What is the Best ICO Structure?
Token sales on the internet are now as common as dirt. You will most likely run into a new one every couple of days. And, despite the new restrictions that the Securities and Exchange Commission of the US (SEC) placed on such sales via their July 2017 report, a lot more of these projects will keep springing up, especially in 2018 going forward. Consequently, it’s now the best time to scrutinize initial coin offerings (ICOs). Let’s look into the different ICO structures and how these affect the crowdsale itself
Just note that our evaluation of these token sale structures does not mean to throw shade on an ICO. Instead, we aim to highlight the strong points of each structure, while exposing the weaknesses. Importantly though, these are just suggestions and recommendations that at no time, should be taken as sound financial advice.
What is a Token Sale?
Initial coin offering refers to the process of selling tokens to the public to raise capital for the network being built. Though touted as the digital world’s equivalent of an IPO, the two differ significantly. While an IPO transfers a company’s ownership from private to public hands, an ICO is an unregulated sale whose only sense of quantification is the potential value of the project or concept that the crowdsale hopes to fund. This probably is the reason ICOs are a lot similar to venture capital.
Types of Token Sale
Despite being relatively new, there are more than a handful of methods that have been explored with various token generation processes that have been concluded in the recent past. These include:
- Capped sale on a first-come-first-served (FCFS) basis
- Uncapped token sale
- Capped auction
- Uncapped auction
- Capped token sale structure with parcel limit
- Capped token sale structure with redistribution
(Image from https://blog.gdax.com/the-perfect-token-sale-structure-63c169789491)
Capped token sale on a First-come First-served basis
In this, a cap is placed on the amount of money the sale can generate. As the name hints, the tokens can be availed at a fixed price on a first-come-first-served basis. Moreover, a fixed or predetermined percentage of the total token supply is allocated to the core developers and founders.
Digital asset exchange firm GDAX considers this as the most common type of token sale, having been used in a majority of the trailblazing ICOs. However, this should not be construed to mean that it is the best.
Uncapped token sale
In this structure, a buyer can accumulate as many tokens he wants. In the same way, there is no cap on the amount of money the sale can generate. The token generation exercise often proceeds for an extended period and insiders receive predetermined fixed portion of the tokens available for sale.
Capped auction of tokens
Initial Coin Offerings that adopt the capped auction structure allow investors to bid on both the price they wish to pay for every token as well as the total amount they wish to spend. This structure places a cap on the amount of money the ICO can raise.
Apart from these, a capped auction the following characteristics:
- A variable amount of tokens are sold, the price of the tokens are equivalent to the lowest bid and proportional to the total amount each investor pledges to spend.
- The number of tokens allocated to insiders depends on the number of tokens sold during the crowdsale. In other words, the amount allocated to insiders is a factor of the total sales.
- The sale structure can either take on the blind auction or Dutch auction modalities.
Uncapped token auction
As in the capped auction, investors are allowed to bid for the tokens. However, it differs from other structures in that the sale, usually on a fixed number of tokens, is done in a descending order starting with the investors who made the highest bid. The sale then assumes this order until the sale exhausts all tokens. This ICO structure does not impose a cap on the amount that can be raised by the crowdsale. While it has stark distinctions from the other structures, it allocates a fixed portion of the total token supply to insiders.
Capped token sale structure with parcel limit
This structure shares a fundamental similarity with the capped sale because it too allows the sale of a fixed amount of tokens that are sold at a predetermined fixed price on a first-come-first-served basis. However, it imposes a ceiling on the number of tokens an investor can buy. Such a cap is achieved by placing a limit on every incoming transaction, while restricting investors from undertaking multiple transactions. For this to happen, this structure relies on unique codes that are generated with every transaction and that are difficult to automate.
The capped token crowdsale with parcel limit places a ceiling on the amount that the crowdsale can generate. In addition, a predetermined portion of the overall token supply is allocated to insiders.
Capped token sale structure with redistribution
This structure allows investors to buy a predetermined amount of tokens at a fixed price. The number of tokens is usually in accordance with the total amount of money each investor pledges. Like the capped auction, the structure allows investors to present bids on the total amount they wish to spend. Other characteristics of this type of token sale include:
- It refunds excess payments made by investors for tokens.
- It imposes a cap on the amount of capital the event can raise. However, unlike other structures, this cap is expressed as a ceiling on the number of tokens available
Like every ICO structure, it allocates the insiders a fixed portion of the overall token supply. Among the structures, this is the only format that ensures every interested investor can participate. The only downside is that in case of oversubscription, a vast majority of the investors are forced to settle for far fewer tokens than they wanted. However, there is a guarantee of a refund for whatever cash is unspent.
Objectives of Token Sales
To rank the above-mentioned types, it is important to first highlight the objectives behind the many ICOs that have been or shall be conducted in future. However, since the ICO itself is a relatively new concept, some of the objectives may appear conflicting. Among these are:
- To distribute the tokens widely – The underlying principle behind Blockchain technology is decentralization. Developers who have an innovation that offer a solution affecting a wide portion of the population may want to have their tokens distributed as widely as possible.
