Talk to a16z Legal Experts: The “Do's” and “Don'ts” of Token Issuance
How can you avoid common pitfalls when looking for a product market fit?
Curated & Compiled by Deep Tide TechFlow
Guests: Eddy Lazzarin, Chief Technology Officer at a16z Crypto; Miles Jennings, General Counsel and Head of Decentralization
Moderator: Robert Hackett, operating partner and head of content and editorial department at a16z crypto
Original title:《Token do's and don'ts》
Background information
This episode of a16z's Web3 program will comprehensively discuss Token-related content — including the role of tokens in decentralized protocols, different types of tokens, and considerations for designing and issuing tokens.
The guests in this issue are Eddy Lazzarin, chief technology officer of a16z crypto, and Miles Jennings, general counsel and head of decentralization, who have advised on protocol design and token design for numerous projects. They'll discuss the differences between Web3 and the early technology era; how to avoid common pitfalls when looking for a product market fit; how to evaluate various designs and strategies, and their risks and rewards; and more.
The need for decentralized protocols
The central role of tokens
Eddy explains why decentralized protocols need tokens to maintain their sustainability and incentivize the participation of all stakeholders. He pointed out that tokens are more than just a payment instrument, but a means used by users and network participants to express 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, rather than just a payment medium for purchasing traditional goods.
Comparison between tokens and traditional protocols
When comparing Web1 and Web2 protocols, Eddy mentioned that although Web1 protocols such as HTTP and SMTP are decentralized, they are eventually absorbed by large companies, causing users to lose control of these protocols. He pointed out that by introducing tokens, decentralized protocols can maintain decentralization through economic incentives. This economic incentive allows the agreement to continue to operate without relying on a centralized entity, 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 token's economic model. He believes that tokens are a key tool to achieve this goal because they can be written and executed within a program to ensure that the agreement continues to operate as designed.
Types and classifications of tokens
Eddy mentioned several different types of tokens in the discussion, pointing out that each has unique features and market positioning within decentralized protocols. He listed some common token types, including:
Stablecoins: For example, USDC and USDT, these tokens usually anchor the value of fiat money and aim to reduce price fluctuations and provide users with a more stable store of value and a medium for trading.
Arcade Tokens: These tokens are generally used in specific application scenarios or platforms. Similar to a point or reward system in games, users can obtain them by participating in activities or completing tasks.
Meme Coins: These tokens usually originate from internet culture or humorous content on social media, and although they may lack substantial application, they can sometimes garner widespread attention and speculative interest due to their community-driven nature.
Eddy emphasized that different types of tokens need to consider their specific features and target markets when designing and launching to ensure their effectiveness and sustainability in decentralized protocols.
Legal and regulatory challenges
Regulatory uncertainty
During the discussion, Miles highlighted the legal risks and regulatory uncertainties faced by token issuance and decentralized agreements. He pointed out that with the rapid development of cryptocurrency and blockchain technology, regulators around the world are paying increasing attention to these emerging technologies. However, since the legal framework is not fully mature, projects often face complex legal and compliance challenges when designing and issuing tokens.
Miles mentioned that the project team needed to carefully consider its legal structure when launching a token to avoid potential legal issues and regulatory penalties. He recommended that the team adopt different strategies to mitigate these risks, including:
Compliance review: Detailed legal and compliance reviews are carried out during the token design phase to ensure compliance with local and international laws and regulations.
Legal advice: Seek professional legal advice to understand the latest regulatory developments and requirements 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 despite the challenging legal and regulatory environment, through careful planning and professional legal support, the project can effectively navigate these complex areas and innovate and grow based on compliance.
The value of governance and decentralization
The technical and legal advantages of decentralization
Eddy and Miles emphasized the technical and legal importance of decentralization. They pointed out that by decentralizing control, decentralized protocols can provide users and communities with greater autonomy and transparency, thereby enhancing the reliability and trust of the system.
Technical advantages: Eddy mentioned that decentralized systems reduce the risk of single point of failure and improve system resilience and security through distributed network architectures. This architecture allows 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 agreements can reduce dependency on a single entity through a decentralized governance structure, thereby reducing the risk of concentrated legal liability. Furthermore, decentralized governance mechanisms can give community members more decision-making power, so that agreements can better reflect users' needs and interests.
The pros and cons of token governance
When it comes to token governance, Eddy and Miles also explore its potential pros and cons. Token governance usually involves token holders participating in the decision-making process of an agreement through voting or other mechanisms. This approach can enhance community participation and the democratic nature of the agreement. However, they also pointed out that token governance may present some challenges, such as:
Governance participation: Although token governance empowers users to participate in decision-making, actual participation may be low, causing a small number of large holders to have excessive influence on the decision-making process.
