Buyback System, What it is, and Why it is Beneficial to the Token Holder.
Several crypto projects have explored the concept of token buybacks to transfer value into communities and to token holders. Several projects are testing their versions of trade-offs and buybacks. In a buyback model, a network typically generates income through the circulation of a single currency token. Proceeds are then used to burn the network’s native token. This idea is intended to increase token value by reducing its supply as the income generated grows. Buying back tokens is one way to achieve this goal.
The buyback of shares works in predictable and known ways in the stock market, but buybacks can significantly vary in structures in crypto. This article gives a brief overview of how Buybacks work and why it is beneficial to the token holder.
What is a buyback?
A buyback, also known as a repurchase, is a mechanism whereby a company uses cash resources to re-acquire a portion of its shares in the stock market. In the case of crypto, the company uses cash resources to repurchase its token, thereby reducing the volume of tokens outstanding on the open market.
When a company offers a buyback program, it pays its investors the market price per token to repurchase a portion of tokens, distributed among holders until the day of repurchase.
What happens after the buyback?
After the buyback, a smart contract burns the tokens and deposits them into a wallet without a private key. Therefore, token holders will be able to capture the full amount of profits used for the buyback. According to Vitalik – token value is “backed by the expected value of upcoming fees spent within the system.”
In other words, tokens are similar to “traditional” equity because token holders receive a share of the profits generated by the project, just as shareholders receive dividends.
Similar to stock buybacks, token buybacks involve cryptocurrency projects buying back their tokens from existing holders.
Buybacks Instead of Dividends
Buybacks have been mentioned explicitly as a core aspect of some projects’ business models and token economics. Examples include successful Asian crypto exchanges (Binance, Huobi, Kucoin) and their respective exchange tokens (BNB, HT, KCS).
These exchange tokens have three functions:
1. Exchange method / Trading fee
Trading fees can be paid in tokens by token holders.
2. Discount Mechanism
If token holders pay the trading fees in tokens, they receive a discount on the fees.
3. Buyback Rights/Periodic Payouts
Each exchange pledges to use a percentage of revenues/profits for buybacks regularly.
Binance and Huobi have returned more than $30M in token buybacks due to their respective exchanges’ size and revenues.
Buybacks to Correct Token Allocation
A mаjоr сhаllеngе fоr сrурtосurrеnсiеѕ and ICOѕ is thе allocation оf tоkеnѕ аt the bеginning оf thе рrоjесt. Mаnу projects rеѕеrvе a fixеd аmоunt оf tokens tо inсеntivizе futurе partnerships, dеvеlореrѕ, etc. A роtеntiаl оutсоmе of thiѕ “single allocation” challenge iѕ that thеrе аrеn’t enough tоkеnѕ tо hand оut a few months/years down the linе.
Thаt’ѕ whу some рrоjесtѕ have started buying back tokens in the ѕесоndаrу mаrkеt to mitigаtе this iѕѕuе. Some examples:
Pundi X: Crурtо рауmеntѕ аnd роint оf ѕаlе project Pundi X rероrtеd buying ETH worth *2000 in Junе for itѕ раrtnеrѕhiр rеѕеrvе.
Arаgоn: Aragon iѕ a wеll-knоwn DAO project thаt has been buying itѕ tоkеn rеgulаrlу аnd рubliѕhing quarterly reports.
Promoting long term price stability and value growth
In the current market environment, volatility is higher in digital markets than in traditional markets. Digital economies are still in infancy, so investor confidence is low. Issuers should formulate a clear, compelling, profitable, and stable value proposition within the digital ecosystem to attract investors.
The issuer benefits from buyback and burn programs in four ways: Firstly, once the token’s been listed for secondary trading, the token value will grow, thereby leading to price stability. Secondly, investors will find the token more attractive. Thirdly, buyback-and-burn generates greater liquidity because the secondary market demands higher asset trading on exchanges. Reduced volatility, therefore, results from increased liquidity. HODLing the token further increases its price stability, as buyback-and-burn incentivizes long-term growth investors to hold on to them.
Are buybacks good for token holders?
The reason behind the use of buybacks can be many, including the need to reorganize the allocation process, deflating the number of tokens in circulation due to errors in economic calculations, driving up prices artificially, creating hype, or as a gesture to token holders.
It is common for buybacks to be conducted for internal purposes and decreasing volatility, and improving liquidity. Low supplies stabilize prices over the long term by the law of supply and demand. Furthermore, many available assets result in a negated scarcity principle, which results in lower interest towards them.
All of the reasons for buybacks are subject to criticism, as they immediately arouse a reaction from the community, which starts asking questions regarding the logic behind such decisions. Whatever the criticism, holders of tokens facing buybacks will see them as a chance to sell their tokens, or they will buy more and double down on an investment in anticipation of price appreciation.
Would buybacks be a good idea?
Buybacks have been conducted by companies such as Nexo, Binance, and others. Nexo, for instance, bought back its asset because its core development team believed it was undervalued. Therefore, they decided to reduce the number of project tokens in circulation, which would assist in correcting the market price.
Similar to their counterparts in the financial markets, crypto buybacks are used to reduce the number of digital assets in the circulation of a company. The reasons for such programs are many, but the result is usually a significant boost to the asset’s price.
Buyback mechanisms will become more aggressive in the long run. In addition, there can be no manipulation, and investors can certainly ask for proof of burned tokens. In the end, investors and markets will benefit from less uncertainty, thus promoting long-term price stability and value growth.