Aug 23, 2022
How to Approach Token Allocation—A Web3 Guide
What You Need to Know About Token Allocation
At the heart of most web3 projects is the token. A project’s token is the blood pumping through its economy’s veins, ensuring that value flows to keep systems running. For example, on the engage-to-earn social network Taki, platform users exchange their own user coins which are tied to the value of $TAKI, the project’s token. While not all web3 projects need tokens (a topic for another time), most choose to create tokens and are immediately faced with the challenge of figuring out what to do with them. Based on our lessons from launching several web3 projects that have tokens, we outline the best practices for navigating token allocation and utility in the article below.
While a great token allocation will not ensure a project’s success, a poor one will ensure its failure. Investors can be mercenary and consumers can get skittish, so you cannot rely on faith and good will alone. In general, good token allocation follows two key principles:
- Allocate tokens based on value contributed
- Enforce alignment via lockups, vesting, and milestones
(1) attracts contributors to the project and (2) ensures contributors commit for the long term.
Allocate Tokens Based on Value Contributed
It takes a village to raise a web3 project: founders spearhead the idea; investors provide funding; developers build; marketers advocate; community grows. Tokens are the incentive that brings the village together. Different projects have different needs, and their allocations vary accordingly.
For example, consider the stableswap protocol Curve. The technology to swap tokens is easily cloned, but the liquidity itself is not. Curve’s success is dependent on the depth of its liquidity pools — deeper pools have less slippage, less slippage encourages more swaps, and more swaps collect more fees. As such, $CRV’s largest allocation is towards community liquidity providers.
Similarly, Filecoin is a protocol with a simple purpose — storing files. Filecoin’s success depends on how efficiently and reliably they can store files. As such, their token allocation is predominantly oriented towards incentivizing storage providers.
Looking at multiplayer games, they require a critical mass of players to support matchmaking, active marketplaces and a vibrant community. Most web3 games have the biggest slice of their token pool dedicated to “play-to-earn” incentives (though that term has fallen out of favor lately), allocating a majority of tokens to the community. Play-to-earn is analogous to user acquisition costs in traditional games, buying growth and attempting to solidify a core audience. Once that critical mass is reached, additional players are no longer crucial to the game’s success, and play-to-earn rewards can be dialed back in favor of sustainability. However, that is easier said than done; restraint is difficult to show during the heady days of growth, as both Axie Infinity and Jay Powell have proven. Still, it is better late than never.
Players alone are not enough. Games need to be built, supported and expanded. The development costs of games are notoriously high, and long-run support requires long-run funding. Large chunks of the token allocation are also often dedicated towards supporting development (under the categories of “Reserve,” “Ecosystem,” “Foundation,” “Token Sale,” etc.)
With that said, there is a great degree of flexibility in token allocations. For example, looking at various layer-1 blockchain projects, their token allocations vary between public, private, and community-focused. While this does reveal differences in their philosophies and priorities, they are all ultimately trying to provide the same service — a public ledger that is decentralized, scalable and secure.
For a data-driven look at how token allocations have evolved over the years, read this article.
Source: https://messari.io/article/power-and-wealth-in-cryptoeconomies
Enforce Alignment
The crypto community is notoriously profit-motivated and self-interested. This is true of both private investors and public communities. Fledgling projects sometimes distribute tokens too loosely, which can create premature sell-offs and shatter community confidence.
For example, in July 2022, the $GARI token from Chingari (a major Indian social media app), crashed 90% within an hour, as an unknown whale sold off $2 million worth of $GARI. No individuals were incriminated, but the dumping whale is likely an insider, whether a team member, a crypto business partner, or a Bollywood celebrity sponsor. In the development team’s official vesting schedule, no major unlock tranches were supposed to occur for another 6 months. Likely at some point in the flurry of partnership deals, a large amount of unlocked $GARI was let loose to a paper-handed partner.
Source: CoinMarketCap
When Distributing and Unlocking tokens, Consider the Following:
Lockups, Vesting, and Milestones. As with traditional company equity, token lockup and vesting schedules ensure that recipients are aligned for the long-term. This is doubly important for tokens, as they are far more liquid than traditional equity. For example, when partnering with an advertising agency, putting your token payment behind a 1 year lockup ensures that they are attempting to promote your project over the next year, not just a short-term pump-and-dump. Milestone-based unlocks can help set clear goals and reduce time-uncertainty. Common milestones include exchange listings and mainnet launches.
Duration matters. Lockups are designed to protect a project during its infancy. Larger projects take longer to build and require longer vesting periods. For example, an ambitious MMO game like Star Atlas will likely take 4+ years to complete building. However, their team and investor token lockups fully vest within 2 years. In the interim, $POLIS (the game’s governance token) will likely endure heavy sell pressure as development chugs along and public interest wanes.
Mitigate sell pressure. Deter bursts of sales pressure that might overwhelm liquidity and trigger a price drop and panic selling. Release tokens gradually, such as with linear vesting, rather than all at once. Restrain excessive reward grants, especially from Sybil attacks utilizing multiple accounts to claim rewards. Set the additional KYC verification and establish anti-bot tools and withdrawal limitations as appropriate for a project. If you anticipate a large token release, prepare by deepening liquidity in DEX pools or with market makers.
Concentration. Be wary of allocating too many tokens to one particular party. During fundraising, pay attention to the ticket size and avoid allocating too much per ticket. Outsized shares may be granted to key players like the core team or strategic investors. Those outsized shares can come with longer lockups to ensure long-term alignment.
One final note — build in flexibility, as the future is unpredictable. No matter how much effort goes into growth projections and emissions planning, reality will always diverge from your plans. Avoid hard commitments for multi-year token emissions, and prepare backup plans in case growth is 10x or 1/10th the size you expect.
For a data-driven analysis of token allocations, check out Lauren Stephanian’s articles on token distribution and vest schedules. While I hesitate to call anything “optimal”, I always appreciate some good data!
