Tokenomics Guide #3: The Launch

When to launch, Where to launch, How much liquidity do you need

The previous two articles of the Deus Ex DAO tokenomics series covered “Do I need a token” and “Real Yield — How to distribute profits to token holders”. These two articles have given some guidance around if a token is necessary for your project, an overview of what mechanisms capture value generated by the product and distribute this value to the token.

The below article will build upon the knowledge gained from the previous two articles and help give an overview on all things token launch. Looking at when to launch, where to launch, different launch mechanisms, liquidity and emissions. Attached is the Deus Ex DAO tokenomics template, a free tool to play around with that will give you some guidance on token distribution, valuation, allocations and vesting.

When to launch

As covered in Tokenomics Guide #1 Do I need a token? launching the product before the token is becoming increasingly common and allows for the product to hopefully find PMF and a constant user base prior to token rewards beginning.

However, launching the token after the product may not be always possible, especially if the token is required for utility within the product (such as a blockchain which requires the token for securing the network) or if the team has self-funded and requires fundraising via token sales to further development.

If these considerations are not applicable and the token utility can enhance the product in a further version (think a v2 deployment coupled with token launch) then waiting for PMF is the ideal scenario.

Once all conditions have been met it’s time to think about the following considerations in regards to launching the token.

Where to launch

When thinking about where to launch, there are multiple options that projects will incorporate to balance the value add from investors, attract different types of investors and decentralization of holders.

Some of the major options are listed below in which a project may use 1 or a combination of when launching their token:

1. Initial coin offering (ICO);

The crypto equivalent of an initial public offering (IPO) used in traditional markets, ICOs were previously the biggest crypto start-up fundraising tool, ahead of venture capital and before launching on a decentralized exchange was common.

An initial coin offering works by selling tokens in exchange for another cryptocurrency such as ETH with the price and supply of tokens for sale being either static or dynamic, depending on the sales conditions. Generally an ICO is conducted at the very early stages of a project’s life cycle, before a product or potentially even a whitepaper has been released.

ICOs have come under regulatory scrutiny during the 2017/18 boom-bust cycle as they are seen to be unregulated and high risk investment vehicles and there are concerns around the status of the tokens raising via ICO being considered securities under U.S. securities law.

2. Pre-sales:

Pre-sales can come in various forms such as seed round investments, private rounds and public sales. These token sales are a way to distribute your token into the hands of early supporters who will be stakeholders at launch and beyond.

Tokens are sold at a discount to these investors as a way to incentivise them to assist with funding throughout the early stages of a project’s life cycle. Generally for seed and private round investors there is some token vesting component (potentially with or without a cliff), however for public sale participants these tokens are (generally) liquid upon launch.

3. Initial exchange offering (IEO);
IEOs are similar to an IDO, except launched on a centralized exchange rather than a decentralized exchange. The exchange that the token is launching on will charge a fee for their marketing services and also their infrastructure to facilitate the launch. A market maker will also have to be employed to provide the liquidity and allow for the post launch price discovery to be facilitated.

IEOs are very popular for more ‘normie’ crypto projects whose target audience may not be familiar with transacting on chain via a decentralized exchange. IEOs generally offer a sense of legitimacy or confidence to the launch as the exchange launching the token (should) complete some due diligence checks and also has reputation damage at risk.

Some other benefits of an IEO include:

• Security for both the token issuers and investors: Token issuers gain as well since centralized exchanges platforms manage all things related to regulations, such as mandatory KYC/AML checks for every participant.
• Frictionless process: IEO platforms ensure almost anyone, regardless of their experience in the crypto space, can easily contribute.
• Guaranteed exchange listing: IEO tokens are listed on the IEO exchange soon after the IEO.
• Benefits for the projects: Such as enhanced marketing effort by the exchange, exposure, and interest in the project.
• Benefits for the exchanges: Including new users signing up with them only for the sake of purchasing and trading IEO tokens.

IEOs also have some drawbacks due to the current unclear regulatory landscape and forcing investors to complete KYC checks, potential market manipulation, unclear supply dynamics and bots that may front-run the launch.

4. Initial DEX offering (IDO);
An IDO is a popular method of launching a token amongst web3 native and DeFi protocols. This is due to the target audience usually owning a self custody wallet and operating on chain using decentralized exchanges.

Initial DEX offerings have many benefits for projects looking to use their token launch as a fundraising mechanism and a way to distribute their token to the community. IDO’s also have a low cost of listing due to the fact that the project can seed the liquidity pool themselves which also allows them to have immediate liquidity for the token to be traded.

