Initial Community Offerings are the future
Leadership & Org Update 04
I listen to a lot of people interested in building decentralised apps and designing cryptocurrencies explain their businesses. Last week, I was in a meeting with a CFO with a great track record who was looking to build a blockchain business and create value for investors and users through designing a cryptocurrency. He was hoping to design a currency that would create a sneaky 10x.
They assured me that everything was on track, but after a few minutes of getting to know one another, they revealed that they are stuck on tokenomics. As usual, I was told that the business has sought the advice of many experts, yet nothing had made sense to them. Every call — be it with mathematicians, Bitcoin maximalists, economists, or crypto consultants — ended up with the person on the other end of the line trying to push the business into something that doesn’t make sense with which they are uncomfortable.
I listened for a while, mumbling yeses and nos, and waited for them to challenge me. As I did, I wondered, “why will this conversation be different?” By now, the CFO is just expecting another hour of pain that gets them nowhere.
In their hearts, this business knows their current approach is flawed, but they can’t explain why. The alternatives involve asking fundamental questions of yourself and the business you are building, and forces you to challenge deeply held assumptions. In my experience, this tension is frustrating for everybody, but unfortunately, most go ahead with a model they know won’t work rather than of grappling more deeply with the problem.
Businesses that should raise on equity (Security Token Offering, STO) try to design tokens, businesses that should design tokens (Initial Coin Offering, ICO) raise equity, and only a few design currencies that build community in addition to appropriately releasing funds (Initial Community Offering).
The purpose of an Initial Community Offering is not just to raise funds, but to build the community for network effects to grow.
Because post-2017 blockchain businesses think of Initial Coin Offerings as purely fundraising vehicles, they design their currencies trying to promise price upside. This creates perverse incentives where nobody ever wants to participate in the economy by spending money. If the buyer expects a 100x increase, then the seller is basically offering their product for a 99% discount. It’s a lose-lose scenario.
In this model, it’s no wonder that everybody believes Initial Coin Offerings are dead and are moving to STOs. STOs are designed to attract investors, rather than build a community. For a network-based business, no community means no adoption, no revenue, and ultimately, no profit or value created. It’s another lose-lose scenario.
What caused the early Initial Coin Offering success?
Some early ICOs were successful because they created an enormous community with a commitment to building and low expectations of financial reward — much like a kickstarter project. They had a desire to address financial inequality through new monetary systems and brought projects to the world. Early fundraising efforts:
- Focused on the community rather than investors, as there were very few investors in the ecosystem at that time.
- Brought low expectations of financial reward and high expectations of product.
- Addressed true distributed needs, not replicating existing businesses.
- Had a community that could handle large volatility because there was no downward selling pressure or viable alternative (no short selling, only believers in the industry).
- Managed expectations so that emotional attachment and product viability was demonstrated rather than promised upfront.
What changed?
Businesses came into crypto, bringing their existing patterns and beliefs, seeing only the signs of success, and not their conditions. A crypto bubble meant that everyone was focused on extracting value instead of creating it. This meant:
- ICOs became about investing, therefore prioritising financial returns and investment rounds over community.
- Hype and promises of financial reward outweighed credible assessments of product.
- Solutions were framed from a centralised perspective rather than thinking about where decentralisation would make sense.
- The non-existent community would not handle large volatility.
- The costs to the user of the product or service were often large and important, so the 100x return, 99% discount dilemma kicked in.
For almost every blockchain project — be it protocol, an up-and-running business, or a startup trying to find product market fit — fixed supply is the wrong approach in the post-2017 bubble context, except in what would be highly unique circumstances.
As an industry, we still have not grasped the context of early success and the distortion of later efforts. Because of this, we are at risk of moving on to another failed model in the STO without bringing to life the true potential of an Initial Community Offering.
Security Token Offerings don’t build a community.
The STO model is a distributed version of the current IPO: lowering barriers to entry, increasing access, and offering fractionalisation, which has potential for businesses as they exist today. But this model doesn’t work for Bitcoin or Ethereum, because adoption required their community of users to decide to use the technology and their financial model connected rewards with adoption instead of ownership. Ethereum could have sold equity — but what would you own, and how would you go about building a community to satisfy the needs of the equity holders?
STOs don’t build community because there are no community-building incentives inherent in the equity model. Unfortunately, distributed systems are, almost by definition, their community. STOs can also suffer from the same trust issue as today’s centralised world; the value creation on the network may not be transparent, and holders may have to trust companies to distribute value correctly.
