Over the years, crypto economics has given birth to all manner of creative solutions to the token distribution puzzle. It began with Bitcoin’s slow and steady mining-based approach, which rewards “miners” for validating transactions and securing the network. Then there was the Initial Coin Offering or ICO, based on a classic crowdfunding mechanism that sent crypto soaring to the moon and back in 2017.
Other popular processes include the private allocation model that’s designed to attract investment from venture capitalists, and mechanisms that try to emphasize fairness and meritocracy, encouraging participation in return for rewards. Airdrops have also taken off big time, paying bounties to encourage user activity.
When choosing how to distribute their tokens, crypto projects must strike a balance between decentralization, perceived fairness, and speed of growth, and bear in mind that the chosen model will likely have a major impact on their overall reputation.
1: ICOs, IDOs and IEOs
These three models all share similarities, and so it’s probably okay to bunch them all together. The best known is the ICO, which was popularized by Ethereum way back in 2014. The basic premise is that the project sells all or some of its total token supply to the general public, with the highest bidders getting first priority. The concept kicked off the spectacular “ICO craze” of 2017, when dozens of crypto projects ended up raising multiple billions of dollars during one of crypto’s first bull runs.
For projects, these models can provide them with substantial funding to accelerate development. But there’s a major downside too, for investors are taking an enormous risk. The Wild West nature of crypto means there’s very little protection on offer, which is why so many have fallen victim to so-called “rug pulls.”
ICOs and their variants are designed to be fair, but in practice they rarely work that way. While Ethereum pulled it off well, in many projects it was the investors with the fattest wallets and the fastest internet connections that came out on top, walking away from the sale with outsized stacks of tokens. There’s also the risk of investors “dumping” their tokens shortly after the sale concludes, which can cause extreme price volatility.
2: Fair launches
In contrast to the above is the “fair launch,” which eschews private sales, pre-mining and other gimmicks in the pursuit of absolute fairness to every community member. We’ve seen a number of variations of this, but the general principle is that tokens should be “earned” through verifiable contributions to the network’s health.
That’s exactly what Ault Blockchain is doing. It’s a new Layer-1 network building high-performance financial infrastructure, and its plan is to distribute its total supply of 100 billion AULT tokens only to contributors over the next ten years. To participate, users must purchase a license to operate a mining node and perform verifiable work such as validating transactions, or by building dApps on the network. The protocol issues new AULT daily, based on its protocol-controlled emission schedule.
Fair launches are a great way to ensure true decentralization, because no one can buy control of the network. Because there are no allocations to early investors or even the developers, everyone starts out on an equal footing, and is forced to make a positive contribution to the network if they want to gain any kind of influence. The downside is pretty obvious though – it means the protocol itself doesn’t earn anything from its tokens, and will have to find funding elsewhere.
3: Private allocations
This distribution model is heavily skewed towards institutional investors, with a substantial portion of the token supply being reserved for VCs and angel investors prior to a public exchange listing. However, it’s common for projects to protect themselves with strict “vesting” schedules that prevent early adopters from selling off their holdings too soon.
The advantage of having VCs onboard is that the project can benefit from the capital they provide and their professional expertise and connections, enabling them to scale rapidly. A case in point is Solana, which successfully pulled this off when raising $314 million from VCs before growing to become the top rival to Ethereum. However, their involvement hurts decentralization, because it means a significant number of tokens are held by a relatively small number of investors. Moreover, tokens often see massive selling pressure once the token vesting periods expire, impacting their price and hurting regular users.
The general consensus is that private allocations are anything but fair, at least in the eyes of crypto purists. Most everyday users don’t have the funds to participate in the best price tiers, which means they often pay more for their tokens and can only acquire a limited stack.
4: Airdrop distribution
Airdrops are another attempt at fairer distribution and are meant to encourage growth by rewarding users who interact with the protocol in some way. They’ve been used successfully by a number of DeFi applications and Layer-2 networks, notably Arbitrum, which distributed a substantial percentage of the overall ARB token supply to early network users.
With airdrops, tokens can be earned in many ways, including making transactions (to encourage network usage) or by posting on social media (marketing). They can be extremely useful for projects that need to “spread the word” and get more attention, but they can also be gamed. Notably, they’re vulnerable to so-called Sybil attacks, where people create thousands of automated bot accounts to harvest the token rewards on offer.
In terms of fairness, airdrops can be very appealing due to the way they reward loyal protocol users. That said, many projects have strict eligibility requirements, which can exclude some users, even if they’re making significant contributions to the project.
It’s not just a fundraiser
Token sales are one of the easiest ways for blockchains to generate funding, but distribution shouldn’t just be viewed as a financial strategy. The way tokens are shared is seen as a reflection of a project’s values, and that’s important when trying to build a strong community.
ICOs were responsible for rampant growth in the early years of blockchain and DeFi, and many projects have gone down the VC route in an effort to fill up their warchests and establish themselves as major players. If a protocol needs funding, it’s very often the smart way to go.
But nowadays we see many new projects embrace fairer launches as a way to establish their decentralized credentials and identities and appeal to the legions of crypto purists, as well as investors who’re tired of the old “pumps-and-dumps” and rug-pull scams.
Fair launches have a lot of merit, because many crypto users are inclined to “believe” in projects that promote true decentralization, transparency and distribution of wealth. Such models are much more attractive to long-term stakeholders, while short-term speculators are inclined to look elsewhere for their ill-gotten gains. When everyone is starting in the same boat, it can encourage participation and growth, for users understand that the more they contribute, the greater the value they earn.