The next evolution of crypto capital

A cryptoeconomics-based opinion piece on the role of public token sale platforms

The two that keep me grounded. Freda & Petro 2021

Introduction

Launching a web3 project is challenging, and doing so without capital is nearly impossible. Considering the current capital-rich landscape, it’s important to appreciate the conviction of Satoshi and other early founders who launched the first projects.

This article focuses on the web3 capital markets. It explores how they have evolved and the current challenges these products face. In an attempt to present a solution to these challenges, I will highlight the potential of community-oriented token sales in empowering decentralized ownership of public goods.”

The history of Web3 capital

Web3’s capital markets have gone over several phases that gradually evolved with founders increasingly able to access funding, but often at the cost of the product.

• Fair launch. Initially, projects were launched without pre-allocating any tokens to the founders.. This approach was very powerful in creating highly decentralized cryptoasset ownership like bitcoin that attempted to remove the risk of any centralization of power to those willing to bootstrap the project. This period is often called the ‘fair launch’ era because of the perception that projects have to be uber-decentralized.
• Pre-mine. A natural evolution of the process saw founders allocate tokens to themselves before the project went live. This approach incentivized driving value to the token through ongoing project development in return for financial benefits. While fundamentally sound, this approach pressures the market to support large early liquidations and only delivers value as the project matures, thus failing to provide sufficient working capital.
• Public token sales. The third phase saw projects sell pre-allocated tokens to whoever was willing to buy them. Institutional investors and retail collectively bootstrapped projects like Ethereum, which raised $18.3m. Fundamentally, the concept is very simple: a project sells tokens with the promise they would be fundamental to the protocol in the future, creating a social form of debt between the builders and the investors. In 2017, public token sales escalated, with several projects raising substantial amounts from less-informed retail investors. Due to the lack of due diligence between the project and the investor, these empty promises led many to lose faith and their savings.
• In 2019, token sale platforms solved several of the trust problems faced by retail investors. These platforms are incentivized to deliver high-quality projects to their communities, functioning as a layer of due diligence. Platforms like Binance Launchpad and Polkastarter exemplify this model, having built their brands by offering access and due diligence as a service.
• Professional early-stage investors. During and after the 2017 public sale frenzy, the provision of early-stage capital significantly shifted towards professional early-stage investors, or VCs, backed by contractual agreements. Projects became linked to investors through SAFTs (Simple Agreements for Future Tokens) and Token Warrants. These agreements are structured to 1) reduce investor risk arising from equity versus token nuances, and 2) enable quick and substantial value access when appropriate.

The state of Web3 capital

In the absence of tangible value from public sales, VCs have become the standard, leaving retail speculators at a disadvantage. Over the past few years, most VCs have provided a stable source of capital for projects, free from the regulatory uncertainties and pressures of retail-driven markets at launch. Since becoming the de facto source of capital, VCs have played an outsized role in developing web3 projects, steering these projects towards their own incentives.

From a practical point of view, both VCs and public raises in current setups tend to yield similar outcomes. Both parties often harbor short-sighted and speculative views on invested tokens. Retail investors buy tokens as their only means of exposure, while VCs use tokens as an exit mechanism, preferring equity otherwise. Overall, few investors participate in sales to access long-term utility; most are motivated by quick financial gains.

Currently, the industry has more accessible capital, but from a cryptoeconomics design perspective, this has come at the cost of comprehensive project development. This situation arises because tokens have become heavily financialized, subject to the demands of VCs, and community members now expect rewards simply for participation. This is a fundamental deviation from the principle that tokens are suitable for bootstrapping but are primarily intended to support products.

To support my view of the current climate, consider the typical services offered by ‘tokenomics’ consultants. Their primary deliverable has become a token issuance model designed to manage selling pressure when seed round investors gain access to their token allocations, with increasingly less effort made to develop well-thought-out, product-oriented tokens. Projects tell VCs what they want to hear and keep the masses content.

In an attempt to stay relevant in this neglected market, some sale platforms have started offering refunds if the sale doesn’t yield short-term returns, thereby refunding investors’ contributions and placing all the risk on the projects. Rather than supporting projects, this approach makes public token sales less attractive.

