Securities, Utilities and All That Lie Between: The Changing Face of Token Design in 2019

Every generation believes it is witnessing history and ours is no different. Reflecting on the growth of the internet, the proliferation of smart devices, the birth of Bitcoin and the rise of tokenized systems, it is hard to dispel the conviction that these are transformative times.

When crypto’s history is written, the highlights will be easy to reel off — Satoshi’s whitepaper, Mt Gox, the birth of Ethereum, the ICO boom and all the rest. What the history books will struggle to capture, however, is the less perceptible changes that have led us to where we are today: an age of financial inclusion where any asset can be tokenized and traded, and where billions of dollars of value can be sent anywhere in the world in a permissionless and trustless manner at the cost of a few cents.

Given the rate at which the cryptoconomy deflated in 2018, dragging the ICO industry down with it, it would be easy to dismiss the utility token boom as a bold experiment that ended badly. That would be disingenuous. Just as two-thirds of new businesses will fail in their first decade, the majority of tokenized projects won’t last the course. That doesn’t invalidate the technology upon which they were launched, but it does suggest scope for improving the business and token models that kickstarted the first wave of initial coin offerings.

With the benefit of hindsight, and in the sobering light of harsher market conditions, a number of facts have become evident:

  • The cryptocurrency market will not support an endless array of payment tokens.
  • High velocity coupled with low user adoption have rendered generic utility tokens impractical for the majority of projects.
  • Smarter token engineering is required to capture value and to justify projects that feature a native token.
  • Token design is still very much in the experimental stage, and there are bound to be false turns along the way. This is natural, and the risk of failure should not deter innovation.
  • Token engineering can be successfully applied to existing projects just as effectively as it can to emerging ones.

The quest to craft better token models

Over the past six months, a number of projects have returned to the drawing board in a bid to revamp their utility token, or even to remove it altogether. Projects have exchanged their token for company equity (IconomiDigipulse); redesigned their token to combat the velocity problem (e.g., CivicStorj); or replaced it with a stablecoin. The willingness of these projects to seize the initiative, rather than risk being saddled with a moribund futility token, should be commended. There is no shame in being wrong — only in the unwillingness to admit to having been wrong. Forward-thinking companies should be receptive to adjusting their business or token model as circumstances dictate.

But what about those aspiring projects that are currently sat on the sidelines, eyeing 2019’s turbulent waters with trepidation? It takes a brave or brilliant project to launch an ICO in the current economic climate.

The solution is not to wait for better market conditions — it’s to create a better concept.

In practice, this means complementing a strong business model and accomplished team with token design that captures value and aligns incentives. In some cases, this may entail offering a security token that will grant investors a share of future cash flows. At AmaZix, we’re helping several clients prepare security token offerings that satisfy the interests of all stakeholders, while elsewhere we’re providing token design/redesign for emerging and established projects. In the field of utility tokens, our token engineers develop models that will slow velocity, increase incentives to hold the token, widen its use cases, and capture more value for token-holders.

We’re also helping clients transition from a utility to a security token model where there is a clear business case for doing so. The benefits of this model are manifold: projects have the reassurance that their token accords to regulatory requirements. Investors have a legally enforceable claim on company assets and a motivation to see the business succeed. Secondary market investors are incentivized to acquire tokens on the basis of project fundamentals.

The evolution of tokenized systems

STOs hold a number of advantages over ICOs, but security tokens are not a panacea. For every project that would be best served by issuing tokenized shares, there’s another that would be better off with a utility token. While we are passionate advocates of tokenized systems, we recognize that utility tokens cannot be an afterthought; a generic payment token tacked on to a project that would function better with fiat currency or a stablecoin (for a detailed analysis of the problems facing payment tokens, see this article by our Head of Advisory and Tokenomics, Jose Macedo). There must be a clear and compelling reason for users to store value in the token — not just transact in it — either because it is integral to enforcing the correct incentives and functionality of the tokenized ecosystem, or because there is some other clear utility to holding the token — one that can ideally be expressed in terms of a discounted cash flow.

Moreover, it is also crucial that the tokenomics and token sale structure are correctly designed to align incentives between all stakeholders (team, investors, miners etc.) and follow industry best practices, as expounded in this article by Jose Macedo.

Bad token models let all of the value flow from the ecosystem.

Selecting and refining the right token model is a mixture of art, science and good old-fashioned experience. It demands a deep understanding of possible token economic models (and their various design tradeoffs), experience accrued through assessing hundreds of projects in order to develop an intuition for when each particular model should be applied, and finally a familiarity with the specific implementations of each token model so that these can be adjusted to suit the project’s desired outcomes.

A good token model captures value.

When it comes to token design, no two projects are the same. Projects in which economic actors are providing services to the network (e.g. miners in PoW, validators in PoS, curators in Steem), for instance, must ensure the game theory is correctly designed so that the economic self-interest of the stakeholders alone guarantees the correct functioning of the tokenized ecosystem. On the other hand, projects that do not have miners, but instead sell a service or provide “marketplaces” for users to purchase some resource from one other, may benefit more from a discount token. Other projects (such as SaaS companies) may simply not require a tokenized ecosystem at all, in which case a security token structure may be more appropriate.

Security tokens assume many forms

Just as utility token models can differ greatly, the same is true of security tokens. Some securitized projects may simply be selling tokenized equity, others may offer a royalty or software license fee, while still others may choose to issue bonds. Not only this, but projects may choose to issue hybrid tokens, combining utility and security features. Then there is the cash flow distribution to be calculated (which must also include a detailed valuation model and financial projections), specific legal status to determine (i.e. what can security token-holders claim in the event of bankruptcy?) and governance features to incorporate.

Applying a cookie cutter framework to tokenized projects is a recipe for failure. Building upon past experience of similar projects, however, is wise. Having had the fortune of assessing 300+ projects in forensic detail, AmaZix analysts have gained invaluable knowledge of what works and what doesn’t in the field of token design. They’re now applying that wisdom to devising token economic models for clients who are raising billions of dollars across an array of industries. From pitch deck preparation to investor introductions and strategic advisory to whitepaper writing, we provide a turnkey service for clients who share our conviction that tokenized systems are the future of fundraising.

BUIDL it and they will come

We’ve no desire to tokenize the world (just parts of it) and we’ll be the first to acknowledge that there’s still work to be done in improving the legal and technical framework to facilitate the issuance, trading, and liquidating of tokenized assets, securitized tokens in particular. Having partnered with leading specialists within the security token industry, including blockchain developers, compliance teams, and fully licensed exchanges, we can connect our clients to the companies who will help them on the next step of their journey.

While the BUIDLing of the infrastructure for security token trading is being refined, there’s work to be done at the sharp end of token design. As you read these words, we’re in the process of helping dozens of clients perfect utility and security token models that will leave them primely positioned to capitalize on the next wave of cryptocurrency adoption. For example, we’ll soon be announcing a client who will be issuing an innovative discount token and distributing it in a sealed bid Dutch auction.

It would be foolish to dismiss ICOs out of hand on the basis of the first wave of tokenized projects. This may be a nascent industry, but the tokenized class of 2019 will look very different to that of 2017. Tokens and securities are both potent value capture mechanisms when applied correctly, and we look forward to incorporating these systems into the projects we have the privilege of partnering with.

Whether your mission is to bank the unbanked, disrupt the music industry, drag the art world into the 21st century or make mortgages great again, there’s a token model for that. If you can dream it, AmaZix can help you refine, raise, and deliver it.