The content of this page was updated in July 2019, with an excerpt from the book Token Economy by Shermin Voshmgir.
In a token sale, smart contracts are used to issue and sell cryptogra- phic tokens in exchange for existing tokens entirely P2P. As opposed to native blockchain tokens that are issued upon successful mining of a block (“Proof-of-Work”), for individual contributions to the net- work to keep it safe, token sales introduced a static mechanism for issuing tokens against a direct nancial fee, before the project was operational.
Token sales allow the issuance of cryptographic tokens in exchange for existing tokens, entirely P2P. They became popular with the advent of the Ethereum blockchain, which allowed actors to create and subsequently sell tokens, with just a few lines of code, with a simple smart contract. These first token sales were referred to as Initial Coin Offerings (ICOs), but as the term “token” became more mainstream, token offerings or ITOs (Initial Token Offerings), and in the specific cases of securities, STOs (Security Token Offering), became the term of the hour. The main idea of those token sales was to fund new projects by pre-selling tokens to supporters. These tokens would typically be exchanged for Bitcoin and Ether, as both o er high market liquidity and are easier to exchange for at currencies, which are typically needed to pay bills, like salaries and rents.
Unlike highly regulated Initial Public Offerings (IPOs), many of the early ICOs were conducted without lawyers, financial intermediaries, or regulatory approval, and therefore seemed more similar to crowdfunding. While early supporters were enthusiasts rather than professional investors, over time, professional investors became interested in these token sales for the high returns on investments that were possible with this new type of asset class in the bull markets of 2015 to 2017. In the process leading up to such token sales, developers would present a so-called white paper describing the technical specifications of a project. However, as opposed to the Bitcoin white paper, and other white papers published by early blockchain projects that focused on the technology, many white papers of recent token sales would o en resemble business plans.
Depending on the use case outlined in the white paper, tokens can have very different properties. Early token sales were o en unclear about the type and role of the token, which o en made it hard to identify whether they resembled crowdfunding or crowd investing vehicles. As opposed to crowdfunding, where the investment is considered to be a donation, or a pre-buy of a product, early token sales gave the supporters the possibility of a return on their investment. Early token sales o en seemed to be a mix between a donation, investment, or risk capital. As regulators became more aware of token sales, the definitions became more stringent. Offering a possible return on investment, especially if the token could resemble a security, would be an indicator that the token might fall under the regulatory authority of securities commissions. Network tokens that allow for use of service within a network mostly do not. Legislators worldwide are still catching up to understand the different types of tokens, and derive necessary regulations.
In this context, it is important to point out that the Bitcoin blockchain never had an ICO, and that the native token (BTC) is continuously created each time a block of transactions is created. Token sales di er from how native blockchain tokens like Bitcoin are issued. As opposed to native blockchain tokens that are issued upon successful mining of a block (“Proof-of-Work”), for individual contributions to the network to keep it safe, token sales introduced a static mechanism for issuing tokens against a fee, before the project was operational. Tokens would be created only once, before the launch of the project, and issued to investors. In such a setup, a certain portion of the token supply, or the entire token supply, is released before the launch of a project, in many cases before any code is written.
History of Token Sales
The first token sale to be conducted was in 2013, when the Mastercoin project issued newly-minted Mastercoin against the payment of Bitcoin. The sale happened entirely P2P, raising around 500.000 USD worth of Bitcoin for the Mastercoin project. The success of this fundraising campaign inspired other projects that followed to use the Bitcoin blockchain for P2P crowdfunding purposes. In 2014, the Ethereum project used the Bitcoin blockchain to raise an equivalent of 18 million USD within a forty-two-day period, breaking all crowdfunding records at the time. The funds raised were used to develop the Ethereum white paper into an operational blockchain. Once operational, the Ethereum blockchain allowed the creation of a decentralized application for any type of P2P value exchange, using a smart contract with just a few lines of code. This smart contract functionality later became popular among other developers and entrepreneurs looking to fundraise money for their projects. Ethereum smart contracts simplified the process of issuing and trading newly issued tokens for other tokens, thereby sparking a series of record-breaking token sales in 2016 and 2017.
