Where does ADA value come from?

ADA coins have a certain market value which is determined by market supply and demand. Where does this value come from? A significant part of the ADA value is determined by the utility of the Cardano protocol. ADA value is a reflection of decentralization, security, scalability, network effect, adoption, DeFi, trust, and other things. What attracts users can be described in one word as utilities. Some utilities are generally overrated, others underrated. User preferences can change over time.

Note that, for example, security and decentralization are not directly utilities, but rather desirable features (users expect them but do not use them directly); let's refer to them as utilities in this article.

Although the value of cryptocurrencies can be influenced by speculation which is currently a significant factor, in the long run, it will be primarily utilities that will have a decisive impact on the market capitalization of blockchain projects. Moreover, the utility generates profit. Profit is extremely important for the long-term economic sustainability of blockchain projects. There is a link between utilities and sustainability. Let's explore this phenomenon from different aspects.

TLDR

Cardano has more utilities than Bitcoin, so it has a better chance of having a large network effect and generating higher profits. ADA is not just a HODL coin. ADA can be a reserve currency thanks to protocol utilities like token minting and smart contracts. Additionally, ADA generates passive income through staking.

Relationship between the protocol and native coins

The capabilities of the protocol determine what users can do with native coins. These capabilities naturally have a direct effect on adoption, i.e. on the growth of the network effect. Obviously, the better the quality of the individual features and the more utilities a protocol has, the higher the chance that the network effect will grow. The growth of the network effect has an impact on the value of native coins, as the demand for coins increases with the number of users. As demand grows, the market value of coins is likely to rise if their number is digitally limited or their inflation is fixed.

Native coins are usually extremely volatile as demand is constantly falling or rising. Is volatility a useful property? And how does high volatility affect utilities?

High volatility does not allow people to use cryptocurrencies instead of fiat currencies, as most of us require money to be able to retain purchasing power in the short to medium term. When you get a salary, you expect the purchasing power of your salary to not drop by more than, say, 0.1% over the course of a month. A 5% loss in the value of your salaries each month would present existential problems for many people, especially in poorer regions.

High volatility is the reason why a store of value has generally come to be regarded as the main utility of native coins. People believe that despite the huge drops in value in bear markets, in the long run (decades) the value of native coins will grow as new users come in, hence demand will grow.

Members of the cryptocurrency communities are constantly arguing about whether a store of value is the only utility blockchain can offer and whether a single project is enough to do it. Instead of long-winded debates, let's look for answers preferably by considering other utilities.

Utilities are always protocol capabilities. The existence of coins, including the store of value utility, is existentially dependent on the properties and capabilities of the protocol. If something goes wrong with the protocol, the value of the native coins disappears immediately. Simply put, the protocol utilities directly determine the value of native coins.

One of the other basic utilities is the ability of the protocol to transfer value between users. They can store value without an intermediary, which is a general feature of all blockchain networks.

Transferring value quickly and cheaply is more useful than slowly and expensively. The quality of the scalability of the first layer is the utility that will affect the network effect. The better the first layer scales, the faster the network effect can grow and the higher the profit for the network.

Second layers, especially state channel-based networks (lightning networks, Hydra, etc.) will always be existentially dependent on the first layers. If the first layer scales poorly, people will not use the second layer either, as it will be economically expensive and user-unfriendly.

People buy native coins mainly in the hope that other people will come after them to increase demand. That's speculation, belief, or narrative, but it's not directly a utility of the protocol. It can be considered a utility, however, because the store of value is based on other features (utilities) of the protocol such as decentralization or security.

The basic utility of the protocol is the transfer of value, i.e. the transfer of native coins. Let's see in the next paragraph what other utilities the protocol may have and how this may affect the market value of native coins.

Cardano has more utilities than Bitcoin

If we examine the differences between ADA and BTC, we have to look at the protocols, i.e. Cardano and Bitcoin. Native coins are essentially just digital numbers in a ledger and there is no fundamental difference between them.

BTC is primarily a HODL coin. People don't use BTC much to pay, so this utility is a potential option that is not used much in practice (yet). Maybe because most people hold BTC on centralized exchanges and don't know how to use LN. Another reason may be that once the demand for sending transactions increases, transaction fees start to rise and people are not willing to pay them. High volatility and low scalability allow Bitcoin to realize a single utility and that is the store of value. Bitcoin is intentionally simple and can't provide more utility at the first layer (let's ignore the scripting capability that allows BTC to be transferred to LN).