- To guarantee all buyers would have a piece of the pie – Instead of targeting investors who have their money ready, you may want to give every willing buyer an opportunity to participate.
- Raise a capped amount of capital – Developing a network comes with certain costs and responsibilities. A shrewd developer, for instance, would prefer to raise just the right amount to avoid holding more cash than is necessary.
- Optimize the exercise – Aside from raising the right amount of capital, other essential targets in any ICO should include selling the tokens at the market price and allocate the token portions accordingly. Discerning the market price may be a little technical and since certain kinds of ICOs leave this to the investors, it is not unusual seeing the developers’ hand coming into play.
Overall, the key objective remains, raising enough capital to fund the network. However, the surging interest in ICOs somehow erases concerns associated with attaining the capital cap.
Which of The Six Structures Outshines Them All?
Each of the six structures offers tradeoffs. It is up to the developer to choose which ones to prioritize and which ones to give up and his proprieties can be seen in the ICO structure he used. Over the past months, industry players have hurled criticism at the various ICOs that concluded in 2016 and 2017. Some uncapped crowdsales, for instance, we labeled ‘greedy’, and rightly so by certain arguments.
However, to sustain such criticism, it is necessary to highlight the properties of a good ICO structure. Such a structure should:
- Have certainty of valuation – Whenever you participate in a crowdsale, you should know with certainty, the cap on the valuation or the portion of the token supply.
- Be efficient – It should eliminate chances of deadweight losses or other such substantial economic inefficiencies.
- Have a ceiling on the amount it raises – A sale should have a predetermined amount it intends to raise. This is to avoid being looked at as greedy and lessens the chances of attracting undue attention of regulators.
- The certainty of participation and success – As much as developers are wary of describing ICOs as investment opportunities, they should offer investors a good chance of being successful.
- Avoid central banking – the developer should hold a fixed, predetermined number of tokens and this number should not be unnecessarily large, lest investors seize control of the network token-wise when it goes live.
In addition, a good structure shouldn’t only promise investment returns, profits or dividends. Rather, it should focus on distributing the token or digital asset that holds a promise of a clear use in the decentralized application ecosystem. The clear use in this instance is twofold: incentivize development of the network and offer clear answers in terms of the order and functionality of the network. Most importantly, it should provide an initiation into the network rather than acting as a means of funding the network.
With these in mind, the six main ICO structures are all vulnerable to reasonable criticism. In the uncapped token sale for instance, the valuation price is highly uncertain. Valuation is important as the ICO can easily attract investors because they’ll know exactly what’s in for them. A good many investors will be worried if they had no idea what the total token supply is. Interestingly, Ethereum was sold in the very same environment. Its sale extended for about a month and a half with discounted sale conducted during the first fortnight.
Another important factor that one that most successful crowdsales have gotten right this far is the number of tokens that should be sold vis-a-vis the amount that should be set aside. Also consider the mode to be used in distributing the funds raised. As a norm, token sale protocols often set aside between 10 and 20% of the tokens available for supply while selling the remaining 80 to 90%. A portion often remains as reserves used to fund the network in future.
Essentially, this means that the network relies on the funds generated from the sale as well as the reserved token. However, tokens should be attractive so that you’ll have an easy time in converting reserved tokens to working capital. For this, prospective investors should have faith in or already see the benefit they could have from the network. But, there are indications that the thresholds set in the token environment are nothing but experimental values.
This probably is the reason some of these figures ran contrary to known practices in the financial and or stock markets. Compare the reserve figures above with the amount a startup has. Usually, only 20% value or thereabouts of a startup is often available for sale and not between 80 and 90% seen in token generation events. Given this, the token sale structures should not be judged on the allocation of reserves, because what is done in token sales goes against the norm in the market.
And, the fact that stock market norms are yet to be replicated in the token generation ecosystem is not reason enough to disregard them. For one, we have not experienced a situation wherein the reserved tokens, as well as the funds raised from the ICO have been depleted. In the typical company scene, this is akin to getting broke and running out of options for raising funds. This possibility however, should not be ignored since most networks are new and remain work in progress.
For this reason, it is possible that the future may see a shift in the manner of structuring in token sales; either a somewhat complete overhaul to include provisions for retaining more tokens during the ICO or adding value to the network so it is profitable aside from solving a situation.
What Is the Place Of Single-Round Sales?
Another valid argument against uncapped token sales is the perpetuation of ‘greed’. However, such branding only begets mixed reactions. Essentially, there are investors who are willing to shell out $20 million (reasonable amounts) all at once to a talented team to oversee the development of a project. This is especially interesting since most crowdsales by default, are single-round sales.
Still, not many people are willing to invest a huge amount of money on a new team that is breaking new ground. This is especially true in token sales where the rewards of the team and the interests of investors rarely jive.
While this argument ends up kicking the Uncapped token sale out of contention for the best structure, there are many reasonable amendments that can be introduced in such a sale to ensure that it meets the objectives of the project. Such amendments should primarily strive to introduce fresh rounds into the token generation process or even break the entire exercise into segments right at inception.
