Dialogue with a16z legal experts: The "Dos" and "Don'ts" of Token Issuance

Original Title: “Token do's and don'ts”

Compiled by: Deep Tide TechFlow

Guests: Eddy Lazzarin, Chief Technology Officer of a16z crypto; Miles Jennings, General Counsel and Head of Decentralization

Host: Robert Hackett, Operating Partner at a16z crypto and Head of Content and Editorial

Background Information

This episode of a16z's Web3 program will comprehensively explore topics related to Tokens— including the role of Tokens in decentralized protocols, different types of Tokens, and considerations for designing and issuing Tokens.

The guests this episode are Eddy Lazzarin, Chief Technology Officer of a16z crypto, and Miles Jennings, General Counsel and Head of Decentralization, who have provided advice on protocol design and Token design for numerous projects. They will discuss the differences between Web3 and early technology eras; how to avoid common pitfalls when seeking product-market fit; how to evaluate various designs and strategies, along with their risks and rewards; and more.

The Necessity of Decentralized Protocols

The Core Role of Tokens

Eddy explained why decentralized protocols need Tokens to maintain their sustainability and incentivize participation from all stakeholders. He pointed out that Tokens are not just payment tools, but means for users and network participants to express their ownership and control. Eddy emphasized that Tokens should be viewed as tools that enable users and stakeholders to represent their ownership and control within the network, rather than merely as payment mediums for purchasing traditional goods.

Comparison of Tokens and Traditional Protocols

When comparing the protocols of Web1 and Web2, Eddy mentioned that while protocols like HTTP and SMTP in Web1 were decentralized, they were ultimately absorbed by large companies, leading to a loss of user control over these protocols. He noted that decentralized protocols can maintain decentralization through economic incentives by introducing Tokens. This economic incentive mechanism allows protocols to operate continuously without relying on centralized entities, thus avoiding user control by large companies like Gmail.

Eddy also mentioned that the advantage of decentralized protocols lies in their ability to bring all stakeholders together and ensure the sustainability and value of the protocol through the economic model of Tokens. He believes that Tokens are a key tool for achieving this goal, as they can be written and executed in code, ensuring that the protocol operates as designed.

Types and Classifications of Tokens

Eddy discussed several different types of Tokens, noting that each type has its unique functions and market positioning within decentralized protocols. He listed some common types of Tokens, including:

• Stablecoins: For example, USDC and USDT, these Tokens are typically pegged to the value of fiat currencies, aiming to reduce price volatility and provide users with a more stable store of value and medium of exchange.
• Arcade Tokens: These Tokens are usually used in specific application scenarios or within platforms, similar to points or rewards systems in games, which users can earn by participating in activities or completing tasks.
• Meme Coins: These Tokens often originate from internet culture or humorous content on social media; although they may lack substantive applications, they can sometimes gain widespread attention and speculative interest due to their community-driven nature.

Eddy emphasized that different types of Tokens need to consider their specific functions and target markets during design and launch to ensure their effectiveness and sustainability within decentralized protocols.

Legal and Regulatory Challenges

Regulatory Uncertainty

Miles emphasized the legal risks and regulatory uncertainties faced by Token issuance and decentralized protocols. He pointed out that as cryptocurrency and blockchain technology rapidly evolve, regulatory agencies around the world are increasingly focusing on these emerging technologies. However, due to the legal framework not being fully matured, projects often face complex legal and compliance challenges when designing and issuing Tokens.

Miles mentioned that project teams need to carefully consider their legal structure when launching Tokens to avoid potential legal issues and regulatory penalties. He suggested that teams adopt various strategies to mitigate these risks, including:

• Compliance Review: Conducting thorough legal and compliance reviews during the Token design phase to ensure adherence to local and international laws and regulations.
• Legal Consultation: Seeking professional legal advice to understand the latest regulatory developments and requirements, thereby formulating appropriate compliance strategies.
• Transparency and Communication: Maintaining transparent communication with regulatory agencies and actively cooperating with regulatory requirements to build trust and reduce legal risks.

Miles emphasized that despite the challenges posed by the legal and regulatory environment, projects can effectively navigate these complex areas and achieve innovation and growth on a compliant basis through careful planning and professional legal support.

The Value of Governance and Decentralization

Technical and Legal Advantages of Decentralization

Eddy and Miles highlighted the importance of decentralization from both technical and legal perspectives. They pointed out that decentralized protocols provide users and communities with greater autonomy and transparency by dispersing control, thereby enhancing the reliability and trustworthiness of the system.

• Technical Advantages: Eddy mentioned that decentralized systems reduce the risk of single points of failure through distributed network architecture, improving the resilience and security of the system. This architecture allows protocols to operate continuously without centralized entities and to be more resilient in the face of external attacks or internal failures.
• Legal Advantages: Miles discussed the potential legal advantages of decentralization. He noted that decentralized protocols can reduce reliance on a single entity through a distributed governance structure, thereby lowering the concentration risk of legal liabilities. Furthermore, decentralized governance mechanisms can empower community members with more decision-making authority, allowing the protocol to better reflect user needs and interests.

Pros and Cons of Token Governance

When discussing Token governance, Eddy and Miles also explored its potential pros and cons. Token governance typically involves Token holders participating in the decision-making process of the protocol through voting or other mechanisms, which can enhance community engagement and the democratic nature of the protocol. However, they also pointed out that Token governance may bring some challenges, such as:

• Governance Participation: Although Token governance grants users the right to participate in decision-making, actual participation may be low, leading to excessive influence of a few large holders over the decision-making process.
• Complexity and Efficiency: Decentralized governance mechanisms may increase the complexity and time costs of the decision-making process, affecting the protocol's responsiveness and innovation capabilities.