“The DAO” was an example of one of the earlier token sales conducted on the Ethereum blockchain. Resulting in the biggest token sale at its time, “The DAO” collected an equivalent of 150 million USD in Ether within a four-week time period. Everybody willing to invest was guaranteed a proportional share of the future revenues of that decentralized investment fund. However, “The DAO” experiment ended prematurely with a spectacular and highly controversial draining of funds, and a subsequent hard fork of the Ethereum blockchain (read more: Part 2 – Institutional Economics or Tokenized Networks). The scope of the fundraising success, paired with the dramatic events and controversial hard fork, brought a lot of attention to this new type of fundraising vehicle in international mainstream media. This spurred a rally of token sales conducted by many more projects to follow. In the ICO boom of 2016 to 2017, more than 800 token sales have been conducted, raising a total of about 20 billion in USD. Many of them were oversubscribed, which means that much more money could have been raised.
While most of the earlier token sales had experienced engineers fundraising for research and development of alternative blockchain protocols, as token sales became known to a wider public, they also became a fundraising vehicle for any type of project, many of which are not related to blockchains or the Web3. Many of these newer token sales launched without any serious business plan, merely marketing a simple idea without any proof of expertise or development. Often, the role and function of the token was unclear, giving the impression that a token was merely issued for fundraising purposes on a shallow marketing promise. Especially in the bull market of 2016 and 2017, the white papers would throw around marketing buzzwords, lacking technical specifications of how a goal should be achieved, and what the exact function of the token would be. These white papers resembled business plans, rather than a technical white paper. They would lay out specifics like a timeline for the project, budget, specify token distribution, token supply, and a promise to deliver a piece of so ware at a future date.
After a two-year rally and token sale boom, the market sentiment started to change in 2018. Most ICOs ended up having a much lower valuation than the total money raised, o en just a few weeks or months after a successful fundraising. At some point, many tokens only had value, if investors could get in early and buy at a discount, just to sell right after the public token sale ended and at a higher price, hoping that someone else would buy their tokens for more than they paid, which o en was the case. In nance and economics, this phenomenon is referred to as “greater fool theory.” So-called pump-and-dump tactics proliferated, where coordinated groups manipulated prices on mostly illiquid tokens. Applying coordinating buying action, artificial demand for the token drives prices up quickly, to make it appear as the new rising star to outsiders. As they were trying to pro t from this sudden price hike, the insiders of the group would quickly sell their tokens, leaving everyone else to jump ship before prices fell. These schemes are illegal in most jurisdictions, yet perpetrators can be hard to catch as steps and actions are concealed with anonymity online.
Only a third of tokens released in 2017 have yet to appear on any exchange. But unless a token gets listed on an exchange, it will hardly have any value, as the investment in the token will be hard to liquidate. Listing tokens on an exchange thus became a bottleneck for many projects conducting token sales, since exchanges had a hard time keeping up with running due diligence on applications of potential new tokens that wanted to be listed. As a result, the listing fees became competitively high. Since exchanges don’t tend to disclose their fees, one can only rely on the information given out by individuals that disclosed that listing fees range from 6000 EUR to 2.5 million EUR.
The overwhelming number of token sales combined with the rise of failed projects and intentional scams made individual investors more critical. The level of scrutiny rose with time and skyrocketed as institutional investors entered the marketplace. Token sales subsequently shifted from being a public offering to a pre-sale of tokens to a small number of wealthy investors before the launch of a public sale. Over time, the increase of private pre-sales has almost sidelined the public token sale process to a promotional event. Furthermore, as a result of increasing regulatory pressure in more tightly regulated countries, many issuing entities switched from Europe, US, Singapore, China, and Russia to unregulated or less regulated jurisdictions like the Cayman Islands and the Virgin Islands.