5. Liquidity bootstrapping pool (LBP);
Liquidity bootstrapping pools are the novel launch design product by Balancer. These ‘smart pools’ are owned by a smart contract and allow any sort of arbitrary logic to be built.

In the token launch scenario, you can think of the starting price of your LBP as the ceiling you would want to set for the token sale. This may seem counterintuitive, but since LBPs work differently than other token sales, your starting price should be set much higher than what you believe is the fair price for your token.

By setting an intentionally high price, this strongly disincentivises whales and bots from snatching up much of the pool liquidity from the beginning of the launch. When LBPs are used for early-stage tokens, this mechanism can help to increase how widespread the token distribution is.

In the example below a team sets its project token to start at 80% weight and DAI to start at 20% (ETH or any other token can be substituted for DAI in practice).

Over a period of time the weights of the two tokens in the pool are adjusted and ultimately flip. This results in the slippage experienced on an order into the pool at the beginning of the token sale being significantly less as time progresses.

LBPs allow teams to build deeper liquidity for their tokens with lower upfront capital costs.

Source: Balancer docs

6. Liquidity mining campaign / Initial farm offering (IFO);

In some cases a token may be distributed to the community via a liquidity mining campaign or boosted rewards for using the product. These launch mechanisms are usually more common with products that can function without the need for a token. This token may be utilized as rewards prior to TGE and distributed to users of the product upon TGE which can be used to pair liquidity.

The token is then distributed to the greater community via token emissions on liquidity pools or via emissions to users of the protocol, for example lenders and borrowers on a money market.

When deciding where to launch, it is important to firstly determine who your target market of launch participants are. It is also important to factor in the expenses for each launch type, such as market making expenses with a professional firm like GSR or the cost of providing the liquidity yourself. It is also important to factor in the utility of your token within your product and where you would like the majority of your tokens being located. If your token has utility within the product and is used for staking or governance then launching on a decentralized exchange may be best as the tokens will be needed on chain to be utilised within the product.

Picking a trading pair

If you plan to have your token tradable on a decentralized exchange it will require a token to be paired with. This token should ideally be a common, highly liquid token such as ETH or USDC. In the current times of aggregators it no longer matters if the buyer has the token in their wallet but this token pairing is aimed more at what your liquidity providers would like to have exposure to. If you pick a more obscure pair, this may lower the appeal for a liquidity provider to provide liquidity to your token as they may not want exposure to the paired asset, thus the liquidity may be lower.

The most common pairs and ones we would advise are ETH or the L1 governance token, such as AVAX or SOL and a USD pegged stablecoin such as USDC, DAI or FRAX (or any of the other liquid stablecoins). As the token price is set between the ratio of the two tokens in the pool, utilizing ETH or a USD stablecoin will have different price effects as the overall market moves.

If you want exposure to the broader crypto market then pairing against ETH is your best bet, if you want to be more conservative and your token to trade more independently then pairing against a USD stablecoin is the way to go.

An example of this:

If your token (XYZ) is paired against ETH and the pool contains 500 ETH and 5,000 XYZ this means your token is worth 0.1 ETH. If the price of ETH (in USD) goes up 10% and there are no trades in your ETH:XYZ pool, XYZ will also go up 10% in USD terms since it is still worth 0.1 ETH. This is also true on the downside, so if ETH loses 10% (and there are no trades in the pool) XYZ will also go down 10%.

If your token is paired against DAI at a ratio of 1 DAI to 100 XYZ your token is worth $0.01. If there are no trades in the pool but the price of ETH goes up 10%, the price of XYZ token will remain unchanged in dollar terms.

Trading liquidity target

After deciding what to pair your token with, the next step is figuring out how much liquidity is required. There is no exact science with calculating a liquidity target but having a goal of 15%-20% of your circulating market cap in liquidity is a good target. This will allow for larger sized investors to enter and exit your token without incurring too much slippage and also allow for smooth price discovery.

A good resource is this liquidity cap target doc, created by @wvaeu and @mechanismcap. It shows how much liquidity is required for incremental trade sizes to maintain a <2% slippage target for a 80/20 Balancer pool and a regular 50/50 univ2 style pool.

Now you know how much liquidity to target, there are a few options on how to obtain that liquidity.

Rent

Renting of liquidity, or better known as liquidity mining is the practice of incentivising liquidity providers to provide liquidity for your tokens in exchange for governance token rewards. Pioneered by Synthetix in early 2020, and subsequently made famous by Compound, high emissions and insane APRs were the narrative of DeFi summer.

In what looks similar to an equity give away, liquidity mining programs have shown to be quite effective in bootstrapping liquidity for early stage projects. Tokens are emitted by the protocol to attract liquidity providers in the hope of them depositing liquidity which will allow the protocol to function or the governance token to be tradeable on the open market.

