Emerging Token Economics: Impact on Valuation and the Capital Stack
Research Note
Overview
As the crypto industry matures, projects and investors have adjusted and evolved best practices in tandem. Token models have similarly evolved to solve a number of problems that have plagued crypto projects for years, and more recent developments in particular have proven effective at optimizing both token economics and distribution. If these trends continue to proliferate and become best practices, this could have a significant impact on the capital stack and early stage crypto deal terms.
Fair Launch Aligns Interests
Token distributions that follow “Fair Launch” principles, as a guideline, ensure a token distribution that is decentralized at launch and organically aligns interests between the protocol’s earliest users and supporters. Pioneered by $YFI, more recent iterations include $SUSHI, $BADGER and $ALCX.
Liquidity Mining Program
Targeted token incentive programs use free market incentives to underwrite initial liquidity for new protocols and a liquid market for the native token on DEXs (i.e., Sushiswap, Uniswap, PancakeSwap). By incentivizing targeted liquidity goals, liquidity mining programs stimulate demand from purely financial interests, independent of the protocol’s functionality. High yields and low market caps can make it easy to bootstrap and stimulate a market.
Staking
Staking pools enable an equity-like claim on dividends, offering some yield with little risk outside of principal risk, offering a different type of purely financial incentive to hold the token. Staking also provides a compounding option for early investors and liquidity providers who are no longer necessarily incentivized to “dump” the token to see a return on capital, and this has proven to be very effective at better aligning interests and retaining more committed capital.
Product-Market Fit
Projects that launch using a combination of the above approaches and principles will be able to attract initial liquidity to support a viable token launch, if only for the mercenary yield farming or staking yields. But the token will not retain value unless it is accruing actual value in the protocol itself and integral to the operation of the protocol in some way. This can be direct, in the utility token model of right to perform work, or via staking, as a yield generating asset, or both.
This is to say that product-market fit becomes the most important determinant of a project’s token economics, as it has traditionally been in bringing new products to market. Incentives and monetary policies can be continually refined over time, but product market fit and an engaged community will be the common denominators in successful crypto projects.
Good examples of token projects that have adjusted their tokenomics after finding some form of product market fit include $ALPHA and $DODO, both of which saw spikes in price and usage after announcing recent updated token incentives which included direct staking models.
Implications For Early Stage Investors and the Capital Stack
Token models can be adjusted to monetize any Web3 project with product/market fit. And an already successful product that engages in a fair launch token distribution will see a feeding frenzy around early liquidity provider returns, organically driving valuations far beyond what could be negotiated privately.
But because this model only works when the launch valuation is low, this necessarily requires keeping pre-token capital raised to a bare minimum. It’s no coincidence that of the above named projects, there was very little capital raised prior to having a liquid token accessible to retail.
- $YFI: $0 raised
- $BADGER: $0 raised
- $SUSHI: $0 raised
- $ALPHA: $2M raised via Binance launchpad
- $DODO: $600K raised privately
- $ALCX: $0 raised
The Integral Protocol just launched, making a point to note that it would not raise capital until the token was public, and still attracted $463M in total value locked within 24 hours.
The market broadly agrees, with some initial evidence that “fair launch” tokens carry a premium in the market. This development makes investing in early stage crypto projects look more like traditional early stage venture investing rather than “token presales”, and we expect to see this trend continue to proliferate.
