Introduction to Token Distribution Mechanisms
An overview of genesis token distribution strategies, including discussion of interactive airdrops as an emerging trend.
- Throughout the industry’s history, projects have employed a wide variety of strategies to distribute tokens at network genesis. The most common has been a token sale, though newer projects are more frequently exploring other designs.
- Recently, interactive airdrops have gained prominence, allocating tokens to target user groups based on network contribution or interest. Such an approach has the potential advantage of engaging niche audiences, yet does not solve the problem of ongoing development funding for the project and introduces new considerations projects must weigh.
Distribution is a Strategic Decision
In the vast majority of protocols supporting digital assets, the digital asset itself is intentionally designed as something of value. Hence, protocol developers need to make decisions about how that asset gets distributed, both initially and on an ongoing basis. These decisions reflect a set of current or future objectives, and can be a key factor in determining the project’s ultimate success or failure. In this set of decisions, projects are often balancing a complex set of tradeoffs, a shifting sense of community judgments, limitations of the underlying technology, and often the need for both future flexibility and eventual decentralization of control.
Cryptoeconomic design decisions concerning distribution can be split into two categories, which are generally defined in the code–or at least in the core design–at the network’s inception:
- Genesis Distribution: a distribution that defines the network’s starting conditions: simply, who owns how many tokens at network launch.
- Ongoing Distribution: a distribution that is (typically) transparent, rule-based or principled, and continues during the network’s functioning, often to subsidize elements of network operation.
Genesis distribution decisions are often the most complex, because they constrain decisions for ongoing distribution and must be made at an earlier point in time. Such distributions often take the form of token sales, pre-mines, airdrops, and allocations to founders, developers, foundations, or early investors. These allocations are generally determined by actions taken prior to network launch (ie, investment or development work), and are not typically tied to work after the network has launched. A principal objective in genesis distribution is bootstrapping the network at inception, including a base of users, network operators (if applicable), developers or third-parties, and market participants.
This memo will discuss at a high level which “Genesis Distribution” strategies projects have historically employed.
Genesis Distribution Strategies
Industry projects utilize a wide variety of distribution designs, including early examples such as:
Bitcoin had no initial distribution; the first BTC were allocated to the successful miner of the first block, which contained no transactions. The entire supply is distributed through an ongoing distribution of block rewards.
Ethereum had an initial distribution event in which it sold the genesis supply of ETH and allocated a portion to the Ethereum Foundation. Its ongoing distribution is based on block rewards and goes entirely to Ethereum miners.
Ethereum Classic was a hard fork of Ethereum. Its initial distribution, as with the vast majority of hard forks, mirrored Ethereum’s network state and preserved the portion of ETH held in the DAO contract. Further, its ongoing distribution is notably distinct from Ethereum’s in that it includes a long-term supply cap and a distinct block reward reduction schedule.
ZCash, like Bitcoin, did not have a formal initial distribution event. Its ongoing distribution, however, included a mechanism called a ‘Founder’s Wallet’ in which over the first four years of block rewards, a defined portion of ZEC is allocated to certain parties: initial investors, the core project team, a foundation, and a strategic reserve.
There is evidence that a wide variety of distribution designs can be successful in creating a secure, valuable network and cryptoasset, though best practices have changed significantly over time and depend on the particular objectives of the project and the purpose of the token.
Genesis Token Distribution Mechanisms
|Method or Mechanic||Definition||Use||Notable Types|
|Token Sale||Exchange of fiat or crypto consideration for tokens, often prior to completion of development work.||• Sell future goods or services|
• Solicit investments in the project
• Incentivize ‘skin-in-the-game’ amongst token holders
|ICO, IEO, SAFT|
|Internal Allocation||Tokens allocated to project participants, usually as a form of compensation or incentive.||• Compensate team, partners, or advisors|
• Compensation for minor work or added value
• Incentivize ‘skin-in-the-game’ amongst token holders
|Team, Advisor or Partner Allocations, Founder’s Reward, Premines|
|Passive Airdrop||Tokens allocated allocated automatically to public participants at zero or nominal cost without their active participation, often based on other cryptoasset holdings.||• Distribute tokens to interested parties|
• Market a project amongst broad user groups
|Airdrops, Chain Snapshot|
|Interactive Airdrop||Tokens allocated at no cost to public participants based on active participation or claims process.||• Incentivize ‘skin-in-the-game’ amongst token holders|
• Market a project to targeted potential user groups
|Lockdrops, Merkle Mines, Targeted Airdrops|
|None||Zero tokens allocated at the genesis block; all earned through subsequent network contributions.||Incentivize new participants to contribute to the network||Genesis Block|
Evolution of Genesis Distribution Mechanisms
Throughout the past ten years of the industry, a wide variety of distribution models have emerged. The following graph considers the cumulative frequencies of genesis distribution methods across the set of all SCI Signal projects, minus stablecoins and those with insufficient detail available, based on year launched.