Liquidity mining does have some positives:

• Acts as a means of distributing the governance token to those who are providing work to the protocol (providing liquidity). Protocols often have a treasury full of tokens which need to be distributed to the community. By distributing these tokens to actors helping with liquidity this allows governance power to be in the hands of users rather than just investors.
• Low up front cost to attract liquidity as liquidity can be purchased on a block by block basis. Pairing liquidity is expensive as the protocol has to provide the other side with funds from investors and token sales, if there are not enough funds raised renting liquidity is the most cost effective option in the short term.
• Liquidity can be attracted very quickly, due to the fact that a high APR acts as a marketing tactic. Farmers are always on the lookout for the next high APR farm and will move their capital to the highest yielding option at that time.

Although there are some benefits there, that’s where they stop. Some negatives of liquidity mining are:

• Significant sell pressure: Inflationary token emission incentives short-term behavior that increases sell pressure on the farm tokens. Mercenary liquidity providers often sell their rewards to recoup their investments.
• Goal misalignment between protocols and LPs: LPs are incentivised by higher reward rates, rather than a strong belief in the success of the protocol. Hence, when the rewards are scaled back or exhausted, the LPs will remove their capital and move on to the next opportunity.
• Impermanent Loss (IL): The success of a protocol causes price appreciation in its native token, causing a significant impermanent loss scenario for liquidity providers. This misalignment disincentivises long-term LPs even if they are long-term believers in the protocol.
• No buyer of last resort: During a market crash or in times of uncertainty, LPs tend to remove their liquidity from the pool as they run for safety. It is at these moments when liquidity is needed the most and if there is insufficient liquidity depth, it will lead to a downward death spiral of the protocol’s token price.

Bribe

Bribing for liquidity is the common term used to describe incentivising governance token holders of another protocol to direct their voting power in the direction that the briber choses. These governance token holders are incentivised with tokens that are in addition to their regular governance token rewards.

Incentivised voting (bribing) was made popular by protocols (such as Frax) bribing veCRV holders to direct CRV gauge emissions to their pools on Curve. By doing this, Frax was able to gain high amounts of CRV emissions on their FRAX pools which then can be used as income from protocol owned liquidity (POL) and attracts other liquidity providers to these pools, which in turn creates deep liquidity which is a must have of any pegged assets.

Bribing for liquidity quickly grew in popularity, with protocols bribing CVX holders for their governance power over the Curve protocol and then expanding to other meta-governance protocols. Currently almost any protocol with a vote-escrow token design has a meta-governance protocol built on top and a bribe market facilitating incentivised voting to the base vote-escrow token holders.

Although bribing for liquidity does require a specific base asset design, such as Curve gauges to direct emissions, if you were planning on launching on Curve or Balancer there are marketplaces which facilitate incentivised voting to the governance token holders of these platforms.

Positives of bribing for liquidity:

• Due to emissions being paid in other protocols governance tokens, yield can be earned on POL and sold without impacting the bribing protocols token price. This is especially true for protocols who own a large amount of their own liquidity as the emissions directed to these pools can act as another form of revenue, or could be locked for additional governance power over the DEX the liquidity is pooled upon.
• Can be used to facilitate governance decisions as well as liquidity. Bribe marketplaces are also possible for general governance decisions. For example, you could bribe a DEXs governance token holders to be issued a gauge position on that DEX.

Some negatives:

• Only profitable in certain conditions. If there is large competition against other protocols who are also bribing this can drive up the necessary amount of tokens to be distributed in order to gain any sort of voting power, thus making bribing less profitable.
• Profitability may also reduce as the price of the governance token emitted from the gauge emissions drops in price.
• Bribing for liquidity is only a temporary solution. Much like renting liquidity, bribing is only applicable for the voting round that is current. Once the bribing stops (or reduces), those votes will move to the next highest bidder and the emissions will reduce. In turn LPs will usually chase the highest emissions so they will remove their liquidity from your pools.

Buy

Buying liquidity is a concept pioneered by Olympus DAO and their bonding program, now Bond Protocol. Bonding works by protocols offering up their governance tokens at a discount compared to the market rate in exchange for assets they would like to accrue. In the majority of cases these assets are their own LP tokens.

By bonding their own LP tokens it allows the protocol to own their own liquidity. They are still emitting tokens to the market as is done with renting and bribing, although now they receive something in return that isn't temporary. Owning their own liquidity allows a protocol to earn trading fees from that liquidity that would usually be going to other LPs, minimize liquidity mining expenses (or end them all together) and build sustainable and reliable liquidity for their token.