For instance, such a crowdsale can be conducted as a Dutch auction but with a lower cap. In this case, the auction is less likely to sell 100% of the available token supply. The remaining tokens can then be auctioned later with a slightly higher cap. The process can then be repeated until the tokens are sold out.
The Most Probable Way Forward
Despite the modifications such as these proposed on Uncapped token sale to eliminate the uncertainty of new money in even unfamiliar hands, a lot still remains unsolved. The world of token generation events, as such, is staring at the following expected unfoldings almost with uncanny certainty:
- A few networks will run out of capital from both the reserves and the funds raised during the crowd sale. This will prompt succeeding ICOs to hold far more than the usual 10 to 20% of the tokens available for supply.
- Fintech startups with value-added services may get remunerations from this additions just as non-crypto corporations such as Facebook, Google and Apple are benefiting from the protocols they have developed, but that is secondary to their main provisions.
- Users registered in these protocols may soon be forced to agree on dilution, rather mutually, so that such protocols could raise funds by admitting new investors, in case the corporation needs to fund further development. This remains the most sound option when a startup runs out of capital and does not have other options to raise more.
But, what happens when a startup sets up more than the normal 10 to 20% and ends up with more funds than it requires? The obvious solution is to conduct a vote to let the investors (token holders) decide to either distribute or burn the said tokens. This rudimentary option remains the most viable since it ensures that every token holder gets or loses an equal share of this value pack.
Agreeing on mutual dilution, too, presents another challenge. Raising funds through the protocol for further development is akin to creating more room for new investors in a startup by diluting shares. While it is easy to do this with stocks, it is a little cumbersome in the crypto coins environment. Why? Because the move requires very fluid and well-functioning decentralized governance structures. But said structures have yet to be developed since no corporation which offered a token sale has yet to experience mutual dilution.
Ostensibly, this means that ranking the ICO structures on the basis of the assumptions highlighted above stands on no firm ground at the moment since it depends on factors that a) aren’t a norm in business and b) remain experimental at the moment to allow for empirical conclusions.
Other Important Considerations
A lot of developments have occurred in the token generation scene. And, with increased interest from the authorities to blockchain applications, ranking the token generation structures becomes even more complicated because of legal implications. For instance, isn’t possible, at least theoretically, that some or every aspect of a Capped token sale on a first-come-first-served basis is illegal while a Capped auction of tokens meets all the stipulations of the law?
These concerns remain rather unrefined because token generation remains a novel concept. But taking in a report from the US Securities and Exchange Commission that has already classified some tokens as security and others as digital currency, we no longer have a levelled playing field. As such, a structure that suits a particular token may not appeal to the objectives of the next because of legal concerns. If anything, the law defines securities that are different from digital currency and what suits one will not necessarily work for the other.
Is it Catch-22 yet?
A lot of factors hinder us from determining which ICO structure is the best. What’s true is that a structure that best meets the needs of a particular token and its developers, is the best for that situation. However, and for the sake of forging convenience and conventionality, leading figures in cryptocurrency are already proposing innovative moves to change current ICO structures. But, it’s unclear whether such proposals are meant to gift the token generation ecosystem with the best structure.
For instance, Vitalik Buterin, the revered Ethereum founder, proposes that where there is conflict in an ICO structure, a compromise of sorts may be necessary. His suggestions are mostly in line with finding wiggle room that satisfies the five qualities of an ICO structure. These qualities, certainty of both valuation and participation, imposing a cap on the funds an ICO may raise, efficiency and proportionate distribution that eliminates central banking, are all ambiguous in the context of all the kinds of structures discussed in this text.
An ICO will be hard pressed to ensure certainty of both valuation and participation at the same time. A compromise, as such, may be necessary but consider the situation at hand. At the same time, ensuring that an ICO structure caps the amount raised, remains efficient and still eliminates the aspect of central banking among issuers may not be possible, without fiddling with the rules of engagement.
When certainty of valuation is the key aim but certainty of participation is also important, Vitalik suggests that developers use the Dutch auction. Essentially, a Dutch auction revolves around determining the price of the tokens after accepting all bids from every investor. This allows the issuer to get the highest possible price for the tokens.
Vitalik, however, adds that such a move needs to include a slight modification. Instead of holding on to the unsold tokens, the network can redistribute them to every token holder proportionately, donate to players in the network who are building value-addition infrastructure or airdrop indiscriminately. Alternatively, any combination of any of these three measures may work just as well.
In addition to redistribution, Vitalik supposes that the issuer can hold on the unsold tokens. For this move, Vitalik says that central banking can be eliminated by putting in place, an automated plan that defines how the remaining tokens can be spent. This proposal already eliminates any form of token sale structure that advocates for a redistribution aside from what Vitalik advocates.
Thirdly, the Ethereum founder advocates for a Capped token sale but with emphasis on the number of tokens every investor can purchase. Of course, such a move requires an in-depth KYC process. However, this option introduces an interesting angle; deadweight loss, which is an inefficiency since it means all investors may participate, including those that have none or only have minimal interest in the tokens.
Overall, we cannot pinpoint which one is the best ICO structure and how we may not see a structure emerge as best for a long time.