The bull market swung into a bear market. As investors became more critical and regulators started to be more vigilant, general prices of crypto assets went down. According to some statistics, more than 70 percent of projects turned out to be scams, not allocating their received funds as promised, either as a result of mismanagement or in an outright hit-and-run fashion. A total of 7 percent failed or got abandoned before trading. Only 15 percent of the projects were publicly listed at all. In 2017, out of over seven hundred token sales, over 15 percent of them failed at funding, 40 percent got funding but then failed, and another 14 percent got funding but slowly faded into obscurity. In spite of successful fundraising, many projects are not generating any economic results, with negative ROIs for the token investors. While by the end of 2017 tokens were heavily overpriced, the market seems to have started ushing out many non-viable projects, sometimes maybe even viable ones.
Regardless of market sentiments, however, token sales are here to stay. Depending on which sources one believes, the numbers vary greatly. The trajectory shows that token sales have become a more and more popular fundraising and investment vehicle. These statistics vary due to a lack of reporting standards, and the fact that a growing portion of tokens is offered in a pre-sale to a select number of o en undisclosed investors. The numbers seem to be on the rise, even in this bear market. It is estimated that in 2016, token sales raised over 600 million USD. 2017 numbers are estimated around 7 billion USD. For 2018, estimates range from 13 billion to 25 billion, with some spectacular token sales raising over a billion, like Telegram (1.7 billion USD)41 or EOS (4.1 billion USD)42, and all of that based on a simple promise and o en no product at all. Comparing this data with traditional forms of fundraising, we can see that global crowdfunding volume in 2015 was around 34 billion USD and is projected to grow to 100 billion USD by 2025. Global VC funding is also on the rise, with currently over 250 billion per year.
Types of Token Sales
In the early days of token sales, due to lack of explicit regulation, many developers assumed that they had total freedom on how to conduct those token sales, and hardly any sale was executed in the same way as another. Different approaches were experimented with, the most distinguishing factor of which was the price curve of the token throughout the different stages of the sale: (I) price increase; (II) price decrease; (III) fixed price; and (I) undetermined price. Token sales can set at a fixed exchange rate for the tokens to be issued over the duration of the sale. The rate could also increase incrementally over time. In such cases, it is assumed that early investors who take the biggest risk get the best price per token. Other options include Dutch auctions, where the sale starts at the highest price per token, and proportionally decreases until the end of the auction. Token sales can, furthermore, issue a fixed amount of tokens, or an unlimited amount of tokens. A token sale might be conducted in a way where tokens are distributed as a percentage of total funds raised. In this case, investors receive a percentage of tokens corresponding to the portion of their investment compared to total funds raised. The EOS project, for example, sold equal portions of their total token supply per day – the total money invested per day decided the investors’ allocation of that day’s token portion.
Full text and high-resolution graphics available as paperback & ebook: Token Economy, by Shermin Voshmgir, 2019
About the Author: Shermin Voshmgir is the Author of the Book “Token Economy“. She is the director of the Research Institute for Cryptoconomics at the Vienna University of Economics, and the founder of BlockchainHub Berlin. In the past, she was a curator of TheDAO, and advisor to various startups like Jolocom, Wunder and the Estonian E-residency program. In addition to her studies at the Vienna University of Economics, she studied film and drama in Madrid. Her past work experience ranges from Internet startups, research & art. She is Austrian, with Iranian roots, and lives between Vienna and Berlin.
About the Book: Blockchains & smart contracts have made it easy for anyone to create a token with just a few lines of code. They can represent anything from an asset to an access right, like gold, diamonds, a fraction of a Picasso painting or an entry ticket to a concert. Tokens could also be used to reward social media contributions, incentivize the reduction of CO2 emissions, or even ones attention for watching an ad. While it has become easy to create a token, which is collectively managed by a public infrastructure like a blockchain, the understanding of how to apply these tokens is still vague. The book refers to tokens, instead of cryptocurrencies, and explains why the term “token” is the more accurate term, as many of the tokens have never been designed with the purpose to represent a currency. However, since tokens do have similarities to fiat currencies, the role of money as a medium of exchange is analyzed at length in this book. This book gives an overview of the mechanisms and state of blockchain, the socio-economic implications of tokens, and deep dives into selected tokens use cases: Basic Attention Token, Steemit, Token Curated Registries (TCRs), purpose-driven tokens, stable tokens, asset tokens, fractional ownership tokens, Libra & Calibra (Facebook), and many more.