Is the ADA coin a store of value or currency? Most people view ADA very similarly to BTC, i.e. it is a store of value and a potential currency that is currently volatile. From a utility perspective, there is no difference between ADA and BTC. Bitcoin is an older project, so the acceptance of BTC is higher. However, as we said, people don't use this option much yet. Once cryptocurrencies start to be used for payment, merchants would be happy to accept ETH, ADA, and other cryptocurrencies as well.

Cardano is a platform that can offer users multiple utilities. Thus, ADA is not only a HOLD coin, but it can also be a reserve currency, for example. Cardano enables the creation of sophisticated financial services through smart contracts.

One of the existing projects is the algorithmic overcollateralized stablecoin DJED. DJED maintains a peg to the USD, making it much better suited for payments than ADA. ADA coins are used in defined proportion as collateral to allow users to mint DJED.

This gives Cardano an extra utility as each DJED user increases the network effect of the platform. DJED users may not be directly exposed to the high volatility of ADA coins, so they are not typical ADA/BTC holders. Users of stablecoins can be ordinary people from developing countries who need to have a stable currency for payments or remittances. Note that ADA coins are locked in a Djed contract, so there are fewer of them on the open market. This can push the market value of ADA coins up.

Note that higher programmability (compared to Bitcoin) and token minting are two utilities that will influence the growth of the network effect (adoption) and therefore the market value of ADA coins. BTC would be a great reserve coin, but Bitcoin doesn't have the utilities that allowed an algorithmic stablecoin to be created. If BTC was used as collateral for DJED, the network effect of Cardano's network will grow, but at the same time, it will increase the market value of BTC. This is a win-win situation.

DeFi will enable the creation of equivalents to traditional financial services. Similar to DJED, DeFi services will have a positive impact on protocol adoption, which will positively translate into ADA market value. ADA serves as a base payment after fees and also as a reward for SPOs and stakers. The growing adoption of Cardano will naturally reflect in the market value of ADA as there is no other way to be part of the success than to hold ADA.

Each NFT collection or set of tokens for which there will be demand will increase the utility and profit of Cardano. So will every application including DEXes and lending platforms. The potential is huge and we are at a stage where institutions and businesses are just testing the possibilities. Once financial assets are tokenized through blockchain, SC platforms will secure huge capital and enable trading. To some extent, they will take over some of the services offered by banks and other financial institutions. It is not a question of if, but when this will happen.

Cardano employs Proof-of-Stake consensus, which means that all stakers receive regular rewards. Unlike Bitcoin, Cardano has a cash flow. 20% of the fees are put into the Cardano treasury and 80% go to SPOs and stakers. The economic incentives (profit sharing) are set up to encourage people to hold ADA. The success of the platform economically enriches ADA holders.

ADA coins are used as a scarce resource to decentralize the Cardano network. Each staker essentially decentralizes the network and will have decision-making power not only in Catalyst but also in the governance of the project. In the Bitcoin network, the primary voting is through ASIC miners, so BTC holders have no decision rights. ADA holders are stakeholders of the Cardano network.

The link between the protocol and native coins is much stronger in the case of Cardano than in the case of Bitcoin. If the Bitcoin ecosystem is ever going to have higher utilities, it will very likely be at the second layer networks. The profit will go to the second layer holders, but not directly to Bitcoin or BTC holders. Every second layer will siphon off profit even in the case of Cardano, however, due to the higher utility there is a greater chance that the profit will still be relatively high.

The quantity of utilities is not a static property and can grow over time with technological progress and innovation. This applies to all current and future utilities. The IOG team plans to increase the scalability of Cardano so that the quality of the underlying utility will increase. Higher scalability logically increases the chance of higher adoption. Increasing the capabilities of the Plutus platform, token minting, as well as brand new utilities such as decentralized identity will all influence the success of Cardano.

If you think about it, you may find that Bitcoin's success is based 80% on faith (narratives or speculation) and only 20% on utility. For Cardano at the moment, it might be 70% faith and 30% utility. So it's relatively similar. The fundamental difference is that for Bitcoin this ratio will not change much, whereas, for Cardano and other SC platforms, utility and network effects will one day dominate. Thus, success will be based on 80% on technology (utility) and 20% on faith. Faith will not be necessary as everyone will know how many people use Cardano.

