Market Power and Redeemable Loyalty Token Design

Abstract

Digitalization led to a rapid expansion of loyalty tokens typically bundled as part of product price. Some tokens, such as those in the airline industry, already account for tens of billions of dollars and are major contributors to revenues. An open question is whether, as technology evolves, firms will have a strong incentive to make loyalty tokens tradable, functioning as their own capital pools, raising regulation issues, including for monetary and banking authorities. Our main finding is that an issuer has a strong incentive to make tokens non-tradable by earning a higher revenue even though the consumer would be willing to pay a premium for tradable tokens, as non-tradability effectively enables a finance channel based on the user base. We further show that an issuer with stronger market power tends to make its revenue more token-dependent. Empirical results from airline mileage and hotel reward programs align with our theory.

Yang You’s website.