As mentioned earlier, if a project can aim for 15%-20% of their circulating market cap in liquidity, ideally 60%-80% of this liquidity would be owned by the protocol itself. This allows for sufficient liquidity to remain during all market conditions and will act as another source of revenue for the protocol.

Some downsides of buying liquidity are:

• Buying liquidity is expensive due to the bond discount which is used to incentivise actors to visit a third party to bond their LP tokens rather than just buying the tokens off the open market. Without this discount the process doesn’t work. Although this is expensive, it is cheaper than giving the tokens out for free as is the case with renting and bribing for liquidity.
• Bonding usually involves outsourcing the process to a third party, such as Bond Protocol. This third party and additional contract interaction adds further smart contract risk for the bonders and protocol.
• Bonding tokens adds friction to an already poor UX. DeFi is still very difficult for the average user, so adding additional steps and complexities only reduces the market of users competent to perform them.

In addition to bonding for liquidity, fundraising can also be utilized to buy and own your own liquidity. Whether this is from a private or public sale, selling tokens (or future tokens) to investors during seed, pre-sale and public sale rounds is a great way to raise funds to pair with your liquidity.

Launch price

Trying to determine the best launch price is one of the hardest decisions to make when launching a token.

If you set the launch price too low, you may miss out on a large amount of money you could have earned with a higher launch price. If you set the price too high, there is a risk of those with liquid tokens at launch selling their tokens and impacting the token price, public perception of the protocol and risk reputation damage.

Ideally, aiming for the lower side is a safer bet over the long term. This will allow early investors to (hopefully) see some nice price appreciation and attract new investors, liquidity providers and users to your protocol. Although the token is not a representation of the quality of the product, good price action can act as a marketing tool and gather attention of the wider market.

Below covers some options to look at when trying to determine what launch price is suitable:

1. Research your competition if you have any and what their token launched at and their current market cap. This will give you a good insight into what the market thought of their launch price and what is the current perceived fair value for their token. Always remember first mover advantage is something to consider, so even if you believe your product is better it may pay to be conservative with your comparison to competition.
2. If you are self funding your liquidity pair, this can be used to determine the launch price. For example, if you have $500,000 to put towards your initial liquidity and you want to release 10% (10M) of your tokens your FDV will be $5,000,000 with a launch price of $0.05.
3. Utilize a bonding curve or auctions and let the market decide the price. Bonding curves and auctions are perfect for raising capital to seed initial liquidity with and distributing the token to the community whilst also letting the market decide what a fair launch price is. This is done in many different ways such as English or Dutch auctions or along a pre-programmed price curve. Although they all have their nuances, on the completion of the sale the perceived fair price is reached and this will determine the public launch price.

Deterring mercenary capital

Research from Nansen analyzed activity on MasterChef.sol contracts to try to aggregate the data and see how yield farmers were behaving.

Some of the results from this research were shocking, although not that surprising:

• A large majority of farmers appear to exit within the first 5 days of entering a farm, and half of all farmers never stay beyond 15 days. 13% of addresses still have their funds in these contracts.
• 42% of yield farmers that enter a farm on the day it launches exit that farm within 24 hours. Around 16% leave within 48 hours and by the third day, 70% of the users who deposited on the first day of that farm had withdrawn from the contract. This is believed to be caused by the reduction in emissions that occur each block post launch.

As shown by this research, deterring this mercenary capital is of the utmost importance and can be done by utilizing mechanisms such as locking or vesting rewards.

Requiring LPs to lock their LP tokens for an extended period of time or to earn boosted rewards is a great way to filter out the mercenary capital and leave behind LPs who are prepared to stick around for the long term. These locks may vary in length from a week to multiple months, with rewards being boosted for those who lock the longest.

Vesting of rewards was pioneered by GMX and has proven to be extremely successful. In the case of GMX their token emissions are distributed as esGMX, a token with equal reward and governance weight as the regular staked GMX token without being liquid. These esGMX tokens can be vested over the course of 1 year if certain conditions are met, such as keeping your tokens or liquidity staked. By vesting rewards over a long period of time this still rewards past and present stakers with protocol fees and governance rights but requires them to stick around to vest their tokens and sell them.

Conclusion

As covered in this article, there are many moving parts when valuing, launching, distributing and maintaining a token. The information covered in this article is not exhaustive and the token launch space is ripe with innovation and experimentation.

Please experiment with the attached Deus Ex DAO tokenomics template. This tool will allow you to input potential token allocations, vesting and supply schedules to give an overview of what certain token distributions may look like.

Navigating this space alone can be daunting, if you are looking for token advisory please reach out to us here at Deus Ex DAO and our advisors would be happy to help you with any token or product related questions.