Tokens cannot provide compound interest; where are the real investment opportunities?

Original Title: Why Tokens Can't Compound

Original Author: Santiago Roel Santos, Founder of Inversion

Original Compiler: Luffy, Foresight News

At the time of writing this article, the crypto market is experiencing a crash. Bitcoin has touched the $60,000 mark, SOL has dropped back to the price level during the FTX bankruptcy asset liquidation, and Ethereum has also fallen to $1,800. I won't elaborate on the long-term bearish arguments.

This article aims to explore a more fundamental question: why tokens cannot achieve compound growth.

For the past few months, I have maintained the view that, from a fundamental perspective, crypto assets are severely overvalued. Metcalfe's Law cannot support the current valuations, and the divergence between industry applications and asset prices may persist for years.

Imagine this scenario: "Dear liquidity providers, the trading volume of stablecoins has increased 100 times, but the returns we bring to you are only 1.3 times. Thank you for your trust and patience."

What is the strongest objection among all these? "You are too pessimistic and do not understand the intrinsic value of tokens; this is a completely new paradigm."

I am precisely aware of the intrinsic value of tokens, and that is the crux of the problem.

The Compound Engine

Berkshire Hathaway's market capitalization is now about $1.1 trillion, not because Buffett's timing is precise, but because the company has the ability to achieve compound growth.

Every year, Berkshire reinvests its profits into new businesses, expands profit margins, and acquires competitors, thereby increasing the intrinsic value per share, and the stock price rises accordingly. This is an inevitable result because the economic engine behind it is continuously growing.

This is the core value of stocks. It represents ownership of a profit-reinvesting engine. After management earns profits, they will allocate capital, plan for growth, cut costs, and buy back shares. Every correct decision becomes the cornerstone for the next growth, forming compounding.

$1 growing at a 15% compound rate for 20 years will become $16.37; $1 stored at a 0% interest rate for 20 years will still be $1.

Stocks can convert $1 of profit into $16 of value; whereas tokens can only convert $1 of transaction fees into $1 of transaction fees, with no appreciation.

Show Me Your Growth Engine

Let’s take a look at what happens when a private equity fund acquires a company with an annual free cash flow of $5 million:

First Year: Achieves $5 million in free cash flow, management reinvests it into R&D, builds a stablecoin fund custody channel, and pays off debt—these are three key capital allocation decisions.

Second Year: Each decision generates returns, and free cash flow increases to $5.75 million.

Third Year: The earlier gains continue to compound, supporting a new round of decision implementation, and free cash flow reaches $6.6 million.

This is a business growing at a 15% compound rate. The $5 million grows to $6.6 million, not because of market sentiment, but because every capital allocation decision made by people empowers each other and progresses layer by layer. If this continues for 20 years, $5 million will eventually become $82 million.

Now let’s see how a crypto protocol with an annual fee income of $5 million develops:

First Year: Earns $5 million in fees, all distributed to token stakers, with funds completely flowing out of the system.

Second Year: Perhaps it can still earn $5 million in fees, provided users are willing to return, and then still all distributed, with funds flowing out again.

Third Year: The amount of income depends entirely on how many users are still participating in this "casino."

There is no compounding to speak of because there was no reinvestment in the first year, and naturally, there will be no growth engine in the third year. Relying solely on subsidy programs is far from enough.

Token Design Is Like This

This is not a coincidence, but a legal strategy design.

Looking back at 2017-2019, the U.S. Securities and Exchange Commission conducted a thorough investigation of all assets that appeared to be securities. At that time, all lawyers advising crypto protocol teams gave the same advice: never let tokens look like stocks. Do not grant token holders cash flow rights, do not allow tokens to have governance rights over core R&D entities, do not retain earnings, and define them as utility assets rather than investment products.

Thus, the entire crypto industry deliberately drew a line between tokens and stocks in their design. No cash flow rights to avoid seeming like dividends; no governance rights over core R&D entities to avoid seeming like shareholder rights; no retained earnings to avoid seeming like corporate treasury; staking rewards are defined as network participation returns rather than investment income.

This strategy has been effective. The vast majority of tokens have successfully avoided being classified as securities, but at the same time, they have lost all possibilities of achieving compound growth.

This asset class has been deliberately designed from its inception to be incapable of creating the core action of long-term wealth—compounding.

Developers Hold Equity, You Only Hold "Coupons"

Every leading crypto protocol corresponds to a profitable core development entity behind it. These entities are responsible for developing software, controlling the front-end interface, owning brand rights, and connecting enterprise cooperation resources. And what about token holders? They can only obtain governance voting rights and fluctuating rights to fee income.

