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A discussion on responsible protocol token funding

At the recent NYC’s #consensus and #tokensummit, almost every other person I met start or end with a variation of the question: Do you have a token for sale? What token should I buy?

At the recent NYC’s #consensus and #tokensummit, almost every other person I met start or end with a variation of the question: Do you have a token for sale? What token should I buy?

Token funding is faster, more liquid, and equitable to all participants, compared to VC funding. Plus isn’t it an amazing mass growth hack for adoption.

That’s the promise, and generally true when things are well designed.

Yet the funding structure of some projects deeply concerns me, as a long-time crypto entrepreneur and token participant. Some had little substantial technical research or development, lack proper team (except the usual “advisor” tricks), or worse off, consider token distribution an “exit” opportunity for the founders.

With the price rise, FOMO (fear of missing out) is yet still at all time high.

This post is intended to start a discussion on this critical topic. We as industry practitioners have a major responsibility to self-regulate, and shape the right market dynamics for this emerging industry.

Note: This post focuses on considerations for protocol tokens that has utility value in a decentralized network (such as Ethereum, DFINITY), or tokens in dApp (Gnosis, Augur, etc.). Other type of tokens (such as those representing bonds or equity) are not in the scope of discussion.

What are we funding, really?

Protocols are softwares, but not just any old software. They are a set of software code that provide a coordinated service by formalizing (economic) relationships among its human and/or machine participants. By design, it benefits the public, and a properly designed protocol excels in something highly valuable known as Social Scalability, as explained by Nick Szabo.

To be more precise, what we’re really funding is typically a specific instance of a protocol. The $18m contributed to Ethereum, is primarily tied to one instance of the Ethereum network (ETH) — with specific genesis block structure and backed by Ethereum foundation, though it could be argued that Ethereum Classic and other forks benefited from it.

Now, how does that compare to traditional technology startup?

  • A startup funded by private company has a fiduciary responsibility to maximize shareholder values, first and foremost.
  • A protocol (instance)’s objective, on the other hand, is to maximize values to all ofits public participants.

Public protocols are by definition open-source, permission-less (to participate) andautonomously, if not perpetually, functioning(independent of its developer). Thus we could logically extend that:

Donations to fund Public Protocols are, in fact, contribution to Commons. We are funding public good with private money, at scale and with economic incentives.

This crucial difference — of contributing towards a commons and sustainable network, rather than to a private company — should define how we think these funding activities, rather than simplistically recycle any startup logic. [1]

Note [1]: For example, valuing a protocol-based network’s tokens are fundamentally different from valuation of a startup even with comparable function, user and growth, for many different reasons —among them, “velocity of money” effect (for dApp Tokens), value as an independent network, not suffering from typical organizational uncertainty, better liquidity, and high loyalty level of the participants incentivized by the tokens. See Alek’sexcellent articlefor more discussions.

We should all care about: Aligning incentives with the devs

The tokens behind these public Protocols are created as an instrument to incentivize large group of independent actors to collectively make the protocol based network more valuable, specifically on two set of people:

a) rewarding developers for their initial efforts and on-going developments

b) incentivizing participants in the protocol to contribute, such as providing computation, uploading data, serving as an additional security factor, and etc.

In a “trust-less” protocol, the strongest implicit trust is being placed on the developers (and foundations/companies behind them) to not screw up the protocol, either intentionally or for lack of motivation/competency.

Hence, what we should be constantly optimizing for ways to incentivize them and align their interest with rest of community.

1. Funding a Foundation vs. a Private Company

Given that public protocol themselves resemble public good and the general ethos of decentralization community, there’s a strong argument that many projects, exceptions notwithstanding, should adopt a not-for-profit foundation-based model— where all money collected and a portion of the tokens goes to the foundation as an endowment.

A specific nuance though is how to deal with early contributors or companies who made significant financial investments to progress the project, prior to the token distribution. Reasonable / known practices include returning the investments as debt (with risk-adjusted interest), or reward the contributors with a portion of the tokens in proportion to the initial investments.

Founders – this is not an “exit event” for you

We should in particularly caution against attempts to turn the token funding into anexit event, such as significant cash payment as part of money raised. The distribution of the tokens are merely a beginning of a new dApp or Blockchain network.

The point of rewarding founding team with tokens is to incentivize them to continue create value for the network and align their interest with broader stakeholders.

Yet by agreeing to cashing out to the founders/team, this creates a dangerous incentive — the donators implicitly accepted a significant “payment” — which they may not fully realize — for a new network that have not withstand yet test of code quality, security or user adoption.

Should we fund private company at all for tokens?

