Crypto Market Faces Lemon Risk Blockworks Launches Transparency Framework

In his 1970 paper “The Market for Lemons,” economist George Akerlof explained the phenomenon that occurs when sellers possess more information than buyers. This asymmetry in information can lead to a market where the odds of acquiring a low-quality product are disproportionately high. In the context of used cars, buyers cannot distinguish between good and bad cars, resulting in both being traded at the same price, which is too low for a good car and too high for a bad one. This incentivizes owners of bad cars to sell, flooding the market with lemons and driving out good cars. Akerlof warned that this could lead to a market where only bad products exist, and no market exists at all.

This dynamic may also be applicable to the crypto market. Felipe Montealegre highlighted that liquid token investors are concerned that tokens are becoming a lemon market. Despite the inherent transparency of blockchains, many crypto projects are not fully decentralized, and crucial details such as lock-ups, market-making deals, and OTC transactions remain opaque. Even basic information like revenue and the number of tokens in circulation is often difficult to determine. This informational advantage held by the primary sellers of tokens, typically the creators, may be turning crypto into a market for lemons.

However, there is a potential solution to this problem. Blockworks has launched a “Token Transparency Framework” aimed at encouraging token projects to eliminate the informational advantage that crypto sellers have over buyers. This framework is based on the premise of securities regulation, which is to inform investors rather than protect them. Before the creation of the SEC in 1934, investors had little information about companies and their equities, leading to a lack of participation in the stock market. The introduction of securities regulation and insider trading laws aimed to create a perception of fairness, encouraging broader participation in stock markets.

The NYSE President Emil Schram emphasized the importance of the stock exchange being accepted by the public as a place to raise capital, rather than just a gambling den. This effort seems to have worked, with an estimated 62% of US adults now owning equities, compared to less than 3% in the 1930s. With luck, Blockworks’ transparency framework could do something similar for crypto. Dan Smith, who helped create the framework, describes it as a “crypto-native S1,” referencing the exhaustive IPO filing that compels companies to divulge every possible thing a prospective investor could want to know. The SEC’s job is not to pass judgment on whether a stock offering is good or bad, but to ensure that a company is sharing enough information to allow investors to make that determination for themselves. Blockworks’ transparency framework is an important step in the same direction, aiming to prevent crypto from becoming a market for lemons by ensuring that buyers know what sellers do.