How NFTs Will Change Crypto Airdrops Forever
What is an Airdrop?
Airdrops involve crypto projects sending free tokens en mass to a group of users. Airdrops are critical at the start of a new cryptocurrency. They allow tokens to be distributed to a large audience who can establish a decentralized market by trading and providing liquidity. Furthermore, token airdrops are an effective means of promotion and they allow crypto projects to reward early evangelist users.
In the past, projects would offer tokens to the public at a fixed price via Initial Coin Offering (ICO). However, ICOs were banned in the United States in 2018. Now, in 2022 the need to distribute tokens in a decentralized manner is more important than ever.
Traditional Airdrops are Flawed
The traditional airdrop method comes with several critical flaws. A large issuance of free tokens to the public, during the early stages of a projects lifespan, is highly inflationary and often leads to extreme sell pressure. This can impact investor sentiment which is difficult to overcome, especially in bearish market conditions.
Also, the IRS considers airdrops to be “ordinary income” for recipients. The market value of airdropped tokens at time of receipt is added to the users tax burden as ordinary income. In many cases, token airdrops are worth thousands of dollars and this creates a sizeable tax burden.
Taxes are incurred no matter what, even if the recipient doesn’t sell any of the tokens. If the value of the tokens decline, the user is stuck with a tax burden for the original value. If the tokens do go up in value, the user will be taxed on a capital gains basis when they sell.
Traditional token airdrops cause major issues for both crypto projects and airdrop recipients. NFT technology can solve these problems.
NFT Gated Token Distribution is the Future
NFTs can be used to distribute tokens in a manner that eliminates the flaws of traditional airdrops while adding key benefits. The process is simple, a crypto project will deposit tokens into a single-sided staking pool that is only accessible by staking their NFT. The project team has control over the rate at which tokens are distributed so they can mitigate inflationary impacts.
By using NFT gated token distribution there is no ordinary income tax burden for recipients. In fact, users can stake their NFTs and claim tokens without incurring a taxable event until deciding to sell. NFTs are a completely separate digital asset from the crypto project’s token. The owner of the NFT has the opportunity, not obligation, to stake the NFT and earn tokens. The IRS recently ruled favorably towards crypto staking in Jarret v. U.S. and NFT gated token distribution maximizes these tax advantages.
NFT gated token distribution includes several additional value add dynamics as well. NFT owners can choose to sell their NFT at any time; thus selling their claim to the remaining token allocation. Best part? The crypto project earns royalties when the NFTs are traded, unlocking a new source of revenue.
There is a limited distribution of tokens available to the NFTs, and they must be staked to access it. Participants who engage with the protocol are rewarded with tokens while unstaked NFTs miss out on the distribution. This encourages holders to keep their NFTs staked and away from marketplace listings; fostering scarcity within the collection. — NEKO Litepaper
Comparative Scenarios
Below are two scenarios which compare a traditional token airdrop vs NFT gated token distribution method.
Scenario 1: Project A uses the traditional airdrop model to distribute 5% of their total token supply to 10,000 people via a single airdrop. Upon execution of the airdrop, 5% of the token supply is instantly tradable on the market.
Based on the market value of Project A’s token at the time of airdrop, each recipient received $1,000 USD worth of tokens for free! Unfortunately, there is a catch. The recipients must decide to sell immediately and cover their tax burden, or hold and risk decline in value.
Many of the airdrop recipients decide to sell at least a portion of their tokens to cover tax burden and lock in profits. This results in a significant decline in the token price causing even more people to sell. A week after the airdrop event, the tokens are now only worth $500 USD. Unfortunately, the recipients are still taxed on $1,000 worth of ordinary income.
Scenario 2: Project B uses the NFT gated token distribution method to distribute 5% of their token supply to 10,000 people. Project B deposits 5% of their token supply into a single-sided staking pool. Then, users mint a collection of 10,000 free NFTs. The tokens are only accessible by staking the NFTs in the single-sided staking pool.
Project B decides to release the tokens to staked NFTs over a period of 1 year. The market has a much easier time absorbing any sell pressure.
In the early stages, sellers prefer to trade the NFTs which does not result in selling pressure to the token. They are selling their claim to the remaining token allocation, not the tokens themselves. Project B earns royalties whenever the NFTs are traded. The revenues generated from royalties go to directly support the project and token.
Project B’s token continues to grow in price over time as the team completes milestones and builds their brand. Success!
NFT Gated Token Distribution in Action — It works!
The Trove Labs team is actively testing the NFT gated token distribution method in projects we have Founded. We implemented it with NEKO token and the Good Fortune Felines NFT collection. It has been several months since the Good Fortune Felines minted and the statistics couldn’t be more bullish! At the time of writing this article, only 1% of the NFT supply is listed for sale and over 88% are staked earning their vested NEKO token allocation.
Trove Labs is also developing the Jump DeFi platform on NEAR Protocol. Jump DeFi will offer streamlined infrastructure for NFT gated token distribution that any project can use. The JUMP token “airdrop” distribution will leverage this as well!
Conclusion
Utilizing an NFT collection as the main source of funding is quickly becoming the norm for web3 projects. This will inevitably lead to NFT gated token distribution as the main method of allocating tokens to users. It is a better solution for everyone involved.
DISCLAIMER: The Trove Labs team are by no means experts in tax law. None of the information in this article is financial advice.
Reach out to us for consulting and development. We LOVE Tokenomics! team@trovelabs.xyz
David Leer, Co-Founder Trove Labs
Follow dleer.ious on Twitter: https://twitter.com/dleer_defi
Jump DeFi Twitter: https://twitter.com/JumpDeFi
NEKO Twitter: https://twitter.com/goodfortuneNFT
