Demystifies the link between VDAs and blockchains
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Although there is growing acceptance around the unsustainable value of VDAs, the topic is still full of jargon and is somewhat inaccessible to the wider public. There are also still critics who often consider VDAs to be ponzi schemes with no underlying value. This article attempts to break down the true value of VDAs in a simple way.
How are VDAs and blockchains connected?
To understand the value of VDAs, it is first important to understand what a blockchain is. One can think of public blockchains as digital ledgers, similar to online spreadsheets, shared across and maintained by a network of participants who view and validate the stored data.
Such blockchains enable participants to trade with each other on the network without the involvement of a central server, and all these transactions are recorded on the database in a distributed manner by several network computers. These computers are called nodes. They initiate transactions at the request of network participants and verify transactions initiated by other nodes.
VDAs play a fundamental role in the functioning of public blockchains. They create incentives and disincentives for nodes and other network participants to engage in the blockchain, productively.
For example, on the Polygon network, MATIC is used to pay nodes for services such as sending transactions or running smart contracts. Without MATIC, the entire system would not work as nodes would have no incentives to engage in the network. Likewise, to discourage malpractice, blockchain networks utilize mechanisms such as “proof of stake”.
Nodes validating a transaction must “bet” their VDAs and risk losing some or all of them if they engage in fraud. Many blockchains actually destroy one’s efforts as a punishment for a provable attempt to destroy consensus data.Determine the value of VDAs
Clearly, VDAs are fundamental to the functioning of any public blockchain. No transaction can be initiated on such blockchains without VDAs. At their core, VDAs enable the transfer of value digitally without the involvement of a third party, with assets native to the internet. This is something that has so far been impossible. Therefore, the fact that VDAs have value is clear beyond doubt. However, given their newness, the process of determining this value is slightly different from traditional assets, as their cash flows are not as predictable. Like any other asset, the underlying value of VDAs depends on several factors such as core characteristics, demand, supply, network effects and utility.
The importance of scarcity, fungibility and durability in VDAs
The core characteristics of VDAs are critical in determining their value. These properties include scarcity, fungibility, durability, portability, security, decentralization, programmability, and the use case of the underlying blockchain. Each of these characteristics plays a crucial role in determining the value of a VDA. For example, scarcity is an important feature that makes Bitcoin valuable. It has a limited supply of 21 million coins, which ensures that it maintains its value over time.
The role of network effects and tools in VDA valuation
Another factor that is key to the value of cryptoassets is the network effect and the utility it offers on the blockchain. Crypto-assets are the key mechanism by which blockchains encourage players to engage constructively with the network and build on it. The more developed the use cases and network effects of a particular blockchain, the more valuable its original token will be, resulting in higher earnings for participants who hold it. This drives participants to strengthen the robustness and value proposition of the blockchain they are invested in. If participants see no value in acquiring the token, there is no reason for them to be part of the blockchain and such a network will cease to exist. As a natural consequence, if the network is robust and the blockchain has a good value proposition, its original token will have value. The transfer of tokens in the secondary market is also involved here and contributes to the value of the token, as a consequence of which it strengthens the blockchain.
How demand and institutional adoption affect VDA value
The demand for VDAs is another important factor in determining the value of cryptoassets. On-chain metrics such as active addresses, exchange wallet flows, adjusted trade volumes, hash rates, and funding rates can be used to gauge demand. Institutional adoption also reflects the value of a crypto-asset. If a crypto-asset is widely adopted by institutions, it is likely to have a higher value than one that is not.
Transparent supply: A unique characteristic of cryptoassets
While some factors affecting valuation are apparently harder to determine in the crypto ecosystem, other factors such as supply are more transparent in this area compared to other traditional assets. Most cryptoassets have defined and open guidelines for their supply. In the case of Bitcoin for example, based on consensus rules, new supply is created as miners receive block rewards, with a gradually decreasing amount of Bitcoin added to the total supply and distributed to a miner approximately every ten minutes. Block rewards are halved roughly every four years, and the supply is limited to 21mm bitcoin in total. After 21mm of bitcoin have been mined, miners are expected to continue validating transactions on the network in exchange for a portion of the network fees.
Conclusion: The Future of VDAs and Blockchain
VDAs are a transformative technology that enables never-before-seen use cases. They have intrinsic value and it is to both India’s and Indians’ advantage to engage with them as they form the basis of public blockchains. By working together, we can ensure that this technology is used to its full potential to create a better economic future for everyone.
(The author is Chief Public Policy Officer, CoinDCX)
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