Early projects, such as Bitcoin, issued no tokens in the genesis block. Token sales became a popular model following the success of the Ethereum ICO and its emergence in 2017 as a token sale platform. Projects such as Ripple and Stellar issued all genesis tokens to internal company reserves and distribute them over time through various airdrops and sales. More recently, the industry has seen a relative slowdown in token-based funding, and a small uptick in interest in more exotic methods such as interactive airdrops.
Emergence of Interactive Airdrops
The growing popularity of interactive, targeted airdrops is a notable recent development in the industry. Such airdrops aim to bootstrap a network at genesis by distributing tokens to target user groups in exchange for nominal participation or work. Recent examples of this trend include:
- Althea, a wireless mesh network, airdropped a small amount of tokens for learning about the project and a larger amount for individual contributors who organize an Althea subnet in their local community. Since Althea’s growth is dependent on individual communities setting up the requisite physical infrastructure, the project aims to incentivize this by directly rewarding organizers with tokens.
- Handshake, a distributed DNS extension, airdropped the majority of tokens to current holders of major top-level domains and verified open source contributors. Given that adoption of the Handshake network is dependent on users migrating from the existing DNS system, airdropping tokens directly to existing stakeholders may be an effective bootstrapping method.
- Livepeer, a live video transcoding network, utilized a ‘Merkle Mine’ that allowed Ethereum addresses to optionally claim tokens in exchange for work on the Livepeer network. The aim for Merkle Mining was to distribute tokens to likely real users, rather than speculators, through a demonstration that would-be-holders could perform a non-trivial proof.
- Edgeware, a Polkadot-based smart contract platform, utilized a ‘lockdrop’ in which users locked ETH in a smart contract for a fixed duration in exchange for Edgeware tokens. Effectively, the cost of the tokens is the opportunity cost of locking ETH, and Edgeware is able to spread awareness amongst potential developers as an Ethereum alternative.
The common thread across these examples is the attempt to target token allocations towards user groups who are more likely to actively participate in the live network by distributing tokens to users demonstrating sufficient interest and/or ability to contribute. While not contributing funds as in a token sale, participants are required to perform some work or take an active step in order to claim the funds. This is in contrast to many previous airdrops, which often allocated tokens automatically to all holders of another cryptoasset, most commonly ETH. Such broad, indiscriminate airdrops have arguably been ineffective and allocate many unclaimed tokens to disinterested users. For example, the recent Stellar airdrops through Keybase and Blockchain.com wallets saw a majority of distributed XLM transferred to exchanges or left unclaimed.
Relative to token sales, such targeted airdrops do not raise funds for development, yet may be effective in raising awareness and distribute tokens widely. While these projects are still in early stages and strong conclusions about the effectiveness of such strategies are difficult to ascertain, it remains an area of token distribution and cryptoeconomic design whose potential has yet to be fully explored.
Design decisions concerning initial token distribution can have considerable impacts on a project’s prospects, though a wide variety have been used successfully throughout the history of the industry. While token sales are the predominant strategy amongst projects launching today, methods such as targeted airdrops have gained traction. In particular, such an approach may be appropriate for projects aiming to distribute tokens and incentivize participation amongst a specific audience of potential users, and that have funding support for network development through other means. Passive airdrops are a comparatively blunt distribution mechanic and have thus far struggled to incentivize users to meaningfully participate in the network; however, they are generally considered fair, which in the blockchain industry is a much-discussed though often poorly understood characteristic projects strive for. Despite their potential advantage of a more engaged user base, interactive airdrops run the risk of introducing arbitrariness to a process for which being unbiased is a key advantage.
The industry likely hasn’t seen either the end of interactive airdrops or the fullest expression of their potential. In general, projects experimenting with this distribution mechanism need to weigh the following factors when developing their distribution strategies.
- Funding Model: Token sales had the distinct advantage of raising funds to support ongoing core development, an issue that has bedeviled the cryptoasset industry since Satoshi stepped away from Bitcoin. Eschewing this means developing some other mechanism maintain the blockchain elements of the network, whether equity funding, donations, a founder’s wallet, a proposal system, or plans to sell reserved tokens into an active post-distribution market.
- Regulation: The SEC has made it clear that airdrops aren’t magically exempt from securities law, so projects must understand the regulatory implications of their distribution mechanism, even if it doesn’t involve a sale.
- Token Function: Distribution of a medium-of-exchange token aka payment token should involve a different set of targeting criteria than a governance token.
- Fairness: Rules involving targeting certain groups over others will invite additional scrutiny. The industry has an unfortunately long and colorful history of projects finding ways to enrich insiders without justification, warning, or explanation.
- Roadmap / Project Stage: Targeting criteria should reflect the current state of the network, the priorities appropriate for its growth stage, and the usability of the infrastructure currently built.