Andreas Park PRO
Professor of Finance at UofT
Tokenomics: Financing with Tokens
Instructors: Andreas Park
Tokens as financial instruments
- to understand token/coin offerings, we must first understand
- what is a security
- who you can sell to
- what's different about tokens
- then
- what types of tokens exists?
- how do we assess their value?
The crypto-asset landscape
Current (Nov 2022) Status
Current (Nov 2022) Status
VCs/Funds in Crypto
How are tokens brought to market?
Old way: own website etc
Dedicated services: Coinlist
Initial Dex Offering
Initial Exchange Offering
Cumulative sales during the first bull-market
Data: coinschedule
$25B total
$18.7B in '18
Speaking of Coinschedule
Dedicated services: Coinlist
- Token sale management tools
- Pre-sale allocations
- Whitelisting
- Investment control (tiers etc)
- Analytics and documentation
- Compliance framework
- KYC/AML, verification tools
- Legal support
- Payments
- ETH, BTC, USD with phishing protection etc
Around 1B in token sales so far
- Popularized in 2019
- Partnership with a crypto exchange (e.g., Binance, Gate.io)
- Trust: expectation that exchange has performed due diligence
- Reach: event promoted to exchange's userbase (reduced marketing budget)
- Liquidity: token listed on exchange that handles IEO
- Vesting options
- BUT:
- Strong centralization: exchanges become gatekeepers
- Large fees paid to the exchange by project
- Exchange can enforce holding/staking requirements for their own token
Initial Exchange Offering
https://cryptorank.io/
IEO Data for 2022
- about 490 projects
- total raised about $440M
- ≈ $1M per project
- Popularized in 2020
- Distribution via launchpad/DEX (e.g., Uniswap, BSCpad, DAO maker)
- More decentralized
- Low cost, no fees to an exchange
- Participants retain custody
- Immediate liquidity and trading via AMMs
- User buys "IOU"s -> receives tokens during Token Generation Event
- BUT:
- Still have to satisfy launchpad criteria (staking, whitelisting)
- Lopsided towards DeFi, sophisticated DeFi users
Initial Dex Offering
https://cryptorank.io/
IDO Data for 2022
- about 550 projects
- total raised about $180M
- ≈ $400K per project
What is a security?
- most conversion contracts; subscription to shares, stock, units or interests; share or interest in a trust etc;
- Any profit-sharing agreement or certificate.
- Interest in an oil, natural gas or mining lease, claim or royalty; collateral trust certificates; non-insurance income or annuity contracts
- Any investment contract.
- Derivatives that are prescribed to be a security.
What is a security? Ontario
- Any instrument or unit commonly known as a security.
- Any title to, or interest in, the capital, assets, property, profits, earnings or royalties of any person.
- Any option, subscription to or other interest in a security.
- A debt security or a share, stock, unit, unit certificate, participation certificate, certificate of share or interest, preorganization certificate or subscription that is not [regulated in some other way as some kind of deposit]
- A crypto asset – other than one that falls within [other definitions]
Sidebar: “crypto asset” means a digital representation of value or contractual rights, which may be transferred and stored electronically, using distributed ledger or similar technology;
Sidebar: Designation orders (CMA Section 127) (paraphrased)
- If the Chief Regulator considers it not in the public's interest, then it can designate a security not to be a security.
- If the Chief Regulator considers it in the public interest, it can designate
- a crypto asset to be a security;
- a crypto asset to be a derivative.
What is a security? The Howey Test
Note: in Canada, it is the Pacific Coin test
What is a security? The Howey Test
- 1946 U.S. Supreme Court case of SEC v. W.J. Howey Co.
-
instrument = security if
- involves investment of money or other tangible or definable consideration used in a common enterprise
- with reasonable expectation of profits to be derived primarily from the entrepreneurial or managerial efforts of others.
- Note from furniture store to finance a customer’s purchases:
- not a security (purpose is to facilitate the purchase)
-
Notes issued by a corporation for the general use of the company
- buyer is primarily interested in the economic gain from the entrepreneurial efforts of others => is a security!
- Form (formal certificate, nominal interests in the physical assets, etc) is irrelevant.
So: is PoS-ETH a security?
Taxonomy of Tokens
Tokens standards
- Most tokens to date run on Ethereum.
- https://eips.ethereum.org/EIPS/eip-20
- Common language: "Our token is ERC-20 compliant"
- ERC=Ethereum Request for Comment
- Set of 6 mandatory functions that yield 4 items:
- total token supply,
- account balance,
- transfer of token from one party to another;
- Approve the use of token as a monetary asset.