Despite these challenges, Eddy and Miles still believe that decentralized governance is one of the key factors for achieving the long-term success and sustainability of the protocol.

Market and Product Fit

Definition and Importance

Market and Product Fit refers to the state where a product meets the needs of its target market and finds its positioning in the market.

Eddy emphasized the importance of this concept in decentralized protocols and Token projects. He pointed out that market and product fit is crucial for project success, as it determines whether the product can achieve widespread adoption and sustained use among users.

Strategies for Achieving Market and Product Fit

• User Needs Analysis: Eddy suggested that project teams deeply understand the needs and pain points of their target users to ensure that product design and features genuinely address user problems. This requires extensive market research and user feedback collection.
• Iteration and Optimization: Through continuous product iteration and optimization, projects can better adapt to market changes and user needs. Eddy emphasized that flexibility and rapid response are important factors in achieving market and product fit.
• Community Participation: In decentralized projects, community participation and support are crucial. Eddy believes that by building strong community relationships, projects can gain valuable user feedback and market insights, allowing for better adjustment of product strategies.
• Market Education: For emerging technologies and products, market education is key to helping users understand and adopt the product. Eddy suggested that project teams invest resources in market education activities to enhance user awareness and acceptance of the product.

Challenges and Solutions

Achieving market and product fit is not easy; Eddy pointed out some common challenges, such as intense market competition and diverse user needs. He suggested that project teams respond to these challenges through differentiation strategies and unique value propositions while remaining sensitive to market trends and user feedback to adjust and optimize products in a timely manner.

Good and Bad Practices in Token Issuance

Token issuance is a critical step for blockchain projects to raise funds and drive ecosystem development. However, there are good and bad practices in the Token issuance process that project teams need to carefully consider and follow. Here are some common good and bad practices:

Good Practices

Decentralization:

• Eddy and Miles emphasized the importance of decentralization, viewing it as one of the core values of blockchain technology. Decentralization not only helps reduce reliance on managers but also brings technical and legal advantages.
• Decentralized systems can better protect users from the effects of information asymmetry and can also reduce the risk of being classified as securities legally.

Clear Economic Model:

• Ethereum was mentioned as a successful example due to its clear economic model, which can maintain value over the long term.
• Tokens should have clear use cases rather than merely existing as speculative tools.

Community-Driven and Participation:

• Effective Token issuance should encourage community participation, ensuring that the use and governance mechanisms of Tokens are clear and necessary.

Bad Practices

Decentralization Theater:

• Miles mentioned "decentralization theater," where projects claim to be decentralized but are actually controlled by centralized teams. This practice lacks technical advantages and may pose risks to consumers.

Tokens with Unclear Use:

• Issuing Tokens solely for governance is considered a bad practice, especially when governance is not genuinely needed.
• In examples mentioned by Robert Hackett, some projects force users to use their Tokens, while these Tokens have no actual function or value.

Legal Risks:

• Publicly selling Tokens in the U.S. may be viewed as securities; Miles emphasized that this practice should be avoided as it poses significant legal risks.

Premature Token Issuance:

• Miles pointed out that many projects issue Tokens prematurely without clear use cases or market fit, often leading to failure.

By following good practices, project teams can increase the success rate of Token issuance and lay a solid foundation for the long-term development of the project.

Summary and Recommendations

The Importance of Decentralization:

• Decentralization is not only a legal requirement but also a core technical value. It provides system robustness and global adaptability, allowing users and developers to trust and rely on these systems.
• Decentralization can reduce reliance on management and lower the risks of information asymmetry, which is one of the core concerns of securities law.

Clarifying the Use of Tokens:

• Before issuing Tokens, projects need to clarify the actual use of the Tokens. Tokens should not merely exist as speculative tools but should contribute to the operation of the protocol and the healthy development of the ecosystem.

Avoiding Premature Token Issuance:

• Many projects rush to issue Tokens without clear product-market fit and Token use, which can lead to legal risks and market failure. Projects should issue Tokens only after determining their functions and market needs.

Legal Compliance and Risk Management:

• Projects should fully consider legal compliance when issuing Tokens, especially in the U.S. market. Avoid unnecessary legal risks, such as publicly selling Tokens that may be viewed as securities.
• Strategies such as decentralization, excluding the U.S. market, or limiting the transferability of Tokens can help reduce legal risks to some extent.

Community Participation and Governance:

• Community participation is crucial for the long-term success of projects. Projects should design reasonable governance mechanisms to ensure that the community can effectively participate in decision-making when necessary.
• Voting should be used as a last resort, only when necessary, rather than as the primary justification for Token issuance.

Economic Models and Incentive Mechanisms:

• The economic model of Tokens should be carefully designed to avoid unnecessary speculative behavior and market manipulation. Projects should focus on building a sustainable economic ecosystem.
• When designing incentive mechanisms, attention should be paid to balancing the interests of both supply and demand sides to ensure market stability and predictability.

Focusing on the Product Rather than the Token:

• Eddy emphasized that founders should focus on the design and implementation of the protocol rather than solely on the Token itself. Tokens are part of the protocol, not the entirety.