Complexity and efficiency: Decentralized governance mechanisms may increase the complexity and time cost of decision-making processes, affecting the responsiveness and ability of protocols to innovate.
Despite these challenges, Eddy and Miles continue to believe that decentralized governance is one of the key factors for the long-term success and sustainability of the agreement.
Market and product alignment
Definition and importance
Product-market fit (Product-Market Fit) refers to a state where a product can meet the needs of the target market and find its position in the market.
Eddy emphasized the importance of this concept in decentralized protocols and token projects. He pointed out that market and product fit is the key to the success of the project because it determines whether the product can be widely adopted and continuously used by users.
Strategies to achieve market and product alignment
User Needs Analysis: Eddy recommended that the project team thoroughly understand the needs and pain points of target users to ensure that product design and functionality can truly solve users' problems. This requires extensive market research and user feedback gathering.
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 quick response are important factors in achieving market and product alignment.
Community participation: In decentralized projects, community participation and support is critical. 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 the key to helping users understand and adopt the product. Eddy recommended that the project team 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 an easy task. Eddy points out some common challenges, such as intense market competition and diverse user needs. He recommended that the project team address these challenges through differentiation strategies and unique value propositions while remaining sensitive 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 critical step for blockchain projects to raise capital and drive ecosystem development. However, there are good and bad practices in the token issuance process that require careful consideration and compliance by the project team. Here are some common good and bad practices:
Good practices
Decentralized:
Eddie and Miles emphasized the importance of decentralization as one of the core values of blockchain technology. Decentralization not only helps reduce dependency on managers, but also brings technical and legal advantages.
Decentralized systems can better protect users from information asymmetries, and can also reduce the risk of being treated as securities in law.
A clear economic model:
Ethereum was mentioned as a successful example because it has a clear economic model and is able to maintain value over the long term.
Tokens should have a clear purpose and not just exist as a speculative tool.
Community Driven and Engaged:
Effective token issuance should encourage community participation to ensure that token uses and governance mechanisms are clear and necessary.
Bad practices
Decentralization as a show:
Miles mentioned “decentralization as a show”, where a project claims to be decentralized but is actually still controlled by a centralized team. There is no technical advantage to this approach, and it may result in consumer risk.
Tokens that lack a clear purpose:
Issuing tokens for governance only is considered bad practice, especially when governance isn't really needed.
In the example mentioned by Robert Hackett, there are projects that force users to use their tokens, and these tokens have no actual functionality or value.
Legal risks:
Public sales of tokens in the US may be considered securities, and Miles emphasized that this practice should be avoided as much as possible, as it poses huge legal risks.
Issuing tokens too early:
Miles notes that many projects issue tokens too early without a clear use or market fit, which often results in failure.
By following good practices, the project team can increase the success rate of token issuance and lay a solid foundation for the long-term development of the project.
Summary and suggestions
The importance of decentralization:
Decentralization is not only a legal requirement; it is also a core value in technology. It provides system robustness and global adaptability, so users and developers can trust and rely on these systems.
Decentralization can reduce dependency on management and reduce the risk of information asymmetry. This 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 the tokens. The token should not only exist as a speculative tool, but should help the operation of the protocol and the healthy development of the ecosystem.
Avoid issuing tokens too early:
Many projects hastily issue tokens before there is a clear product market fit and token use, which poses legal risks and the possibility of market failure. The project should determine the token's functionality and market demand before issuing it.
Legal compliance and risk management:
Projects should fully consider legal compliance when issuing tokens, particularly in the US market. Avoid unnecessary legal risks, such as the public sale of tokens that may be considered securities.
Legal risks can be reduced to a certain extent through strategies such as decentralization, excluding the US market, or limiting the transferability of tokens.
Community Engagement and Governance:
Community participation is critical to the long-term success of the project. Projects should design reasonable governance mechanisms to ensure that communities can effectively participate in decision-making when necessary.
Voting should be used as a last resort, only when necessary, and not as a primary reason for issuing tokens.
Economic models and incentives:
The token's economic model should be carefully designed to avoid unnecessary speculation and market manipulation. The project should focus on building a sustainable economic ecosystem.
When designing incentives, care should be taken to balance the interests of both supply and demand to ensure market stability and predictability.
Focus on the product, not the token:
Eddie emphasized that the founders should focus on the design and implementation of the protocol rather than just the token itself. The token is part of the agreement, not all of it.
