A Framework for Token Sale Self-Governance
This analysis considers best practices in token sale disclosures, offering a view towards how projects should self-regulate.
2017 has been an incredible year in the cryptoasset and blockchain industry at large. As we compile and review data from 2017, we cannot help but reflect on the dynamic, dramatic and significant evolution of the industry and community over the last year.
To end the year, we want to release a report on self-regulation within the token sale / ICO industry. It is in informed by countless internal conversation and debates throughout our network, the review of over five hundred different projects, and the dozens of notices and actions from regulators around the world. We have thought about these as we plot the likely futures of token sales in 2018 and beyond, evaluate individual token economies, and help entrepreneurs with their crypto-economic design. We are proud to share our thoughts here.
It is a living document. We will be returning to it. We hope community members think deeply about the issues presented and begin demanding transparency from projects seeking to sell tokens.
We would like to thank the many individuals and organizations who have reviewed this document and provided feedback. If you would like to provide feedback or be involved in future versions, please reach out at email@example.com.
A Framework for ICO/Token Sale Self-Governance
To date, over $4 billion USD has been raised in ICOs, also known as token sales or token generation events. More than $4 billion of this has been raised this year, with over 500 projects having completed a raise and more than 100 announced or in progress. Both the projects and participants hail from across the globe, and the list of countries keeps growing.
We believe ICOs represent a genuinely new and disruptive financial vehicle that can be used to launch a protocol, product, ecosystem, community or company. This allows innovative ideas to find support and for increased participation in venture-stage project support. However, the unique combination of million-dollar-raises, frontier technologies and regulatory ambiguity has created immense variation in project quality, honesty, standards, and sincerity.
We recognize the need to protect participants from unscrupulous opportunists. Establishing protocols around communications and disclosures can greatly help by creating reasonable and informed expectations among sale participants. ICOs are also not all the same. The purpose and structure of token sales can range from something quite similar to a crowdfunding campaign to something that closely resembles traditional financial vehicles. Some launch wholly new economic ecosystems for which there is no clear predecessor.
Similarly, the allure of raising funds through an ICO has attracted first time entrepreneurs and Fortune 500 corporations alike. These can launch subsidiary companies, foundations, cooperatives, and even DAOs that attempt to be none of the above. Some tokens are clearly securities and acknowledge themselves as such. Others are more ambiguous. How each unique token and network are treated by regulatory bodies is equally variable. Several countries are developing frameworks for selling tokens that are less onerous than public security offerings, others are barring them completely, and many more are ignoring them entirely. Because these token sales are often receiving funds from people around the world, there may be multiple regulatory regimes that apply to a single sale.
The blockchain community was founded upon, and continues to be driven by, building innovative, independent and disruptive solutions to problems across every facet of society. The rapid emergence and popularity of tokens and ICOs presents an opportunity for the community to come together in establishing best practices and practical solutions to common problems through active, open discourse. In addition, the current regulatory environment presents an opportunity for the blockchain community to establish a set of standards for industry self- regulation. These standards could guide lawmakers in the future as they determine how to regulate the blockchain industry. In the meantime, they can help entrepreneurs, investors, and project backers alike. As with many of the most exciting and potentially transformative projects under development, the principles, standards, and best practices around ICOs should come from and be led by the industry itself.
Disclosure: The Cornerstone Of Any Transaction
The community right now is playing a dangerous game of doublespeak regarding whether ICOs are investments that does a disservice to their complexity. On the one hand, many commentators have framed these as everything except an investment. Some say they are just ‘donations’—and in turn, donors will receive tradable counter-donations commensurate with the money they gave and which they can resell on a secondary market that may or may not emerge. Others say they are merely a means to distribute tokens to initial users, more akin to pre-selling a product. On the other hand, it is clear that some people who participate in ICOs clearly think of themselves as investors and want the price of the token to go ‘to the moon.’ Youtube channels abound with people talking about how to make millions on ICOs.
Many outsiders, seeing this juxtaposition, assume those trying to avoid full securities regulation are either naive or duplicitous. We think the truth is more complex. Clearly, some people treat these events as investments, but some people invest in wine and whiskey too while others mostly enjoy their tastes. In addition, there are serious concerns about distribution of any token supply, and many ICOs are implementing measures to ensure broad participation that arguably limit the amount of money they can raise. It’s also easier to deal with a couple investors than a thousand. Finally, ICOs are incredible marketing events. Token holders do seem more likely to use a protocol than non-token holders, and if a person purchased a token, all the more so. In other words, in terms of an ICO’s purpose and intended effect, it’s clear that it might simply be a more complex transaction than ‘investing.’
