The cryptocurrency industry has undergone a dynamic evolution, marked by cycles of exuberance, disillusionment, and iterative progress, From the meteoric rise of Initial Coin Offerings (ICOs) to the decentralized finance (DeFi) boom and the emergence of Internet Capital Markets (ICM) today, each of these phases have been characterized by bold experimentation, followed by setbacks from speculative excesses, and misaligned incentives. These cycles have driven the industry to learn critical lessons, refining token designs to better align with user needs, project sustainability, and market realities.
This report explores the historical trends in token models, highlighting how the crypto industry has navigated hype cycles to innovate fundraising mechanisms, address utility challenges, and adapt to shifting market and regulatory dynamics. By examining past failures and current developments, we aim to assess how close the industry is to building a sustainable token model and what gaps still need to be addressed to unlock the full potential of tokenized ecosystems.
The ICO Era: A New Way Of Capital Formation
The ICO era began first with the Ethereum ICO and was accelerated by the birth of the ERC20 token standard. ICOs were a new way of capital formation, an alternative way of start up funding that was accessible to all. It fulfilled the decentralization ethos of crypto – typical middlemen such as venture capitalists and investment bankers were not required. However, it is important to note that tokens did not confer the same ownership rights as equity in listed companies. The primary driver of token appreciation comes from increased demand in the token, which requires the product to achieve scale that leads to greater mind share from investors.
The hype surrounding stories of overnight millionaire founders from successful ICOs attracted a bunch of developers to launch projects with no intention of seeing them through. Coupled with the exuberance of retail investors, capital continued to plough into these ICO projects with little to no due diligence. The net result is a total of approximately 78% of ICOs that appear to have turned out to be scams as seen in Figure 1. Eventually, the ICO era was put to an end after increased scrutiny from regulatory bodies after the proposed Libra launch.
Key Takeaways:
- ICOs gave founders an incentivization dilemma which could have hindered protocol growth
- ICOs also attracted a wave of developers drawn by strong retail interest, though not all projects were built with long-term sustainability in mind
- Overall, ICOs were a new way of capital formation that was accessible to all and demonstrated the strong retail interest in participating in start up funding
DeFi Summer: The Birth of Liquidity Mining and Governance Rights
The period of DeFi Summer saw protocols experimenting to address these key questions: How do we align token holders to the protocol to encourage holding, and how do we get these tokens into loyal and committed users? These questions eventually led to the introduction of token utility and experimentation in token distribution.
We first begin with the genesis of “liquidity mining” in July 2019. Synthetic first introduced this concept, where a portion of protocol inflation was diverted towards users who provided liquidity for certain trading pairs. The rationale was that the trading fees as part of the Uniswap pool did not compensate the liquidity providers sufficiently, and by rewarding them with protocol tokens, they would be more incentivized to provide liquidity, which benefits users through lower slippage. In other words, the token was being used to bootstrap the protocol by incentivizing activity, while rewarding liquidity providers who were core to the protocol.
However, while liquidity mining incentives were given out to strategic participants of the protocol, they could only realize the returns if they sold the tokens – a double edged sword for the protocol. So how do we give token holders a reason to hold onto the token? Compound Finance took the concept of liquidity mining one step further by assigning governance rights to their own token. This was the first form of token utility, where holders of the tokens could now vote on decisions surrounding the protocol, such as introduction of new assets, development of new features and technical upgrades etc. Token holders were made to feel like shareholders attending company board meetings, albeit with no economic rights to the protocol.
At this point, we can see the benefits of liquidity mining in bootstrapping protocol growth. However, the idea of governance as token utility did not result in sustained demand for tokens. In the case of Uniswap, only 7% of $UNI claims are still being held today, and only 1% of the wallet have increased their $UNI position, i.e. vast majority of airdrop recipients sold the token. This is further backed up by the fact that 98% of airdroppers did not take part in the governance process at all. Therefore, in spite of the well intentioned experiments to distribute tokens fairly and in a targeted manner, governance rights ultimately did not give token holders a big enough reason to hold onto them.
Key takeaways:
- Liquidity mining was the first iteration of token distribution by rewarding users who bootstrap the protocol, and later experimented as a way of fair distribution of tokens
- Retroactive airdrops were also introduced as another form of token distribution, with the aim of rewarding organic use of the protocol and achieving a wider distribution of governance participants
- Governance rights were the first form of token utility where token holders could participate in protocol level decisions. However, governance does not sustain demand in the long term given reflexive nature of price when it starts to go down
Beyond DeFi: Extension of Liquidity Mining & The Multi-Token Model
The novelty of liquidity mining extended beyond just DeFi summer. The ability to utilise protocol tokens as an acquisition tool with no cost led to huge success of Web3 Game
Axie Infinity, and DePIN network Helium in a short period of time. Rather than utilising a single token model, both Axie Infinity and Helium experimented with a multi-token model, with the goal of separating speculation and organic game growth through the use of various tokens.
Key Takeaways:
- The concept of liquidity mining is further extended as a bootstrapping tool for other use cases such as Gaming and DePIN
- The idea of multi token models to separate speculative demand and local economy is difficult to execute, often falling short due to lack of utility for one of the tokens
- Tokenomics is an iterative process where stakeholder interests and needs are only clearer when the product has gained traction
Influx of Private Funding: The Shift Towards Valuation Games
In 2021 – 2022, we saw a rapid increase in private funding, raising 41.46B and 40.12B respectively. To put things into perspective, the amount raised in 2021 alone was almost twice the amount that was raised between the years of 2017 – 2020 (22.6B).
To accommodate the influx of capital, projects began raising more rounds to accommodate more investors and extend their runway. The net result is price discovery happening in the private markets. In the past where valuations were only realised on TGEs, there is now demand in the secondary markets, where earlier investors were able to realise their investments to another fund. To illustrate this, imagine that an up and coming L1 raises a seed round at a US$50M valuation, Upon successful testnet deployment and closing of several protocol partnerships, it managed to close a funding round at US$500M prior to its TGE. In this example, seed round investors are already up 10X and may be happy to sell their private allocation at a 20% discount to lock in a 8X return.
Given the increase in the number of funding rounds prior to TGE, private investors often signal alignment by locking their tokens up for longer periods of time, leading to a smaller proportion of circulating supply on token launch. Coupled with the practice of airdrop and points farming, where users expend capital to use the protocol in hope of receiving an airdrop when the project launches, it may have led to inflated metrics which helps command a higher launch FDV.
However, once the airdrops are done, we often see a drop off in protocol metrics and market valuation by extension. This has led to the negative perception of “low float, high FDV” launches that were common in the last two to three years.
Key Takeaways:
- Private funding skyrocketed in 2021 after highly successful fund returns from those that deployed in the earlier years
- Influx of private capital means more valuation rounds prior to TGE, and the higher investor allocation means a lower circulating float on launch
- Airdrop / points farming was prevalent which boosted protocol metrics which led to a higher valuation on launch
- Private funding inadvertently shifted the focus from token utility to optimizing valuations
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