A Legal Engineer’s Guide to a “Fair Launch” ⚖️ 🚀
Part 2 — Fair Food For Food Fights
The Fair Launch Movement as aptly described by Gavin McDemott:
“The fair launch emerged from DeFi because of this ecosystem’s composability and readiness to experiment with novel bootstrapping mechanisms. But I believe the fair launch to be a far bigger movement than most people think. Stated directly: The fair launch approach will become one of crypto’s most important creations, eventually finding application in many other domains.”
To watch this evolution of fair launches it is perhaps most instructive to watch the evolution (and perhaps devolution) through a case study method. With any system, the flaws and benefits become more evident over time and both become more exploitable. One area that is of interest is how to solve or militate the “free rider” issues that are native to most systems and environments in the “tragedy of the commons”. How to get people, protocols, and businesses to fund development of the common infrastructure. Both to reward “past” contributions and more importantly from a utilitarian perspective to fund future development of the ecosystem commons. Gavin McDermott further describes this tension as follows. “[Take] an ecosystem where the communities are owners and governors of physical/digital products and experiences … while financial markets come into play, it is a meaningfully different world compared to DeFi. However, these adjacent ecosystems have an important intersection: infrastructure. And shared infrastructure is the key.”
Coordination games are inherent in any system, but perhaps the most when people are trying to solve for a two sided marketplace. The yield farming craze was arguably pioneered quietly in the depths of the Synthetix reward systems. Where incentives and rewards were demonstrated for participants to maintain collateral ratios, mint synthetic instruments and provide liquidity for the protocol to maintain pegs for its synthetic dollar $sUSD, and parity between trading pairs $sETH and $ETH. But, with all systems they evolve and are iterated upon.
Case Study #1 — $COMP from Compound
The farming of governance tokens reached a fever pitch with lending protocol Compound and its COMP token. The governance of the protocol was offered to those who use the system as providers of liquidity or borrowers of liquidity. The idea being that it quickly helps put the ownership of the protocol into the decentralized community. Basically allowing the team and investors to exit to and/or join the community. What are these generous venture capitalists and entrepreneurs doing giving things away for free? It is important to note what the owners and original investors of Compound get in return.
- Liquidity — the life blood of investing. For some illiquid investments, the exit needs to happen slowly over time as the cash flow is recouped to provide the return on investment. Illiquidity discounts for assets are large.
- Path to Decentralization land. Following the ICO, and SAFT, and many other token models is the SAFG (also Gavin McDermott). This provides a path for a community owned project to arguably avoid being held a security under regulations. For a path to thread this needle, read some of the ever prescient thinking of Hester Pierce
“The SEC’s approach in these cases has made it extremely difficult for a company to distribute a token — a process that typically includes planning for a future in which people use the network and talking positively about its prospects for success — without running into a charge that the company is engaged in a securities offering. We have even hinted that a token airdrop in which tokens are given out freely might constitute an offering of securities. How is a person supposed to get a network up and running when she cannot even give away the tokens necessary to use the network?”
3. Users. The lifeblood of any business is users. VC’s are often a provider of marketing dollars to some extent, and the next phase is a test to see if the marketing dollars can acquire enough users to turn the flywheel toward profits. On Compound, the customers are acquired and rewarded for using the product. This model follows in the step of the more familiar “Coop”. These governance tokens confer some “right” upon its holders to participate in the protocol. Decentralized governance is missing the core of the apple, the CEO, the board, etc. These roles are filled through governance proposals in a decentralized protocol.
4. Exit liquidity. Cynicism should run deep in crypto. So what if we “incentivize” a pool of liquidity that will feather our exit from the protocol. The ever present dichotomy of different investing timeframes and horizons. How to incentivize parties to work together to maximize long-term value. Bookmark this one for the incoming Sushi tummy ache in future case studies.
The tokenized governance of $COMP has certainly had its challenges and success stories. For the governance process, it requires 100,000 COMP or over $15,000,000 worth to make proposals. So now doubt this is a very top heavy, whale dominated governance process.
Large $COMP proposal requirements obviously prevent proposal overload from small fish needlessly spamming the governance process. But overall makes having one $COMP similar to having one share of GE. Makes it hard to really dig into the governance process as it is clear that any vote is going to fail unless supported by the oligarchs.
As we discussed in Part 1, fairness is often a matter of opinion. Is it fair that the largest investors in a protocol have a larger share in the governance? Is it fair that minority interests effectively have zero realistic sway in governance?
It should be mentioned that $COMP governance also has a really novel feature regarding delegation. Small $COMP fry can delegate their voting power via smart contract to “protocol” politicians that they believe represent their interests.
- Open questions from a legal standpoint? What responsibilities (if any) do the protocol politicians have to their token constituents. Can they lie, cheat and collude against their interests?
- Can delegates collude with each other to lead a Barbarians at the Gate activist investor coup against the protocol’s insiders
- What attack vectors do other “yield farming” projects open for tokenized governance. For example, what happens if a other “food token” project gets hacked and the tokens are used to vote for merger?
- Can governance be “rented” in things like Power Pool. Reminds me of the statement warlords loyalty can’t be bought. But it can surely be rented.
So generalized notions of fairness are words that people throw around, but generally are very squishy and difficult to manage the edge cases. That is why there is such a large body of law and regulations, Williams Act, fiduciary responsibility, etc that has developed to protect minority interests (and majority interests) in corporate governance. Tokenized governance is probably not equal to corporate governance, but many will try to pigeonhole into existing paradigms.
Special thanks to Adam J Kerpelman for providing comments. Next case study to follow will be YFI, stay tuned…..
All links provided are for informational purposes only and not meant as recommendations of the people or products. Nothing herein is legal advice and should not be relied upon without reaching out to your own personal attorney. The linked ABA disclaimer is appended to the blog.
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To be continued…..
