The most recent addition to the scene has been explosive, combining radical decentralist impulses with a Wild West entrepreneurial spirit: the initial coin offering (ICO). What has marked this trend most visibly has been the proliferation of a new asset class, the ERC-20 token, most often representing a share, very loosely defined, in a nascent business, organization or project.
Let’s imagine a simple example: a startup decides it wants to create a role-playing game (RPG) that exists on the ethereum blockchain. In order to raise funds to create and then develop the game, as well as cover all related expenses (salaries, advertising, etc.), it decides to undertake an ICO.
In practice, this translates into the creation of a specific token that can be purchased in a sale, often through other cryptocurrencies, and that capital is then funneled back into the project.
This process eliminates the need for venture capital and establishes a direct relationship between startups and an open field of crypto investors. In many cases, there will be more traditional seed funding or private sales involved, but it is the public sale that will generate the most capital.
This is “tokenomics” defined in its first and most direct sense, a self-funding mechanism for projects within the crypto economy.
What has captured the attention of the wider public and mainstream media with this new mechanism is the sheer scale of that funding. For instance, right now the much-scrutinized Telegram Open Network (TON) ICO is reportedly building it way toward an obscene $2.5 billion over the course of three fundraising rounds.
We have even watched as celebrities such as Paris Hilton and Floyd Mayweather have promoted such ICOs, much to the chagrin of the SEC, who issued a warning about such endorsements.
Even Goldman Sachs, never the friendliest commentators on the crypto economy, issued a report noting that token sales have eclipsed venture capital as the primary source of funding for early-stage tech companies.
Given the glut of capital flowing into this area, it is somewhat surprising that the token and the economy it undergirds remains so ill-defined. However, the ambiguity is not incidental, it is a direct outcome of the regulatory twilight zone in which ICOs operate.
Tokens by function
For now, the attitude of financial regulators worldwide can best be characterized as relatively permissive. So long as fraudulent behavior and flagrant derelictions of securities laws are avoided, a none-too restrictive form of self-governance has been tolerated.
The SEC will crack down, as we have seen recently, on clear-cut scams, but to everyone else, the advice has tended to be that if your token is a security then you need to register with us, but if not, then it is hands-off for the moment.
This has resulted in the very nature of the token remaining open-ended, often a practical decision, since the definition has serious regulatory implications.
When not explicitly stated as a security, and operating in full compliance to what that entails, a token has tended to be defined by its utility. This is the token defined through its function. A token understood as a security is a financial instrument that mirrors the traditional securities found within the “regular” economy.
The obvious correlate is a share in a company where the investor hopes to gain a return based on performance. In this model, tokenomics will ideally adopt the best standards from the relevant regulatory body, but it is not uncommon for ICOs to simply ignore them (or, as is common as well, to be ignorant of them)…
Read Full: Three Definitions of Tokenomics