We consider the cornerstone of any industry self-governance to be clear, reliable information against which projects can be held accountable. This matches the spirit of investor regulation and consumer protection laws around the world as well as the ideals behind open source movements that have contributed so much to the industry. Meaningful disclosure has been sorely lacking as standard practice across the industry, but it is the direction in which more serious projects are already headed. Elevating the importance of these disclosures will help to identify projects that are making serious attempts to conduct their sales or capital raises responsibly.
Accordingly, we frame the question of best practices in self-governance as “Is the project equipping potential backers—investors, supporters, or early adopters—with the information they need to evaluate whether or not to participate?” We do not feel that following best practices necessarily results in a project worth backing. Which projects will succeed and which will fail is difficult to identify, particularly at so early a stage. Nevertheless, the hope is that setting standards for disclosures will empower the community to make more informed decisions on their own.
In trying to identify what information potential participants need, we asked ourselves the following questions:
- Would a venture capital investor demand this kind of information?
- Would a concerned consumer advocacy group have a right to this information about a company or its product?
- Would a contributor to an open-source project or a donor to a nonprofit value this kind of information— and be understandably upset if they were misled?
- Does the request respect the unique differences between ICOs, IPOs, venture capital raises, early sales of a product or service, and crowdfunding?
The goal of this document is not to set out a single authoritative and ultimate set of rules for behavior, but rather to act as a framework and a starting point for further discussion and analysis. It is the distillation of thousands of hours of research, analysis, and conversation with people both inside and outside of the industry. Our hope is that this document will serve as a helpful tool both for participants in evaluating projects and for projects themselves in thinking through, and ultimately launching, their token economies. We encourage discussion, critique, modi cation, expansion, and further thought on the ideas and materials presented here, and we will continue to update our thinking as the industry inevitably (and rapidly) evolves.
This framework is intended to cover the diversity of project, product, and sale types, though we recognize that part of the opportunity of these technologies comes from the diversity of their implementations.
We believe at minimum, projects should disclose the following:
Team Identities And Backgrounds
Identification serves two functions:
- It puts forward a public reputation that is at stake in mishandling funds or misleading supporters.
- It helps backers decide whether the team can successfully accomplish their claims and roadmap.
We broadly caution against anonymous teams raising money while acknowledging that we still don’t know the full identities of people behind many major protocols, including Bitcoin, Monero, and Komodo. Nonetheless, we do think that anonymity is different than pseudonymity. Digital trails and reputation can be attached to the latter. Satoshi Nakamoto had a track record in multiple communities relevant to cryptography and computation. The identity of JL77, the developer behind SuperNet and Komodo, has remained unknown, though he (or she) still retains a clear digital trail of contributions and products. Teams should explain who they are and what they’ve done. Then they should provide as much proof as possible. They should also disclose each team member’s involvement—both prior and ongoing — with other cryptocurrency and cryptofinancial projects to allow potential sale participants to identify potential conflicts of interest, or whether the team might be spread too thin.
Current Technology Status And Roadmap
Teams should clearly explain what has already been built and what has not. Whenever possible, they should also prove claims of already completed development with public code or a demonstration. Investors and supporters should understand how far along the core technologies actually are relative to claims made in the white paper. In many cases, theorizing about potential problems in a protocol, app, service, etc. will not uncover all the important flaws that make promised features unattainable. In addition, this information helps supporters understand whether they believe the funds being raised will be sufficient to reach the intended milestones. There is immense value in distributed support for ambitious, fundamentally new, and yet to be developed technologies, but it is critical that in such cases it’s explicitly clear that this research and development will be ongoing and not positioned as solved.
Corporate Structure And Organizational Ownership
Supporters and investors should know what legal entity is behind the product (hopefully there is one) and where it is domiciled. This gives token holders a clue about the regulatory framework that might apply to the company, its operations, and token holders themselves. This has a secondary consideration around revealing potential conflicts of interest among ownership entities.
Legal Status Of Tokens And Token Holders
Teams should disclose how they are treating token holders and what rights those holders have, even if none are granted. There are many questions surrounding the legal status of token holders, and the answers vary. Modum.io records token holders as debt carriers, whereas Tezos gave token holders no guaranteed rights to Tezos tokens. Conversely, buying (traditional) shares in a company in a given jurisdiction affords reasonably clear rights that cut across companies, as does the purchase of a good or service in many jurisdictions. As such, this issue of clarifying legal status is less pronounced in capital raises and the traditional sale of products or services.1
Projects should clearly explain token supply, token sale prices, any applicable bonus structures, and any relevant details like future KYC required. Ideally, there should be some explanation of presale participation, restrictions, and/or prices. Venture capitalists understandably demand to see a startup company’s cap table, which explains who owns which portions of the company and when, combined with information on prior investments. This allows would-be funders to deduce the relative attractiveness of the terms being offered.
