Frameworks for Funding and Token Distribution — Part 4: Community Token Distribution
In the first three parts of the series on token distribution models, I have tackled Utility Token Sales, STOs, and unregulated ICOs. In this final article, I will describe the different approaches in distributing tokens directly to the community without a token sale.
Similar to my last article, I want to kick this article off with nomenclature. While the blockchain community has come up with a myriad of terms that describe selling a new token in exchange for an established cryptocurrency (ICO, Token Sale, Token Generating Event, etc.) there is no fixed term for the process of handing out tokens in exchange for non-monetary value, although this is the oldest way of distributing tokens known in Cryptoeconomics. Lacking a better term, I will call it Community Token Distribution, or CTD for short.
The idea behind this distribution framework is to reward people who positively contribute to the community with freshly minted tokens. In order to do this, you need to find a mechanism that fairly rewards contributions and punishes fraudulent behavior. This is the branch of Cryptoeconomics known as Tokenomics or Mechanism Design.
An example for this is the Proof-of-Work consensus mechanism that is being used by many of the leading cryptocurrencies, such as Bitcoin. By providing hashing power and thus securing the network, contributors get the right to mine blocks and receive block rewards. This is how all Bitcoins are being distributed, completely without a token sale.
With the risks involved in token sales, it becomes an attractive option to skip this step and simply distribute all tokens to the community, especially in regions where there are legal barriers preventing a token sale to take place. Another problem associated with utility token sales is that there is often a conflict of interest between investors and the community: while investors and HODLers want the tokens to increase in trading value, the people who actually use the tokens typically want the exact opposite, as this means that the services provided by the utility token become cheaper. By forgoing a token sale, this problem can be avoided.
While a pure CTD is a good practice in general, there are limitations to this approach. Since no funds are being raised, the portion of the token pool set aside as compensation for the development team needs to be relatively large, to provide enough funds for an ongoing development process. This can lead to a centralization of tokens within the hands of the team members.
Moreover, with this funding method, it becomes very difficult to assemble a competent and professional development team in the first place, due to the greater financial uncertainty for team members. For large projects that require multiple years to complete, pure CTD is therefore not a feasible method.
If a token sale cannot be avoided, it is possible to sell only a small portion of the token pool to investors, while distributing the rest in a hybrid CTD. In practice, virtually all token sales make use of this in one way or another: there are typically phases in the pre-sale life cycle of a project, where a small amount of tokens is distributed to interested users for simply registering on the project’s software platform or following social media feeds. This is commonly known as an Airdrop.
The Airdrop’s big brother rewards contributions to the project’s marketing efforts by distributing Bounties to social media influencers who share marketing content or write positive reviews. When you pay people to shill your project, in most of cases, this will literally attract soulless drones (read: “bots”) that will mindlessly try to complete bounty tasks without making any effort to positively contribute. Unfortunately, these shills are often necessary for a project to get its fair share of visibility in today’s competitive environment. For this reason, many projects additionally hire “ambassadors” as informal employees who receive a monthly recurring token amount, for producing quality marketing content.
One thing that should be paid attention to is that all positive contributions should receive a fair reward. This is where Tokenomics come into play. You want to make sure that the rewards you hand out are both tied to the effort contributors have to make and the value they bring to your project.
For example, Bounty campaigns should have different tiers of rewards. Naturally, writing a blog post or publishing a YouTube video requires a much larger effort than a Tweet and should therefore be rewarded higher, but quality matters as well. A blog post that simply copies parts of your whitepaper is of much less value than a full-fledged review.
Lastly, you want to reward honesty. It has become a bad habit of Bounty campaigns to require Bounty hunters to write positive articles. Keep in mind that you can learn much more from criticism than from praise. You should therefore reward negative but fair reviews in the same way as positive ones. Sure, recruiting an army of yes-men may get you some hype, but if you can face honest criticism and competently address it, you have a good chance of convincing investors that you are seriously building a good product.
Besides Airdrops and Bounties, there are countless other ways to run CTDs, especially for utility tokens. The options for this may vary from project to project, but they should be tied to the token’s functionality. This means that content platforms (e.g. Steemit) reward high-quality posts, computational resource sharing platforms (e.g. Filecoin, BitTorrent) reward users who provide those resources, sportsbooks reward loyal punters, and so on.
The goal of this is to attract a strong and active user base. You should aim to incentivize early adopters to try out and keep using your product. As said earlier, ideally you wouldn’t sell any tokens, but if this is not feasible, try to sell as little of your token pool as possible. Be aware though that, whenever you release more tokens, you devalue the already circulating ones. Make therefore sure that the value of the contributions that you are rewarding offset this inflationary effect.
One of the questions that investors will likely ask you is why you need to construct your own cryptocurrency for whatever you are building, if the same can be done with an existing one. If you are looking to fund your venture through a token sale, your answers will oftentimes sound like excuses, but if you can show that you will use the tokens in order to build a strong community through well-rounded CTD rounds, this is actually a very good reason. Having your own tokens at hand to reward early contributors is a very powerful tool for community building, so use it wisely.
Tobias W. Kaiser is a Research Associate at a-Qube. He is specialized in Tokenomics, decentralized business models, and Game Theory.