Today’s ICOs are deeply flawed and lack the right incentives.
Tokenized Securities Offerings (TSOs) are the solution.
At Sia, we have closely watched over the last year as billions of dollars flow into ICOs. We believe the concept of a token sale is highly innovative, and that offering tokens directly to investors brings numerous benefits. We believe token sales are the future of fundraising and will ultimately displace our traditional systems.
But we have been lately troubled — not merely by the large amounts raised by teams who have delivered nothing but white papers, but also by the perverse incentives that accompany raising capital through the sale of utility tokens.
Today, most ICOs incentivize poor token design. Given that projects raise money through the sale of utility tokens, they wrongly design their tokens to be stores of value instead of convenient mechanisms to access network utility.
Today, most ICOs incentivize poor token design.
We believe that, in the long term, a decentralized network will suffer when its utility token is poorly designed. A capped supply or centralized distribution may incentivize hoarding, lead to frequent supply shocks, and ultimately harm the network’s underlying utility.
We are concerned that the cryptocurrency community has embraced the sale of utility tokens via ICOs as the norm. Instead, we call on crypto projects to adopt other token models that better align incentives for the long term.
This post details our criticism of raising capital through ICOs of utility tokens. It also proposes a different type of dual-token model that Sia has used since 2014, and explains why Tokenized Securities Offerings (TSOs) are the solution.
ICOs: a Paradox of Incentives
Most ICOs look the same: a project — let’s call it Y-Coin — decides to raise capital through the sale of YCN utility tokens. Y-Coin chooses to reserve a portion of the coins (say, 30%) and sell the remainder to investors.
This means that Y-Coin has two sources of funds. The first is direct proceeds from the sale of YCN tokens, which are typically received in Bitcoin and Ether. These funds are used to grow the Y-Coin project through hiring, marketing, and so on.
The second source of funds is from the portion of YCN tokens held in reserve. This, unfortunately, is Y-Coin’s only long term business model. Over time, Y-Coin will need to spend its YCN tokens to cover operating expenses, thus depleting its reserve.
Let’s examine this setup from an incentives perspective. Post-ICO, Y-Coin is sitting on a large amount of liquid capital in the form of Bitcoin, Ether, and YCN tokens. This is the largest quantity of YCN tokens that Y-Coin will ever own, as it will need to spend them in the future to cover expenses.
Therefore, the Y-Coin team is strongly incentivized to increase the value of its YCN tokens in any way possible. If they do so successfully, their YCN — in terms of fiat — will last forever.
When looking at the incentives, it’s important to examine the path of least resistance. In Y-Coin’s case, developing a technically-sound, working network with a large user base is not the easiest way to increase YCN’s value. Instead, the easiest way is to pour resources into marketing and public relations.
…developing a technically-sound, working network with a large user base is not the easiest way to increase YCN’s value.
Counterintuitively, developing a working Y-Coin network may actually decrease YCN’s value, because it would increase YCN’s usage. This is because, in order to access network utility, Y-Coin users need to spend their YCN. This, in turn, increases YCN’s token velocity, which puts negative pressure on YCN’s price. Read more about token velocity here.
The Y-Coin team therefore may even have a disincentive to deliver a working network!
This is all backwards. Our view is that under the current model of utility token ICOs, projects are incentivized to spend funds on marketing while never delivering a working network. What we should be striving toward is token models that incentivize product development above all else.
The question, then, is how do we create true utility tokens that incentivize development while also succeeding to attract investors?
Sia created two tokens, one for utility and one for investment.
Sia: a Tale of Two Tokens
When designing the Sia network in 2014, we chose to pursue a very different token model. Instead of one token, we have two: a utility token (Siacoin) and a revenue-sharing tokenized security (Siafunds).
Utility tokens exist to provide access to a good or service on a decentralized, blockchain-based network. Sia’s utility is cloud storage. Renters on Sia use Siacoin to purchase storage space from a worldwide network of hosts, and hosts receive Siacoin in exchange for storing renter data.
