Original title: "Token do's and don'ts"
Compiled by: TechFlow
Guests: Eddy Lazzarin, a16z crypto CTO; Miles Jennings, general counsel and head of decentralization
Moderator: Robert Hackett, Operating Partner and Head of Content and Editorial at a16z Crypto
Background Information
This episode of a16z’s Web3 program will explore all aspects of tokens — including the role of tokens in decentralized protocols, different types of tokens, and considerations for designing and issuing tokens.
The guests of this episode are Eddy Lazzarin, CTO of a16z crypto, and Miles Jennings, general counsel and head of decentralization, who have provided advice on protocol design and token design to many projects. They will discuss the difference between Web3 and the early technology era; how to avoid common pitfalls when looking for product-market fit; how to evaluate various designs and strategies, as well as their risks and returns; and more.
The necessity of decentralized protocols
The core role of tokens
Eddy explained why decentralized protocols need tokens to maintain their sustainability and incentivize participation from all stakeholders. He pointed out that tokens are not just a payment tool, but a means for users and network participants to represent their ownership and control. Eddy emphasized that tokens should be viewed as a tool that enables users and stakeholders to represent their ownership and control in the network, not just a medium of payment for purchasing traditional goods.
Tokens vs. Traditional Protocols
When comparing Web1 and Web2 protocols, Eddy mentioned that although Web1 protocols such as HTTP and SMTP were decentralized, they were eventually absorbed by large companies, causing users to lose control of these protocols. He pointed out that decentralized protocols can maintain decentralization through economic incentives by introducing tokens. This economic incentive mechanism allows the protocol to continue to operate without relying on centralized entities, thereby avoiding the control of users by large companies like Gmail.
Eddy also mentioned that the advantage of decentralized protocols is the ability to bring all stakeholders together and ensure the sustainability and value of the protocol through the economic model of tokens. He believes that tokens are a key tool to achieve this goal because they can be written and executed in the program to ensure that the protocol continues to operate as designed.
Types and Classifications of Tokens
Eddy mentioned several different types of tokens during the discussion, noting that each token has its own unique function and market position in decentralized protocols. He listed some common token types, including:
Stablecoins: Such as USDC and USDT, these tokens are usually anchored to the value of fiat currencies, aiming to reduce price volatility and provide users with a more stable store of value and medium of exchange.
Arcade Tokens: These tokens are usually used in specific application scenarios or platforms, similar to the points or reward system in games, and users can obtain them by participating in activities or completing tasks.
Meme Coins: These tokens often originate from humorous content on internet culture or social media, and although they may lack substantive applications, they are sometimes able to gain widespread attention and speculative interest due to their community-driven nature.
Eddy emphasized that different types of tokens need to consider their specific functions and target markets when designed and launched to ensure their effectiveness and sustainability in decentralized protocols.
Legal and regulatory challenges
Regulatory uncertainty
Miles highlighted the legal risks and regulatory uncertainties facing token issuance and decentralized protocols during the discussion. He pointed out that with the rapid development of cryptocurrency and blockchain technology, regulators around the world are paying more and more attention to these emerging technologies. However, as the legal framework is not yet fully mature, projects often face complex legal and compliance challenges when designing and issuing tokens.
Miles mentioned that project teams need to carefully consider their legal structure when launching tokens to avoid potential legal issues and regulatory penalties. He suggested that teams adopt different strategies to mitigate these risks, including:
Compliance Review: Conduct a thorough legal and compliance review during the token design phase to ensure compliance with local and international laws and regulations.
Legal Consulting: Seek professional legal advice to understand the latest regulatory developments and requirements so as to develop appropriate compliance strategies.
Transparency and Communication: Maintain transparent communication with regulators and actively cooperate with regulatory requirements to build trust and reduce legal risks.
Miles emphasized that although the legal and regulatory environment is challenging, through careful planning and professional legal support, projects can effectively navigate these complex areas and achieve innovation and growth on a compliant basis.
The value of governance and decentralization
Technical and legal advantages of decentralization
Eddy and Miles stressed the technical and legal importance of decentralization. They pointed out that decentralized protocols can provide users and communities with greater autonomy and transparency by distributing control, thereby enhancing the reliability and trust of the system.
Technical advantages: Eddy mentioned that decentralized systems reduce the risk of single point failures and improve the resilience and security of the system through a distributed network architecture. This architecture enables the protocol to continue to operate without a centralized entity and is more resilient in the face of external attacks or internal failures.
Legal Advantages: Miles discussed the potential legal advantages of decentralization. He pointed out that decentralized protocols can reduce the risk of concentrated legal liability by reducing reliance on a single entity through a decentralized governance structure. In addition, decentralized governance mechanisms can give community members more decision-making power, allowing protocols to better reflect the needs and interests of users.
The pros and cons of token governance
When talking about token governance, Eddy and Miles also discussed its potential pros and cons. Token governance usually involves token holders participating in the decision-making process of the protocol through voting or other mechanisms, which can enhance community participation and the democracy of the protocol. However, they also pointed out that token governance may bring some challenges, such as:
Governance participation: Although token governance empowers users to participate in decision-making, actual participation may be low, resulting in excessive influence of a few large holders on the decision-making process.