This model is ubiquitous in the industry. Core development entities control talent, intellectual property, brands, enterprise cooperation contracts, and strategic choices; token holders can only obtain fluctuating "coupons" linked to network usage and the "privilege" to vote on proposals that are increasingly ignored by the R&D entity.

It is not hard to understand why when Circle acquires a protocol like Axelar, the acquirer buys equity in the core development entity, not the tokens. Because equity can compound, tokens cannot.

The lack of clear regulatory intent has fostered this distorted industry outcome.

What Exactly Do You Hold

Setting aside all market narratives and ignoring price fluctuations, let’s see what token holders can truly obtain.

By staking Ethereum, you can earn about 3%-4% returns, which are determined by the network's inflation mechanism and dynamically adjusted based on the staking rate: the more stakers there are, the lower the returns; the fewer stakers there are, the higher the returns.

This is essentially a floating interest rate coupon linked to the protocol's established mechanism, not a stock, but a bond.

Indeed, the price of Ethereum may rise from $3,000 to $10,000, but the price of junk bonds may also double due to narrowing spreads, which does not make it a stock.

The key question is: what mechanism drives your cash flow growth?

The cash flow growth of stocks: management reinvests profits to achieve compound growth, with the growth rate = capital return rate × reinvestment rate. As a holder, you participate in an ever-expanding economic engine.

The cash flow of tokens: entirely depends on network usage × fee rate × staking participation, and what you receive is merely a coupon that fluctuates with block space demand; there is no reinvestment mechanism in the entire system, nor is there an engine for compound growth.

The significant price fluctuations lead people to mistakenly believe they hold stocks, but from an economic structure perspective, what people hold is actually a fixed income product, with an annual volatility of 60%-80%. This is simply unappealing on both ends.

The vast majority of tokens, after accounting for inflation dilution, have an actual yield of only 1%-3%. No fixed income investor in the world would accept such a risk-return ratio, but the high volatility of these assets always attracts waves of buyers, which is a true reflection of the "greater fool theory."

The Power Law of Timing, Not the Power Law of Compounding

This is why tokens cannot achieve value accumulation and compound growth. The market is gradually becoming aware of this; it is not foolish but is starting to shift towards crypto-related stocks. First, digital asset treasury bonds, and then more and more funds are beginning to flow into companies that use crypto technology to reduce costs, increase revenue, and achieve compound growth.

Wealth creation in the crypto space follows the power law of timing: those who make a fortune are those who bought early and sold at the right time. My own investment portfolio also follows this rule; crypto assets are referred to as "liquidity venture capital" for a reason.

Wealth creation in the stock market follows the power law of compounding: Buffett did not make money by timing his purchase of Coca-Cola, but by holding it for 35 years, allowing compounding to take effect.

In the crypto market, time is your enemy: hold too long, and your gains will evaporate. High inflation mechanisms, low circulation, high fully diluted valuations, combined with insufficient demand and an oversupply of block space, are all important reasons behind this. Super-liquid assets are one of the few exceptions.

In the stock market, time is your ally: the longer you hold a compound growth asset, the more substantial the returns brought by mathematical laws.

The crypto market rewards traders, while the stock market rewards holders. In reality, far more people become wealthy by holding stocks than by making money through trading.

I must repeatedly calculate these data because every liquidity provider will ask: "Why not just buy Ethereum directly?"

Let’s pull up the performance of a compound growth stock—Danaher, Constellation Software, Berkshire—and compare it to Ethereum's performance: the curve of compound growth stocks steadily rises to the right because the economic engine behind them is growing every year; whereas Ethereum's price fluctuates wildly, cycling back and forth, with the final cumulative returns entirely dependent on your entry and exit timing.

Perhaps the ultimate returns of both will be comparable, but holding stocks allows you to sleep soundly at night, while holding tokens requires you to be a market-predicting prophet. "Long-term holding beats timing the market" is a truth everyone understands, but the challenge lies in truly sticking to holding. Stocks make long-term holding easier: cash flow supports stock prices, dividends give you the patience to wait, and buybacks continue to compound during your holding period. The crypto market makes long-term holding incredibly difficult: fee income dries up, market narratives change, and you have no support, no price floor, no stable coupons, only a belief.

I would rather be a holder than a prophet.

Investment Strategy

If tokens cannot compound, and compounding is the core way to create wealth, then the conclusion is self-evident.

The internet has created trillions of dollars in value; where did this value ultimately flow? Not to protocols like TCP/IP, HTTP, or SMTP. They are public goods, immensely valuable, but cannot bring any returns to investors at the protocol level.

Value ultimately flows to companies like Amazon, Google, the Metaverse, and Apple. They build businesses on top of the protocols and achieve compound growth.

The crypto industry is repeating this mistake.

