Crypto projects have begun to use token buybacks as a way to transfer value to token holders. Projects like Maker, Yearn, Binance, and even Ethereum (after EIP-1559 goes live), are all experimenting with their own unique spin on buybacks with their own unique trade-offs.
In the stock market, share buybacks work in predictable ways. In crypto, buybacks can have significantly different structures, and it is important to know where the limits of the "stock buyback" analogy begin and end.
This article gives a brief overview of how stock buybacks work, and explains the differences between the various crypto buyback strategies in use today.
Profitable companies can do two things with their earnings:
- They can return them to shareholders
- They can reinvest the profits back into the business
This decision is typically determined by the available opportunities for the business:
- Fast-growing companies that are entering new markets or heavily investing in promising opportunities may choose to retain their profits.
- Mature, stable businesses with few prospects for expansion may choose to distribute their profits back to shareholders.
In reality, the distinction isn’t always as black and white. Most companies choose a hybrid approach where they retain the portion of cash they need for the foreseeable future, and return the rest to shareholders.
Once a company decides to return profits to shareholders, they must then figure out how to return the profits. In the stock market, there are two primary ways companies do this:
- Stock buybacks (also known as share repurchases)
Dividends are direct cash payments to the shareholders of a company. They can be distributed all at once, or on a regular (typically quarterly) schedule, and have both benefits and drawbacks:
- The main benefit of a dividend is that investors can take that money and do whatever they want with it. There are no restrictions or limits on how they use it.
- The main drawback of a dividend is that the dividend income is taxable, though the rate of taxation varies by jurisdiction and by the type of corporation issuing dividends.
Stock buybacks are indirect tools for transferring value to shareholders, and purchases often happen on the open market. They too have their advantages and disadvantages:
- The primary benefit of buybacks over dividends is that investors don't incur any taxable gains when a company buys back their stock.
- The downside is that investors don't get any liquidity during share buybacks, their ownership stake just grows.
The only change brought about by a stock buyback is that fewer shares are outstanding. If profits remain unchanged, the reduction in shares increases the earnings per share (and the stock's intrinsic value).
Another secondary effect of buybacks is consolidated ownership. Shares that are purchased by a company are either cancelled or held as "treasury shares" for future re-issuance.
Treasury shares have no voting rights, and are not eligible to receive dividends.
Now that we have a high level overview of how stock buybacks work, let's examine the stock buyback strategy of Apple, and use that as a benchmark for comparison against various crypto projects.
Apple is in the midst of the largest capital return program in stock market history.
Since 2012, Apple has returned over $550 billion of profits to shareholders through stock buybacks and dividends.
Of that $550 billion, $421.7 billion has been spent buying back 9.4 billion of the 26.5 billion shares (split-adjusted) Apple had outstanding in Q4 2012.
Apple continues to buy back shares and issue dividends today, with an average quarterly buyback of 1.34% of outstanding shares and a dividend of over $3 billion per quarter.
Now let's take a look at how some of today's crypto token buybacks compare with Apple's stock buyback program, and some of the differences between them.
Note: There are crypto projects that issue rewards that resemble dividends too, but that's a topic for another post.