Siacoin is specifically designed as a utility token and has never been used for fundraising. Siacoin was launched in a manner similar to Bitcoin, where the software was freely released to an early user base. It’s a proof-of-work token, mined via a large network of GPUs and ASICs.
We chose to implement an uncapped Siacoin supply, with an inflation rate that decreases over time. This ensures that new users, even far into the future, can easily obtain Siacoin and purchase storage space on the Sia network.
This ensures that new users, even far into the future, can easily obtain Siacoin and purchase storage space on the Sia network.
(An aside: this does not mean that Siacoin is not a good investment. It simply means that we designed Siacoin to be a useful mechanism for accessing the Sia network’s utility, rather than as a flawed store of value).
The Sia core team also chose to own less than 1% of the total Siacoin supply to ensure decentralization and widespread distribution. Though difficult to track, we estimate that no single entity owns more than 4–5% of the total Siacoin supply.
We believe that well-designed utility tokens are widely distributed, easily accessible, and highly liquid.
Siafunds are revenue sharing tokens. We believe Siafunds are tokenized securities rather than utility tokens. Utility tokens primarily derive their value from use on decentralized networks. Siafunds, by contrast, derive their value from the present and future value of the storage-related transactions on the Sia network.
Siafunds entitle their owners to a fixed portion of the fees paid by renters and hosts on the Sia network. This portion amounts to an aggregate of 3.9% of all storage contract spending.
Siafunds entitle their owners to a fixed portion of the fees paid by renters and hosts on the Sia network.
When renters and hosts form file contracts, renters prepay for storage and hosts post collateral. At the time of contract formation, the 3.9% fee is subtracted from the file contract and distributed to Siafund owners. This occurs at every block, which is on average every ten minutes.
There are 10,000 Siafunds in existence, all of which were generated upon the launch of the Sia network in 2015. Because the number of Siafunds is fixed, as the number, size, and value of the contracts on the Sia network increase, the amount of revenue per Siafund increases proportionally.
Nebulous, Inc. — the company that employs Sia’s core team — owns 87.5% of all Siafunds and less than 1% of all Siacoin. This means that our incentives are wildly different from projects that raise funds through utility token ICOs.
Since Siafunds produce revenue only when users on the Sia network pay for storage, we are highly incentivized to take actions that encourage users to store data on the Sia network.
Currently, this means building a working decentralized storage network that can handle large amounts of data!
Sia’s revenue sharing token model forces us to think long-term and put product development ahead of marketing.
Sia’s revenue sharing token model forces us to think long-term and put product development ahead of marketing. It provides us with the proper incentives to build a working storage network with significant utility.
We believe that tokenized securities, like Siafunds, are the answer to the ICO Paradox.
Projects that want to raise capital can issue tokenized securities that are specifically designed for fundraising and rewarding investors. This could be through a revenue-sharing model, or through a different model that properly aligns incentives.
Projects that require utility tokens — most do not — can freely release their software to an early user base with no pre-mine, no reserve, and no intent to use their utility tokens for fundraising.
Tokenized securities can be sold to the public via Tokenized Securities Offerings (TSOs), which require regulatory compliance designed to protect investors. While the current TSO model has flaws (namely, accredited investor restrictions), we believe it is a better, more honest fundraising model than ICOs.
We believe that raising capital through ICOs of utility tokens leads to flawed incentives, and we hope that new projects in the cryptocurrency space choose to adopt token models that instead incentivize long-term product development.
Sia’s token model consists of two tokens: Siacoin as a utility token and Siafunds as a revenue-sharing tokenized security. We believe this model better aligns our incentives for the long term.
Projects looking to raise capital should issue tokenized securities through TSOs, which we think is a better, more honest fundraising model.
Thanks for reading! We are excited to see what other innovative token models emerge over the coming years.
— Team Sia