- Common standards:
- ERC-20: fungible token
- ERC-721: non-fungible
- ERC-1155: mix of both
- tokens are a re-imagination of value, ownership, use, rewards
-
tokens live on a single infrastructure and can interact with other tokens
- tokens are immediately transferable & immediately usable in DeFi
- token can be programmed to have many features and have many different uses
- tokens can assign ownership to "things" that could not be owned before
What's a crypto-token and what's special about it?
Tokens by use
payments:
- you use them strictly to pay for something
- example: native cryptocurrencies
utility
- you use them to access a specific service of function
- example: filecoin
stablecoins
- digital representation of fiat money
- centralized/decentralized
- examples: DAI, USDC, USDT
governance
- voting rights to determine parameters of a project
- example: UNI, Compound etc
asset
- representation of ownership
- pool claims, digital items
- example: receipts from UniSwap, Compound, NFTs
derivatives
- tokens based on other tokens & functions
- Example: tokensets
Disclaimer: this list in non-exhaustive, new ideas come up every day!
So what if they are securities?
- Regulation of public securities is burdensome
- Early-stage firms (often just an idea!) unlikely to tick all boxes that IPO firms must tick.
- Crypto-assets are available world-wide
- Which regulator do you need to satisfy?
- How do you resolve conflicting rules?
The Idea of a Token-Driven Flywheel
- Liquidity pool example
- trading requires liquidity
- need to attract liquidity
- offer early adopters DAO token that contains claim on protocol fees
liquidity ↗
volume ↗
protocol fees ↗
token value ↗
Insight: protocols use tokens that have equity features as incentives to users
Who controls the Projects? Decentralized Autonomous organizations
UniSwap Lab supports development
a website app accesses the code
token holders control contact features
don't own the code
operation = decentral
control = decentral
anyone can use the baseline code
core code runs on the blockchain
tokens used as rewards
How do we evaluate tokens?
Blockchain Tokens: A New Financing Tool?
- Since Jan 2016: $31 billion for 1,700+ early-stage blockchain start-ups
- TMX Venture (successful, since 1999, for junior firms)
- $42 billion market cap (since 1999!)
- In 2018: 52 IPOs, $2.2 billion
Lessons?
- Significant interest in FinTech
- Appetite by retail investors for risk/early-stage firms
- Possible to raise funds directly from investors
- VCs and intermediaries do provide a service
- money does not substitute for business plan/advice
- "wisdom of the crowd" is non-existent (?)
Tokens as Seignorage Money to Power a Network
Infrastructure
reward and internal currency
Sustainability of network security
Chiu & Koeppl (2016), Budish (2018)
How do cryptocurrencies have value?
Biais, Bisiere, Bouvard, Casamatta (2016), Schilling and Uhlig (2018)
Cryptocurrencies as payment for "real" costs
Sockin and Xiong (2018)
Development and subsequent seignorage
Canidio (2018), Catalini and Gans (2018)
Blockchain Platforms: Economic Transactions with "Decentralization"
Two-sided markets with fixed roles
Consumers - Producers
Consumers - Intermediaries - Producers
Traditional economy
Multi-sided or peer-to-peer markets
Consumers = Producers
requires platform building
Decentralized economy
Traditional "centralized" economy
Service Platform Tokens: Enabling Decentralization?
usage fee or incentive
Service
What is the relationship between token prices and platform adoption?
Cong, Li, and Wang (2018)
How do you finance development without future income flow?
Canidio (2018)
How do you get people to contribute to a peer to peer platform?
Li and Mann (2018)
Tokens as Payments: a New Financing Tool?
usage fee
Application
What can (utility) tokens finance that traditional securities cannot?
Chod and Lyandres (MS 2021):
- Token ⇒ underinvestment, except under VC under-diversification
Davydiuk, Gupta, and Rosen (2018)
- Token retention policy is a quality signalling tool
Tokens as Payments: a New Financing Tool?
usage fee
Application
What can (utility) tokens finance that traditional securities cannot?
Lee and Parlour (RFS 2022)
- Tokens as crowdfunding tool that allows producers to extract untapped customer surplus
Malinova and Park (2018)
- Tokens ≡ output pre-sale; generically equivalent to debt and equity and better than equity under moral hazard
Shakhnov and Zaccaria (2022)
- ICO sale to entice early adopters who provide network externalities
Simple model of revenue-based ICO vs equity financing from the standard corporate finance + IO toolbox
Theorem 1: Without frictions, an optimal token contract finances the same projects as equity
Theorem 2: With entrepreneurial moral hazard,
- any equity-financeable project can be financed by an optimal token
- some token-financeable projects cannot be financed by equity
⇒ There is economic and conceptual merit to token financing
Summary of Malinova and Park
Tokenomics: Financing with Tokens Instructors: Andreas Park
Blockchain 3: Tokenomics
By Andreas Park
Blockchain 3: Tokenomics
This set of slides describes tokens as a form of financing of operations.
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