Sometimes there’re valid reasons, or at least justifiable enough, to fund a private company, or consortium, instead of a not-for-profit. For example, the protocol being developed is in a highly specialized vertical, regional based, or the to-be-funded company have made significant contribution to bootstrap the initial network.

Another consideration is what layer of the protocol is at — the closer you’re to the blockchain/lower layer, the stronger it should be backed by a foundation, so that it actually benefits the broader network participants.

In general, I think a (significant) *“private company funding discount”*should be applied to funding amount and network valuation, to adjust for:

  • uncertainty of a private company (compared to a well governed public foundation)
  • its profit driven influence over the network
  • more likelihood of being “forked” into a new network (due to less independence)


Additional measures should be in place to balance and check the for-profit company, such as:

  • Regular reporting of the funding and deliverables
  • Deliverable-based vesting of funds

2. Vesting of Early Contributor Tokens

The token economy based on key developers and contributors are rewarded a good portion of the token distribution for their past and very much needed future contributions.

Thus, at least part of their tokens (percentage based on how much past vs. future contributions), in particular those paid as part of their paycheck, should be vested over certain period of time, such as 6–12 months or longer, to ensure that they have sufficient incentives to contribute positively to the project, and are making software decisions.

This could be implemented in a smart contract. The control of the vesting, could be held by an independent foundation, a multi-sig of key community representatives, or some type of community governance mechanism.

3. An argument for multiple rounds of fundraiser

You come up with a big idea of decentralized X. Write a beautifully crafted whitepaper. Put together a nice team. Token Launch! 24 hours later, you have $5M in crypto.

Question is, can the founders really execute that big idea after the fundraiser?

The dilemma most token donators face today is they’re almost never given an opportunity for a careful evaluation. There’s always a time rush amplified in a single round.

A more responsible way, for complex projects, is to divide them into smaller rounds with 6 months or longer in between, so people can take controlled risk and observe how the team execute in real world.

This could be achieved by a smart contract that pre-defines the rules for each round. (See DFINITY FDC here for an example)

4. To cap or Not to cap

This is a contentious question.

No-cap sounds inherently greedy — “What would you use all these money for?”.

On the other hand, historically even good entrepreneurs significantly underestimate funding they need to deliver a well crafted product. When you run out of funding, the project fails. No one is happy.

Further, in a bullish market, cap easily result in insider / whale monopoly in a public token sale. (e.g. BasicAttentionToken just finished a ~$40M sale in 45 seconds, and 25% apparently went to a single address).

So there’re really three separate underlying concerns here:

  • team have (just) enough money for maximal chance of success
  • equal participation rights
  • broader distribution for better decentralization

Budgeting & Funding Sources

Assuming the funding goes to a not-for-profit foundation, we need to factor in the budget for the lifespan of the foundation (e.g. 5–10 years). That’s a bit different from your typical startup funding, which usually assumes a 12–18 months leeway as it expects more funding or revenue.

However, the initial crowdfunding is not the only source. You could …

  • Have multiple rounds of funding — as discussed in Section 3
  • Tap into your endowment protocols tokens — which should grow in value if you’re doing a generally good job in adoption and technology. In fact, the performance of a protocol foundation should be at least partly measured in token value growth — in the longer term.
  • Built-in “token creation” mechanisms such that the protocol to issue more tokens to the foundation if the community agrees that the extra inflation is worth the incremental value the foundation creates.

Equality of Participation & Distribution

A pseudonymous decentralized network combined with a bullish market, you end up with whales eating any cap you put on it. That’s also bad if you’re aiming for broader distribution of tokens.

Here’re some possible ideas that attempt to balance this goal with “too much money” problem:

  • Soft Cap with steep premium for Post cap
  • **Quantifying chance of success:**Combine funding event with a Prediction Market on success rate of the project in terms of tech, adoption and etc.

Paths for the Future

The harder questions of course, is why would founding team ever want less money? What’s the check and balance?

In the future, I see two interesting possible paths for protocol-type foundations:

  • In its bylaw, the protocol foundation is at least partly governed by a on-chain community governance mechanism, that has certain budgeting or veto power. Think of a “robot” that has voting power of one in a board of three.
  • A completely “foundation-less” structure that gives the full budgeting and strategy control to a sophisticated on-chain governance structure. This becomes 10x more powerful when a robust stable currency system such as PHI becomes available, and combine with a sophisticated governance such as Blockchain Nervous System (see here).

More discussions

Above is a quick list of ideas. I’d love to engage in any further discussions with any fellow crypto entrepreneurs / investors / developers on this topic.

Find me on twitter (tom_ding) or email (tom at string dt technology).

Tom Ding is building next-gen blockchain and open protocols at String Labs, and is generally interested to meet folks working in paradigm-shifting technology – from blockchain, VR, to nootropics, anti-aging and AI.


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