7 Reasons to launch a token
Why launch a token?
Tokens¹, the ability to add a commercial, interchangeable, asset to a community, protocol, company or DAO is one of the biggest innovations in web3. Tokens have many use cases and reasons for why to launch and add a token to a web3 project. The core premise being that they enable an exchange of data of some kind on chain. This data can be financial (who owns what), communal (who’s interested in what) or informational (who has done what).
In this article I’ll cover the seven core reasons for launching a token. Even among these seven reasons, not all are created equal. Some have stronger use cases than others. The ideal use case being coordination among a group of decentralized players. Launching a token isn’t simple and can be as harmful to a web3 project as it can be beneficial.
The seven reasons for why to launch a token can be grouped into three categories:
- Funding: bootstrapping and raising venture capital
- Governance: active token governance and decentralization
- Utility: coordination, gas and access.
Tokenization gives liquidity and liquidity brings financial interest. Wherever there’s the ability to trade, humans give things value and happily buy, own and speculate. Tokens are no different. Funding a project with tokens is one of the most interesting and unique aspects that web3 has brought to the table. A simple, flexible and novel way to create liquidity and a financial ecosystem where previously there was none.
Beyond the creation of a new technical way to get funded, on a more fundamental level tokens open the gate for the creation of value ‘ex nihilo’. Just by getting people to believe in what you’re building, you can now generate tokens out of ‘thin air’² and accrue real financial value³. Which is why funding is a prime use case for tokens. Fundraising with tokens can be divided into two:
- Raising funds from investors
Each has a different profile for how to fundraise and really why you’re fundraising.
Bootstrapping any new idea is hard. Time is money and usually projects need more than time: they need developers, designers, servers and so on. Bootstrapping requires you to fund these out of pocket which can be expensive! Launching a token can be a way to raise funds for your project.
Why launch a token though? Why not simply raise money from investors? A few simple reasons:
- Most projects are NOT a good fit for financial investors. investing in startups is a hard business. Most startups fail, which is why investors know they have to invest only in projects that have huge upside potential (think the next Facebook or Airbnb). But most companies and projects can’t and shouldn’t be the next Facebook or Airbnb. There are many small and medium sized businesses which are fantastic — they simply don’t fit most startup investors focus area. In web3 there are even more of these kinds of projects, especially in the public goods sphere.
- Raising money from investors is very hard! Who can you raise money from? How do you approach them? What materials are they interested in? How many people do you need to pitch to succeed? What are the legal terms for fundraising? It’s not so easy to raise money from investors, and if you’re not in the right geographic area it can be near impossible. Sometimes it simply isn’t a viable option.
- You want to maintain decentralization. Part of the web3 ethos involves minimum viable governance and maximizing decentralization. If you sell a large portion of your tokens to early investors you could be compromising this — something you might not be interested in for your project.
This is why many people believe that launching a token to help bootstrap their project (and maybe even network effects) can be a good solution for this. You can potentially fundraise the amount you need from people who are potentially more aligned with what you’re building and who you are as a builder.
Fundraising from investors
Venture capital (VC) is a large, well developed ecosystem and web3 is a new area of focus for investors. In an ecosystem where tokens accrue value and not necessarily the builders and the companies that built them, investors have widely adopted to invest in tokens and not just companies.⁴
If you’re building a project that promises a huge amount of upside but requires a heavy upfront investment, fundraising from venture capital probably makes sense. Selling tokens (future or present) has been seen as a good option to get investors interested, raise capital at a higher company valuation and simply raise more capital. Investors can also help with company building and some also have web3 infrastructure specialty which can be very helpful.
Whether this is the right move for a token depends entirely on the kind of web3 project being built. Some tokens suffer greatly from having been sold early on to investors. This can cause centralization, a splitting of your community, where investors got in early and don’t have the same incentives as later ‘regular’ users. It can also cause a large and ongoing overhang of supply to your token. However, it’s still a real reason for projects to launch a token, or think about it.
A word of caution on using tokens for fundraising
While fundraising is a real and important need for builders, this shouldn’t be your primary reason for launching a token. Most tokens launched for these reasons, and these reasons alone, are analogous to securities and do not pass the Howey Test. The Howey Test states that something is a security if it’s an “investment of money in a common enterprise with a reasonable expectation of profits to be derived from the efforts of others”. If your token is simply a fundraising mechanism where someone invests with the expectation of future profits and you’re doing all the work, well that sounds like a security to me.
Secondly, you might be fundraising from a group of people who are not aligned with you and what you’re building. That’s the classic problem of raising from VC: their interest is purely financial and incentivized for you to grow as much and as fast as possible. If you’re bootstrapping from your community and promise rewards you can’t deliver, that can also be a misalignment of incentives. Raising capital sets most projects away from the public goods road and down the profit maximization one. This doesn’t have to be the case, you could opt for a minimally extractive mindset, but it’s usually the case.
The need for tokens to have utility and not simply be an investment contract has led to the explosion in ‘tokens as a governance mechanism’. Which is the second main use case for why to launch a token.
Governance, or lack thereof, is an interesting and important aspect to web3 projects. Similar to fundraising, it’s a new expression in web3 to a web2 concept. Web2 company governance is built around shareholders playing a minimal part and entrusting board members to choose the right executives. It’s a mostly inactive governance mechanism that despite being inactive, governs everything in the company — shareholders can in fact fire, hire or sell the company. Web3 governance is built around two alternative paradigms: minimal viable governance on the one end and maximally distributed decision making on the other. Whether these forms of governance work or not is a discussion for another article⁵. It is none the less a reason for laughing a token.