Distributing tokens to create a community

In cryptoeconomic systems, tokens are distributed through two groups of approaches that differ in terms of objectives. The first category, token decentralisation events (TDE), generally consists of one-time events that strategically aim to decentralize token ownership and are allocated based on the resources/capital participants provide. On the other hand, reward mechanisms represent ongoing incentive systems based on the value of continued participation, with mining rewards being a prime example.

Focusing on TDEs, this approach includes several common mechanisms in the industry, such as airdrops, workdrops, token sales, and liquidity pool (LP) farming. We’ll save the details for another day, but fundamentally, these distribution events could be categorized based on the value received by distributing tokens:

• Financial capital (investments)
• Human capital (e.g., users or nodes)
• Access to resources (e.g., computation or liquidity)

A TDE is the first step that allows a project to become a public good to some degree, which is why token decentralization is the primary objective of this very typical go-to-market event.

Token decentralization is essential both to maintain the perception of fairness and to maximize the utility attributed to the token; after all, people can’t use the token if they don’t possess it. The perception of fairness is a complex topic and often unique to this industry. The opinionated and influential nature of communities ensures equitable relationships between them and the founders, something necessary for developing long-term support. This is a feature we should be proud of.

The future of public token sales

My crypto-anarchist in would advocate for all digital public goods to be funded in public to gravitate to fully decentralized systems where everyone builds, governs, uses and benefits. From a pragmatic standpoint, I rather argue for a standard where the competitive opportunities of public token sales keep VC incentives in check and foster the growth of native VCs, who are essentially large community members. My experience is that the Paradigms, Leminiscaps and Placeholders of the world have been excellent community members of projects.

Yesteryear’s poorly regulated and speculation-driven token sales are unlikely to resurface to the same extent in their current form. Too many retail investors have been burned by unprofessional projects on questionable sales platforms (or self-conducted sales), and projects are now more cautious of legal concerns.

Token sale platforms enabling projects to raise capital while kickstarting their communities will likely emerge as frontrunners in the next cycle.

Here are the key areas that platforms in my opinion should excel at to maintain relevance in an increasingly mature industry

• Due diligence. Platforms should offer a point of trust to both parties, serving not just as a sale mechanism but also as a safeguard. Projects expect compliant and professionally managed sales that safeguard investors from scams and unscrupulous sales tactics.
• Highly regulated sales. Founders must ensure they sell tokens legally. Although some investors may dislike this cautious approach, it is crucial for us to protect our projects from regulatory issues.
• Provide access to both communities. Access should be provided to both the platform’s community of recurring investors and the project’s early adopters. Both participant profile should be assessed based on the potential value they could deliver, and access should be granted accordingly.
• Incubate projects. Very few participants in the industry understand the nuances of going to market as well as token sale platforms do. Going forward, platforms should take responsibility for empowering projects in their market launch, connecting them with the right players, developing market attention, and assisting with token design.
• Community building efforts. The distinction between a community member and a speculator lies in two aspects: 1) product usage, and 2) commitment agreements. Participants should contribute value to the project by engaging in meaningful work (quests) that benefit the project and signal commitment through vesting periods. There exists a significant opportunity to innovate sales mechanisms e.g. a Dutch auction model focused on vesting schedules, rather than solely on price.

Conclusion

Raising capital is crucial in getting any project on its feet, but it can develop misalignment between project goals and capital providers. In 2023, financial capital is far more accessible and the industry has come to accept that developers should be incentivized to do their best and deliver on the vision.

Striking the balance between institutional and public capital is essential as they offer different benefits. Institutional capital is reliable but pressures the token, and thus the product, to benefit their liquidity events. Public token sale platforms in their current designs create speculators who aren’t presented with the opportunity to consider becoming supporting community members. If done right, selling tokens to retail presents additional benefits ranging from zero-cost marketing to building a community of users that support the project, which is very difficult to compete with VC. Still, no VC can deliver the value that the LINK marines do for Chainlink. The downside of involving retail investors is that their support is often tied to token performance in the short run, so we have to design cryptoeconomic incentives and sales that support the long-term growth of networks, protocols and applications.