Stablecoins are gradually becoming the TCP/IP of the currency field, highly practical and with a high landing rate, but whether the protocol itself can capture matching value remains to be seen. USDT is backed by a company with equity, not just a simple protocol, which holds important implications.

Those companies that integrate stablecoin infrastructure into their operations, reduce payment friction, optimize working capital, and cut foreign exchange costs are the true entities of compound growth. A CFO who can save $3 million annually by switching cross-border payments to a stablecoin channel can reinvest that $3 million into sales, product R&D, or debt repayment, and that $3 million will continue to compound. As for the protocol facilitating this transaction, it only earns a fee, with no compounding involved.

The "fat protocol" theory posits that crypto protocols will capture more value than application layers. But seven years later, public chains occupy about 90% of the total market capitalization of crypto, yet their fee share has plummeted from 60% to 12%; application layers contribute about 73% of fees, yet their valuation share is less than 10%. The market is always efficient, and this data speaks for itself.

The market is still obsessed with the narrative of "fat protocols," but the next chapter of the crypto industry will undoubtedly be written by crypto-enabled stocks: those companies that have users, generate cash flow, and whose management can leverage crypto technology to optimize business and achieve higher compound growth rates will far outperform tokens.

Robinhood, Klarna, NuBank, Stripe, Revolut, Western Union, Visa, Blackrock—these companies' investment portfolios will certainly outperform a basket of tokens.

These companies have real price support: cash flow, assets, customers, while tokens do not. When the valuation of tokens is inflated to ridiculous multiples based on future income, the extent of their decline can be imagined.

In the long run, be bullish on crypto technology, choose tokens cautiously, and heavily invest in the stocks of those companies that can leverage crypto infrastructure to amplify advantages and achieve compound growth.

The Frustrating Reality

All attempts to solve the token compounding issue inadvertently confirm my viewpoint.

Those decentralized autonomous organizations attempting to make actual capital allocations, such as MakerDAO buying treasury bonds, establishing sub-DAOs, and appointing specialized teams, are slowly reshaping corporate governance models. The more a protocol seeks to achieve compound growth, the more it must align itself with the form of a corporation.

Digital asset treasury bonds and tokenized stock packaging tools cannot solve this problem either. They merely create a second claim on the same cash flow, competing with the underlying tokens. Such tools do not enable protocols to become better at compounding; they simply redistribute returns from token holders who do not hold the tool back to those who do.

Token burning is not the same as stock buybacks. Ethereum's burning mechanism is like a thermostat with a fixed temperature, unchanging; whereas Apple's stock buyback is a flexible decision made by management based on market conditions. Intelligent capital allocation and the ability to adjust strategies according to market conditions are the core of compounding. Rigid rules cannot generate compounding; flexible decisions can.

And what about regulation? This is actually the most worth discussing part. The reason tokens cannot compound today is that protocols cannot operate in the form of a corporation: they cannot register as companies, cannot retain earnings, and cannot make legally binding commitments to token holders. The "GENIUS Act" proves that the U.S. Congress can incorporate tokens into the financial system without stifling their development. When we have a framework that allows protocols to operate using corporate capital allocation tools, it will become the biggest catalyst in the history of the crypto industry, with an impact far exceeding that of Bitcoin spot ETFs.

Until then, smart capital will continue to flow into stocks, and the compounding gap between tokens and stocks will continue to widen each year.

This Is Not a Bearish Stance on Blockchain

I want to make it clear: blockchain is an economic system with limitless potential and will become the underlying infrastructure for digital payments and intelligent commerce. My company, Inversion, is developing a blockchain precisely because we believe in this deeply.

The issue lies not in the technology itself, but in the economic model of tokens. Today's blockchain networks merely transfer value rather than accumulate and reinvest it for compounding. But this situation will eventually change: regulation will continue to improve, governance will mature, and some protocol will find a way to retain and reinvest value like excellent companies do. When that day comes, tokens will essentially become stocks, aside from their name, and the engine of compounding will officially start.

I am not bearish on that future; I just have my own judgment about when it will arrive.

One day, blockchain networks will achieve value compounding, and until then, I will choose to invest in those companies that leverage crypto technology to achieve faster compounding growth.

I may make mistakes in timing; the crypto industry is a system with adaptive capabilities, and that is one of its most valuable traits. But I do not need to be absolutely precise; I just need to judge correctly in the broad direction: the long-term performance of compound growth assets will ultimately outperform other assets.

And that is the allure of compounding. As Munger said, "What is amazing is that people like us have gained such a huge long-term advantage just by trying not to be stupid, rather than seeking to be exceptionally smart."

Crypto technology significantly lowers the cost of infrastructure, and wealth will ultimately flow to those who utilize these low-cost infrastructures to achieve compound growth.