Complexity and efficiency: Decentralized governance mechanisms may increase the complexity and time cost of the decision-making process, affecting the responsiveness and innovation capabilities of the protocol.
Despite these challenges, Eddy and Miles still believe that decentralized governance is one of the key factors to achieving long-term success and sustainability of the protocol.
Market and Product Fit
Definition and Importance
Product-Market Fit refers to the state in which a product can meet the needs of the target market and find its position in the market.
Eddy stressed the importance of this concept in decentralized protocols and token projects. He pointed out that market and product fit is the key to a project’s success as it determines whether the product can gain widespread adoption and sustained usage among users.
Strategies for achieving market and product fit
User Needs Analysis: Eddy recommends that the project team deeply understand the needs and pain points of target users to ensure that product design and features can truly solve users' problems. This requires extensive market research and user feedback collection.
Iteration and Optimization: Through continuous product iteration and optimization, the project can better adapt to market changes and user needs. Eddy emphasized that flexibility and rapid response are important factors in achieving market and product fit.
Community participation: In decentralized projects, community participation and support are crucial. Eddy believes that by building strong community relationships, projects can gain valuable user feedback and market insights to better adjust product strategies.
Market education: For emerging technologies and products, market education is key to helping users understand and adopt the product. Eddy recommends that project teams invest resources in market education activities to increase user awareness and acceptance of the product.
Challenges and Solutions
Achieving market and product fit is not easy, and Eddy pointed out some common challenges, such as fierce market competition and diverse user needs. He suggested that project teams address these challenges through differentiation strategies and unique value propositions, while maintaining sensitivity to market trends and user feedback in order to adjust and optimize products in a timely manner.
Good and Bad Practices in Token Issuance
Token issuance is a key step for blockchain projects to raise funds and promote the development of the ecosystem. However, there are good and bad practices in the token issuance process that require project teams to carefully consider and follow. Here are some common good and bad practices:
Good Practices
Decentralization:
Eddie and Miles emphasized the importance of decentralization, which they believe is one of the core values of blockchain technology. Decentralization not only helps reduce dependence on managers, but also brings technical and legal advantages.
Decentralized systems can better protect users from information asymmetry and reduce the risk of being legally considered a security.
Clear economic model:
Ethereum was mentioned as a successful example because it has a clear economic model that will maintain value over the long term.
Tokens should have a clear purpose and not just exist as a speculative tool.
Community Driven and Engaged:
An effective token launch should encourage community participation and ensure that the purpose and governance mechanisms of the token are clear and necessary.
Bad Practices
Decentralization show:
Miles mentioned "decentralization for show", that is, the project claims to be decentralized, but is actually still controlled by a centralized team. This practice has no technical advantages and may lead to consumer risks.
Tokens that lack a clear purpose:
Issuing tokens solely for governance purposes is considered bad practice, especially when governance is not truly required.
Robert Hackett mentioned examples of projects that forced users to use their tokens without those tokens having real functionality or value.
Legal risks:
Public sales of tokens in the United States may be considered securities, and Miles emphasized that this practice should be avoided as much as possible because it would bring huge legal risks.
Issuing tokens too early:
Miles noted that many projects launch tokens too early without a clear use case or market fit, which often leads to failure.
By following good practices, project teams can increase the success rate of token issuance and lay a solid foundation for the long-term development of the project.
Summary and suggestions
Importance of Decentralization:
Decentralization is not only a legal requirement, but also a core value in technology. It provides system robustness and global adaptability, allowing users and developers to trust and rely on these systems.
Decentralization can reduce reliance on management and reduce the risk of information asymmetry, which is one of the core concerns of securities law.
Clarify the purpose of the token:
Before issuing tokens, projects need to clarify the actual use of tokens. Tokens should not exist only as speculative tools, but should contribute to the operation of the protocol and the healthy development of the ecosystem.
Avoid premature token issuance:
Many projects have hastily issued tokens before they have a clear product-market fit and purpose for the tokens, which can bring legal risks and the possibility of market failure. Projects should issue tokens after they have determined the functionality and market demand for the tokens.
Legal Compliance and Risk Management:
Projects should fully consider legal compliance when issuing tokens, especially in the U.S. market. Avoid unnecessary legal risks, such as publicly selling tokens that may be considered securities.
Legal risks can be mitigated to some extent through strategies such as decentralization, exclusion of the U.S. market, or limiting the transferability of tokens.
Community Engagement and Governance:
Community participation is critical to the long-term success of a project. Projects should design reasonable governance mechanisms to ensure that the community can effectively participate in decision-making when necessary.
Voting should be used as a last resort, only when necessary, and not as the primary justification for token issuance.
Economic model and incentive mechanism:
The economic model of the token should be carefully designed to avoid unnecessary speculation and market manipulation. Projects should focus on building a sustainable economic ecosystem.
When designing incentive mechanisms, attention should be paid to balancing the interests of both supply and demand sides to ensure market stability and predictability.
Focus on the product, not the token:
Eddie emphasized that founders should focus on the design and implementation of the protocol, rather than just the token itself. The token is part of the protocol, not the whole thing.