Fundamentally, STOs are a pattern copied from the centralised world — the network may be decentralised internally, but ultimately, it’s a centralised entity for end users. The only way to have true decentralisation is by having the users themselves comprise the distributed system community.
What are the keys to a successful Initial Community Offering?
Some crucial design elements that can kickstart a network-based business are:
The community must be able to handle fluctuations or price variability early on. For businesses where this is not possible, e.g. for a loyalty platform where merchants and customers are to receive crypto loyalty coins, merchants are unlikely to want to take the price variation risk, nor go to the effort of conversion. There is a very low chance of adoption. It is better to use an existing national currency or cryptocurrency in these cases.
The community must have few incentives to exit early, and in general should be happy to have their ‘savings’ sitting in the ecosystem for a while before exiting. Small business communities generally prefer money in the bank rather than in an ecosystem so they can manage cash flow.
The currency must represent value creation. It is rare that a project can describe the new value created in their economy and how their currency represents it. You may have created a payments coin that takes cost per transaction from 3% to 2%, or a medical coin for a hospital that takes the cost of accessing medical data from $1,000 to $100 per year. On the other hand, you might be creating non-monetary value through your business. Assuming a currency is a way of making visible and valuing flows, then it is important to know precisely which flow(s) you are valuing.
The business, or reserves of the business, have to be able to handle the redemption costs and volume. What happens if the token goes 100x or 0.01x? Can you honour sales made at these new rates? Can you satisfy angry customers who no longer have any purchasing power? Do you have enough cash in the bank? Most projects with whom I speak have this model wrong in their heads. For example, a blockchain investment platform is likely to design a token with a desired upside of 50x, but if that 50x upside is realised, their reserves are not enough to cover the redemption of investments made at 50x purchasing power from the initial raise.
In most cases, demand, not price, should be satisfied by supply. In the early successes, price was used to satisfy demand, which assumes that supply is also fixed.
Most of the time, however, we want supply to increase to satisfy demand with price remaining reasonably steady. This is like Uber or Airbnb; as demand grows, there may be price spikes or drops.
As new houses rush to come online or new taxis hit the road, prices may temporarily change, but eventually a new equilibrium will be set. In productive economies, we want change in demand to signal new requirements for supply, and have supply come online to meet this demand without having to significantly adjust price. If the motivation of most of the participants in your economy shifts from creating value to speculating on price increases, you’re disincentivizing actual value creation and making your economy weaker.
Overall you should want to reward effective work. Competitive work like mining brings an inefficiency into a productive economy that is likely to be exploited by a better designed solution. Value-added work — like providing housing, transport, or office space — creates a far stronger economy and financial model to compete with even the best centralised businesses.
This is a world where few will succeed, and therefore, understanding context is everything. Your tokenomics can be designed around the new value that is being created, value that is specific to your context. You may need to throw out the models everybody else has, and design the solution you see based on your understanding of how your industry works.
Is an Initial Community Offering for you?
When designed well, Initial Community Offerings are worth far more than the funds raised. They jumpstart communities, attract customers/users, and accelerate your business — but they are not for everybody.
Are you struggling with your tokenomics like the business I spoke to last week? Is it all too hard? Do you think your fixed supply model will fail? Are you able to articulate the value your business creates? Can this value be expressed through a currency or is it better realised through equity? Does your design incentivise use and reward real work?
Some businesses are perfectly set up for a fixed supply economy, others are suited to a variable supply, and most, like the company above, build off existing economies and don’t need a currency at all. Their biggest challenges are which currencies to support and how to bridge money into and out of their business.
All of these problems are solvable with an open mind, a desire to investigate the questions, and the right partnership. The scenario we are looking to create is one where a business finds the ideal fundraising mechanism for them, rather than letting the ease of raising funds blind them to the work necessary for building a successful business.
We can summarise the inquiry of whether an Initial Community Offering is for you in the following table:
Where is Holo now?
At Holo, we finished our Initial Community Offering in April 2018 and have been working hard to build community and product ever since. As we are getting closer to testnet, we are also upping the frequency and breadth of our communications. Community expectations are high, and we are doing our best to live up to them.
In the coming weeks we will be building on the considerations raised above and discuss ways to design decentralised architectures, crypto economies or tokens, and fundraising models in various articles and papers in order to coincide with the test launch of HoloFuel.
We are in the earliest stages of variable supply currencies with global reach. We invite you to be a part of creating this story by joining our community or giving feedback. We look forward to continuing the conversation together.
David Atkinson, Commercial Director
