What Lurks Beneath the Surface Can Capsize you as a Cryptoasset Investor
Five Components of Distribution:
- Insider skin in the game (allocations subject to vestings and lock ups reflecting their preferred status in obtaining tokens)
- Optimized for long-term usage of product
- Equitable token sale (at least 80% of tokens if pre-product / 50% if product is already live at time of sale)
- Broad distribution, should not be accredited / institutional only
- Limited Supply
Optimized for Long-Term Usage
Distribution is also important for maximizing the chances of a network effect developing. If a handful of people control the vast majority of tokens. Achieving the critical mass of economic activity needed to make the project a success is unlikely to occur.This is one advantage of tail issuance versus a fixed supply. Tail issuance at a reasonable inflation rate results in latecomers being able to obtain tokens potentially expanding the size of the network versus a token where supply has already run out.
Evaluating distribution as an individual investor you need to make sure you’re rowing your dinghy in the same direction as the whales that have the upper hand because of their concentrated holdings. If a projects primary vehicle for raising money was obtaining funds from a whale syndicate. You need to understand if these whales are still lurking below the surface.
Looking to maximize their gains by passing the tokens onto the likes of you while the price craters from the selling pressure they induce when unloading their substantial holdings. While less of risk currently. This so-called waterfall has preyed on individual investors for the last year.
As the excitement of new protocols, dApps, and tokens being released gave projects the opportunity to raise gobs of capitals. Whales made massive risk free returns. With individual investors stuck holding cryptoassets down 90% from their highs.
It’s not impossible this story repeats. Make sure you’ve absorbed its lesson.
Insider skin in the game
The distribution model needs to be fair to all participants. Historically, this has meant a coin ICO’d to all at the same time. As regulatory pressure continues to evolve, it has become understandable more cryptoasset projects are having pre-ICO rounds for accredited investors only. Before purchasing one of these tokens either at the ICO or in aftermarket trading, scrutinize the terms offered to Pre-ICO investors.
Generally, they should be paying some type of price for the discount. Including but not limited to:
- Vesting schedule
- Cliff
- Reverse Vesting
Reverse vesting allows an investor to sell an agreed upon amount over a period of time once they have vested.
Ex: Selling 25% every 6 months after holding the token for two years.
Liquidity should be available on a Last In First Out basis. The last investors in who paid the highest price for their tokens should have the easiest terms for selling the token back into the market if they choose to.
I would not invest in a token that had multiple pre-ICO rounds. Additional rounds imply the focus was on providing favorable terms for insiders versus ensuring a certain amount of funds were available to help the project get started with meeting its goals.
Along with the ICO model used to raise funds. How the project leads choose to distribute a token is equally important.
Equitable Token Sale
If a project is pre-product 80% of tokens should go to investors. If a product has launched and the ICO is in part looking to recoup a portion of development costs than at least 50% should be going to investors. Personally, I am uncomfortable with investing in any project allocating less than 50% of tokens to investors.
If a project is pre-product how they are allocating funds is also important. Direct allocations to developers and initiatives like bug bounty programs ensure the project has the foundation required to meet its milestones going forward.
It’s also important to understand if the distribution model is optimized for long-term usage of the product. While proof of work has drawbacks. One of its strengths is it tends to naturally put tokens in the hands of more users versus a pre-mined model especially if mining is competitive.
Competitive mining results in miners delivering tokens to secondary markets with as low a margin as possible. Giving small investors the opportunity to purchase tokens with as small a markup as possible. Broadening distribution and dispersing ownership.
XRP is an example of a pre-mined token where the distribution model is concerning. It pre-mined 100 billion tokens reflecting the total supply at issuance. Most of these tokens ended up in the hands of Ripple. Creating the possibility since launch Ripple could flood the market with tokens driving down the value of existing investors holdings.
Wisely, Ripple recognized this concern and acted to reduce the uncertainty of supply to the market going forward. In late 2017 they placed 55 billion tokens into an escrow account that is only permitted to release a billion tokens monthly. Any unspent tokens return to escrow at the end of the month. If 500 million tokens are spent the remaining 500 million is returned to escrow and reintegrated into the monthly release schedule.
But,
Many pre-mined projects have not proactively addressed this concern like Ripple. If you are evaluating a pre-mined token you need to check to see if they’ve put in place any mechanisms to reduce the potential for supply to flood the market unexpectedly.
Thanks for Reading
Join the MPower365 newsletter to stay up to date on my latest research into cryptoasset investments!
Questions, suggestions for improvements. Please reach out.