Active token governance
Democratization and putting the power back in the individual’s hands is an ethos underpinning many web3 projects. Initially, the way to do this was seen as being through tokens. Tokens as a voting mechanism has been popular for years. The Ethereum DAO hack vote in 2016 is an early example and it becomes extremely popular in DeFi summer in 2020 with the launch of Compound’s governance token. Since then, it’s become evidently clear that a ‘one token one vote’ mechanism doesn’t quite work for real democratization⁶.
However, tokens are still the best way to democratize decision making in web3 projects. Having a token is critical for this and new approaches to do this are emerging. Optimism harkened back to the traditional United States democratic way to do this with a dual house structure: a token house and a citizens house. Gitcoin has led the way in a few governance and coordination concepts, especially around quadratic funding and voting.
Having a token as an active governance voting mechanism grants tokens real utility and as long as they don’t overlap with other parts of the Howie Test (mainly deriving a profit from the benefits of others) they don’t run foul of being considered securities. The issue with them then becomes that beyond governance, they have no utility and are therefore not as appealing to investors. This isn’t a problem in it of itself. It is a problem when projects launch tokens for the purpose of fundraising but clothe them in governance utility so as to avoid regulations.
Decentralization comes when a large, diverse and dispersed group of actors works together to operate towards a common goal. It needs to be large enough to be able resist a minority of actors affecting it. Diversity of the group leads to different motivations, incentives, thought processes and time horizons. Dispersed, physically and electronically, prevents any single event from affecting everyone.
A decentralized governance system aims at getting tokens out to as large a group as this. This enables the governance diffusion that keeps the project decentralized. While this principal holds true for active token governance as well, some projects use their token primarily for this. These projects tend towards protocols: layer 1 and other credibly neutral protocols. Credible neutrality can be a core building block for many web3 projects and protocols and the only way to achieve it is through a widely distributed token launch.
Protocol tokens like this tend to overlap highly with actual utility in the protocol. Which is the next category of why launch a token.
Using tokens as a core part of protocols is where web3 shines. It ties the financial part of a token to the utilitarian part of it. Imagine using Amazon shares to use AWS — that’s the web2 equivalent. Not all web3 projects use tokens in this way, tying together the fundamental use cases of web3, but the best ones do. Utility can be examined in three buckets:
- Coordination: aligning interests and coordinating different parties towards a common goal
- Gas: Tokens are necessary for using the protocol
- Access: Tokens are used to to unlock certain activities or communities
To quote ‘Wen Token: the core thesis behind tokenomics’:
Tokens, and tokenomics, serve to solve coordination problems in decentralized systems. Bitcoin is the best example of this. Bitcoin, the Bitcoin networks token helps coordination of a decentralized system towards a peer to peer payment system and a store of value without any centralized party. Miners are rewards for appending data to the network with Bitcoin and users must have Bitcoin to use the network via fees. Everyone is incentivized to use the same chain, since that’s the only one that everyone else is using, and the largest database has the most value due to network effects.
Another way tokens serve to solve coordination problems is in Proof of Stake coordination systems. The ‘Nothing at stake’ problem solved in the Tendermint whitepaper opened the door to new ways to coordinate that don’t rely on proof of work and network fees. In Bitcoin, miners are incentivized to mine the right blockchain because if they don’t their real world electricity will go to waste. In proof of stake, actors can be relied on to behave in the ‘right’ way because they have staked tokens as collateral. Tellor, a decentralized oracle protocol uses staking for this purpose. To become an oracle, one is required to stake $TRB. If an oracle posts faulty data, they can lose their $TRB.
Without tokens, there is no coordination mechanism, and in my opinion coordination problems for decentralized systems are the best reason for why to use a token.
Gas is probably the most straightforward use case for tokens. To use the system, you need to use the token. There can be no system without tokens. Just like gasoline is needed to use an internal combustion engine, ‘gas’ in the form of tokens, is needed to use the protocol. Ethereum is the best example of this. One cannot use the Ethereum network without paying gas in the form of ETH fees. Some dApps also have adopted this format.
Tokens are required for some activity. This can be gameplay in a web3 game or access to on and/or offline communities. In the traditional gaming ecosystem in game currency has long been a popular mechanism for both engagement and monetization. The same is true in web3 games. This makes tokens used in this way a must for any serious game player, and a project simply can’t be played without a token that lets players do certain things. Access tokens for communities are utilized by letting holders gain access to special events or communities. It’s a ‘proof of seriousness’.
Access utility can come from holding tokens or spending them. For example artists can drop special invites or Discord channels can be made visible to to wallets that hold more than a certain amount of tokens. Alternatively, instead of holding, spending an amount of tokens can be used to gain access to the same perks.
Why launch a token
Web3 tokens are a fascinating innovation that’s changing a lot of the core infrastructure of the web. By tying together utility and financial incentives, a core paradigm of the traditional business world has been broken through. The why behind launching a token is as important as every other aspect of why and how to launch a token. In this article we looked at three core categories of why launch a token: fundraising, governance and utility.
Each of these has valid use cases (although I firmly believe that coordination is the best one), as well as pitfalls. Despite the power that tokens unlock, consider carefully whether you even need a token for your project!
- In this article I use the term to refer predominantly to fungible tokens. NFTs can have different use cases and don’t necessarily overlap with the premise of this article.
- As in good old fashioned code that runs on a cloud that sits on a physical server that burns real electricity to run.
- ‘Real’ being a subjective judgment between people. If someone else values your token and is willing to barter with you for it, it has the same real value as any other fiat currency.
- Most investors have been smart (and greedy) investing in both and double dipping.
- This is a space of active debate in DAOs currently. This podcast interview with Hasu a good starting point to explore.
- Vitalik covers the issues in several blogs: Notes on Blockchain governance (audio version), Moving beyond on chain voting (audio version).
Designing Tokenomics by Yosh Zlotogorski