Tokens, Tokens and More Tokens

Over $331M has been raised in token sales in the past 12 months. What’s really going on?

The most impactful technologies are polarizing and make people uncomfortable. The boom in blockchain-based tokens in the past year has certainly made a lot of people uncomfortable.

On one side, you have people arguing against the use of blockchain-based tokens, citing the unnecessary complexity, regulatory uncertainty and harm that they can cause consumers as a result of abuse from entrepreneurs. And on the other side you have people claiming that ICOs are the future of venture capital and how entrepreneurs will get funded. Both of these takes are headline catching and I understand why the different sides make the arguments. But I think the future is likely to be somewhere in the middle. Here’s some context…

Artwork by Cryptograffiti

Tokens enhance incentives

Understanding the blockchain-based token boom is all about understanding a basic concept in behavioral economics. At their core, tokens enhance the economic incentives of users of internet products. When we have ownership, we naturally care more about the products we use. Economic incentives are the lowest common denominator that we have as humans and embedding incentives into products is powerful. That power has been demonstrated by Bitcoin, which now has a total market value north of $22B and Ethereum, which now has a total market value north of $7B.

As a direct result of blockchain-based tokens, Internet tribes are emerging that some people feel more connected to than the city, state, or country that they physically live in.

The role of tokens in decentralized autonomous organizations

Tokens enable Internet tribes to emerge not in the form of traditional companies as we know them, but instead in a new type of organization called a decentralized autonomous organization (DAO). A DAO is best described as a group of people bound together not by a legal entity and formal contracts, but instead by cryptographic tokens (incentives) and fully transparent rules that are written into the software.

There will be a variety of blockchain-based tokens in the future and it’s possible that when regulations are clearly established, traditional assets like stocks and bonds will be tokenized on blockchains. But for now, there are two legitimate types of blockchain-based tokens that bind participants in DAOs:

  • Usage tokens: A token that is required to use a service
  • Work tokens: A token that gives users the right to contribute work to a DAO and earn in exchange for their work

Usage tokens are based on services where ownership is required to use the service. Bitcoin and Ether are the best examples of usage tokens — token ownership does not give you any specialized rights within the network, but it does give you access to the service (the Bitcoin payment network and the Ethereum Virtual Machine in the case of BTC and ETH). Scarce tokens combined with a useful service can create massive value for token holders and entrepreneurs.

Work tokens are tokens that give individuals rights to contribute work to aDAO (and earn value) to help it function properly. That work can be serving as an oracle (in the case of Augur), being the backstop in a collateralized debt system (in the case of Maker), or securing the network (in the case of Ethereum when it switches to proof of stake).

These two types are not mutually exclusive and there are tokens that serve as both usage tokens and work tokens. An example of a token with both characteristics will be ETH when Ethereum transitions from proof of work to proof of stake.

If you’re building a network-based Internet product, forming a decentralized autonomous organization, implementing a blockchain-based token into the product and structuring the token as a usage or work token is likely to be a winning business model.

Tokens should be thought of primarily as a product feature rather than a funding mechanism

Over 2.4X more funding has been raised in token-based crowdsales than in traditional early stage venture capital (seed to Series B rounds)

There has been a lot of money raised via tokens in the past year ($331.7M+ by my estimation). While blockchains make it easier than ever for entrepreneurs to raise funds (it’s as simple as creating an ETH address and can be done without relying on any bank or any third party service), tokens should not be thought of as a funding mechanism first and there should be a clear purpose for the token (either as a usage token, a work token, or both). There is regulation in the U.S. that prevents the unregulated sale of securities to the public and there are many reasons the leading early stage technology companies today delay IPO, most notably that when you’re publicly traded it’s hard to have a long-term focus. Lack of long-term focus can be paralyzing to technology projects.

Looking closer at the crowdsale data from the past year (spreadsheet here), there are a few major takeaways:

  • There’s an outlier, The DAO, which raised $150M last year and quickly disappeared. While this was an unmitigated failure, the end result of the failure was a successful Ethereum hard fork (the first hard fork for a blockchain at scale). This demonstrates to me that positive things can come away from the failures as well as the successes.
  • There’s been a lot of greed driving the token momentum in the past 12 months. When you see a project like Gnosis, which last week raised $12.5M at a $300M valuation by launching a Dutch auction and only selling 4% of tokens, you should not dismiss tokens as a whole; this is just one approach. But you should recognize there’s a lot of bad approaches and a lot of greed driving the current momentum.
  • There are no live products in this group of 29 crowd sales. Raising significant funding before any product is generally a bad idea. If you look at the history of startups, the vast majority of companies that have set expectations high with a lot of funding pre-product have failed. I think there will be a lot of failure in this batch and expect to see better practices emerge for token-based crowd funding in the future.

Where are we going from here

Tokens are here to stay because of their ability to enhance Internet products and create intensely passionate tribes via network ownership effects. But I think there is a lot to learn from the recent boom, specifically that tokens should not be used for funding first before an actual product exists and that certain types of tokens (usage tokens and work tokens) only make sense for certain entrepreneurs (technically-oriented) building certain types of products (network-based Internet products).

Clear best practices will emerge for how to optimally launch a token-based product and distribute the token; until then, it’s likely bad projects will continue to get funded because of the permissionless nature of blockchains. But it’s important not to throw the baby out with the bathwater — it’s also likely that the breakout consumer Internet products of the next 20 years will be token based.

If interested in learning more, attending the Token Summit would be a good start!

The Token Summit is May 25th in NYC at the Paulson Auditorium at NYU Stern School of Business

About me: I run The Control and am an investor at Runa Capital, an early stage venture fund. Previously, I worked on business development and marketing at Coinbase. Follow me on Twitter, signup for our newsletter, and support us by becoming a member:

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