Too often, we see projects that secure initial backing of presale investors, at what appear to be exceptional discounts, and then transition into a public sale immediately without meaningful advancement in technology and with little transparency to the broader public about the terms. This is a recipe for creating conflicting incentives for supporters with the potential of pre-sale investors participating solely for the purpose of exiting immediately: their returns are attributable to the fact that everyone else paid twice to three times as much. This makes little sense to us. Either raise money and then do something with it before selling the token on inferior terms, OR implement measures to protect public sale participants, such as vesting schedules on presale investments or full transparency of presale terms.
Purpose Of Token
Tokens vary immensely in their purpose, and projects should explain to the greatest extent possible exactly what their token does and why it has value. Future users should have enough information to understand how, when, and why they would need to use the token. The project should explain to potential participants how it has value in the present and for what it can be used in the future. Projects appealing to supporters should fully describe the product the token is backing and how the token integrates with it. Selling a product that is fundamentally different from that advertised is wrong.
Projects should clarify the intended ‘ownership structure’ of the token, including vesting periods that might apply to the founding team, advisors, and pre-sale investors.
Governance And Intellectual Property
The team should clearly explain how the codebase is governed: who owns it, how it is licensed, how is it maintained, who can modify code with commit access, how is the maintenance going to be funded, etc. This is critical in fundamental protocols, like Bitcoin and Ethereum, but the core concern also applies to dapps and the companies behind them. In some cases, token holders have no protections against a company repurposing its intellectual property for personal gain—in contrast to an investor or shareholder who might be able to follow a company’s success through multiple pivots across products and industries—but at the very least, token holders should know when they have no such protections.
Use of Funds
Projects face a dilemma in explaining their intended use of funds. They are vulnerable if they make claims about how they will use their funds because misrepresentation can be considered deception or even fraud—and it’s not always easy to tell if a shift in spending was a prudent response to a changing market or an original misrepresentation. Many projects attempt to raise money on a two to three-year timeframe, which requires a lot of assumptions that will inevitably be wrong. Accordingly, it can be in the entrepreneur’s best interest to remain as vague as possible.
Supporters should rightly know whether the project has given serious thought to how it will allocate its funds. The current practice of providing a pie chart showing how funds will be distributed is unacceptable: no one would ever plan budgets in this way and it provides almost no meaningful detail. Additionally, anticipated costs and their distribution should vary based on the amount raised. Serious entrepreneurs should know their burn rate. In traditional ventures this kind of information is a fundamental expectation of backers. The lack of a realistic and thoughtful plan around the allocation and usage of funds should be of serious concern to all participants.
At a minimum, projects should disclose product milestones related to different raise amounts, an estimated range of things like FTE projections and office expansions, and ideally salaries of executive staff as well. Projects should also lay out a schedule of financial updates and explain how deviations from anticipated spending will be disclosed and justified.
Sale Security and Fund Storage
Projects should explain the security measures they will take before, during, and after the sale. Fund security is typically not a concern in traditional methods of the sale or the product or service or in a capital raising, but there are a limited number of banks and processes that are typically utilized. If there was a reasonable possibility that a check for venture funding could be intercepted without recourse en route to an entrepreneur’s bank account, you can be sure where would be a slide on the pitch deck explaining the particular arrangement of armed guards and reputable banks involved.
An exceptional idea and a experienced core team need more than just funds to build a functional and ultimately successful project. It’s a lesson that’s been learned time and time again by experienced entrepreneurs and investors—there’s more to building a business, community or ecosystem than money and a product. There’s the ever-growing burden of administration, legal and regulatory requirements, logistics, culture, marketing, user acquisition, cost of production, organizational management, etc. Projects should not only acknowledge the challenge of building any organization of size, but also directly address their plans for building and managing a team, developing a community, attracting users, securing partnerships, and otherwise tackling the complexities of turning an idea into a successful network.
A team should understand clearly the industry they are trying to disrupt and why their solution is needed. Clearly articulating the above will allow project backers to immediately appreciate which teams know what they’re talking about and which appear to be making stuff up. This explanation should also treat readers as educated and interested supporters and network participants. Few projects truly operate in brand new markets that they themselves are creating. Only by clearly and fairly assessing their place within their own competitive landscape can a project demonstrate an understanding of the nature of their own undertaking.
Fortunately, the industry is already moving in this direction with better and more sophisticated white papers that often cover these elements. We would like to see this trend continue and develop further.
 This is becoming an issue as it relates to dual-class shares (with some having muted voting rights) and to early-stage investing through things like SAFE and KISS notes, which vary in levels of investor protection and recourse.
 One could argue that initial backers take risk in providing anchor investments and generating momentum: public sale participants can then bet on a winning horse. When little time elapses between two rounds, this situation is similar to securing anchor investments in a startup round, which help provide certainty to subsequent follow-on investors. “Anchor investors” can get discounts, but many leading VC’s argue for standard pricing in a round and when it is championed, it can range from 50% to 20%, rather than the 75%+ we have seen in behind-the-scenes deals.