Many people tend to compare Bitcoin to Cardano and consider the current state of affairs with the assumption that nothing will change in the next few years. But that is a mistake. Cardano will never be completely finished whereas Bitcoin is talked about in this way. Seeing the world through this lens essentially prevents the recognition of the potential arising from various utilities that humanity did not have before the advent of blockchain. Further, it overlooks technological progress. Cardano gets better every year and offers more utilities. Bitcoin changes very conservatively, but not all would-be conservative innovations improve the protocol in the desired direction. Taproot has so far brought more disappointment than joy, as it (along with SegWit) has been abused to create Ordinals and the BRC-20 standard. While these innovations bring Bitcoin's capabilities closer to SC platforms, they are years behind technologically and are not suitable for building DeFi.

Similarly, it's not smart to point to the current adoption of projects, as that changes literally every day. Ethereum has surpassed Bitcoin in many important metrics. Today, it is impossible to argue that the first-mover advantage cannot be overcome. I dare say that at the level of utilities and adoption, Bitcoin has already been beaten.

Only utilities can ensure economic sustainability

Only utilities can provide sufficient profit for long-term economic sustainability. If the protocol can't collect enough fees to provide security, people will stop trusting it or attackers will destroy it. If digital scarcity and security are to be maintained at the same time, utility is the only way to go.

Both Cardano and Bitcoin have a capped number of native coins and fixed inflation that trends toward zero. Over time, security will increasingly depend mainly on the utility. The problem is that HOLD does not generate any profit. In a decentralized world, no one will subsidize security out of their own pocket in the long run. Especially when there will be competition with other digitally scarce coins.

One day, blockchain projects will fight each other mainly for users, i.e. for fees. The more utilities and users, the greater the chance of making a large enough profit to maintain a security budget.

High security is considered one of the biggest advantages of Proof-of-Work (PoW). The advantage can become a disadvantage when there is not enough budget to pay the miners. They will shut down ASIC miners and Bitcoin security will gradually decrease to the point where it will be very cheap to commit a 51% attack. PoW has one major drawback, the cost of security is very high and difficult to sustain economically.

Many points out that without a higher utility, it is not possible to provide security and scarcity at the same time. One of the most likely scenarios is to break the contract with users and introduce infinite inflation of BTC coins, i.e. reduce scarcity and save security.

Cardano has a significantly lower cost of security, as it is provided through modern cryptography and decentralization, i.e. the distribution of ADA coins among users. Still, it is theoretically possible that the reward budget for SPOs and stakers will decrease. If stakers are not satisfied with the rewards, they might start selling ADA coins, thus decreasing decentralization and hence security.

Fortunately, the team and the community are aware of these principles and are purposefully building the protocol to be as useful as possible. The chances of keeping the budget sufficient are very high.

Some protocols burn coins (part of the fees), which artificially reduces the number of coins in circulation and can affect the higher market value of the coins. This can keep the security budget higher. Coin burning can be implemented for PoS networks, but probably not for PoW networks with low scalability.

Conclusion

Currently, Bitcoin and Cardano are not competing, as BTC is primarily an asset for holding capital while SC platforms compete with each other for DeFi users. However, the platforms' native coins are also seen as a store of value. Bitcoin can only transfer value, slowly and relatively expensively. Moving to the second layer requires on-chain fees. DeFi services are relatively similar to each other across platforms and in the long run, user-friendliness is likely to be the main deciding factor.

We estimate that within 10-20 years all blockchain networks will start competing with each other for profit. This can only be achieved through utilities. Neither HODL nor staking generates profit. Profit can only be generated through services and users who are willing to pay for services. Fast and cheap services will be preferred, not expensive and inefficient ones. The winner will be decided 90% by technology, and only 10% by faith.

People sometimes ask if the value of ADA coins or other cryptocurrencies will rise or fall. If Cardano's utility grows, the number of users will grow and thus the value of ADA will grow. However, let's not forget that Cardano is not the only protocol in the world and that the blockchain industry is highly competitive. Use Cardano, try DeFi, and feel free to buy NFT. This will increase its chances of success.