notwithstanding the excellent Joystream project). But if you are going to incentivize behavior, do it with money. I remain extremely skeptical of appcoins, and firmly resistant any suggestion for OpenBazaar to follow this path.

Despite my skepticism and apprehension, appcoins may take off as the dominant way to raise funds for projects and early-stage startups. Caveat emptor.

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Hold on, what about Steem? Check back soon for my analysis!