What would an ideal token allocation look like?

Original title: Token Cap Table Allocation

Original article by Vader Research

Leo, BlockBeats

token economics is often associated with its pie chart allocations, which represent the percentage distribution of tokens among teams, investors, Treasury, and communities. These numbers are typically determined based on non-token investor allocation benchmarks and bilateral negotiations between teams and investors.

token allocation becomes slightly more complicated when a project that is being funded determines what percentage of the token will be offered to existing or future equity investors. There is no standard framework to guide founders on how to allocate tokens to various parts of the market, which often leads to misallocation of tokens between teams and various investors.

In this article, we will introduce:

1. Cumulative value

2. Only intokenUpper cumulative value

3. In equity holdingtokenUpper cumulative value

4. tokenAnd its equity

5. Conclusion

First, cumulative value

Before looking at anything related to cumulative value, let's try to understand the relationship between equity and token. The classification models so far are as follows:

-Accumulated value on the token

- equity holdingThe accumulated value on some tokens

- Accumulate value in both token and equity

The key point here is cumulative value; The value of an agreement depends on its cumulative value. Any metric that represents future revenue (volume, number of users) can be considered a value driver as long as the future revenue converted by that metric will accrue to the agreement.

If a game charges a 5% fee for transactions in the secondary market, and the revenue is earned by token holders, token holders can collectively vote on how to spend the revenue:

-Reinvest in agreements (marketing, recruitment, new products, etc.).

- the proceedsDistributed to token holders (token buybacks, shares, etc.).

Thus, the inherent fundamental value of a token is mainly driven by the value accumulated through the basic income of the business. This value can be accumulated in any currency, including the token of the token issuer.

Similarly, if a decentralized exchange has $10 billion in daily trading volume, but transaction fees are only revenue from equity, then the governance tokens of the DEX have little value. In another example, a DEX that has $10 billion in daily trading volume does not yet charge any fees because it is free to trade through subsidies that stimulate growth. If the exchange decides that the fees it charges are only owned by equity, then the exchange's governance token has no intrinsic value.

The core value driver for each token is the fundamentals of its core business. The percentage of value a token should receive compared to equity determines its basic valuation.

Basic valuation methods can be more complex than this (such as the discounted cash flow method) and there are many exceptions (asset-based valuation), but at a higher level earnings = accumulated value is the rule of thumb. In traditional financial markets (stocks, bonds, commodities, foreign exchange), most of the investment money is managed by institutional investors, where professionals analyze the securities and manage the money. Institutional investors build complex models to value each tradable asset and, based on their assumptions and market sentiment over time (fear/greed), infer a valuation range that reflects the fundamental value of the company.

However, in crypto markets, most of the invested money is managed by retail investors, who do not prioritize fundamentals the way institutional investors do (like Dogecoin, Shiba, Luna Classic, and NFT pfp). So the market, the crypto market may not reflect fundamentals as quickly as the traditional financial market, but this is expected to change in the next 2 or 3 years given the increasing capital flows into crypto.

2. Accumulate value only on the token

Let's imagine a situation where founders finance equity and plan to launch a governance token that rewards and incentivizes active agreement participants. Governance Tokens give active agreement participants a sense of ownership, with the aim of further strengthening their loyalty, retention, and experience.

This may be one of the most engaging ways to reward gamers, with DEX or lending platforms rewarding users for providing lock-in liquidity, decentralized social networking platforms rewarding the best content creators, and blockchain rewarding network verifier. token rewards can also be viewed as a user acquisition/retention tool.

To encourage protocol participants to acquire and hold tokens for a long time, tokens should be designed in such a way that future business success drives the value of tokens. If all the proceeds go to equity instead of tokens, what drives the token value? Why would an active protocol participant hold the token instead of immediately selling it? Rational participants would not want to hold a token that is nothing but a meme token because they know that these tokens will eventually be sold.

It also casts a bad light on the reputation of the protocol, as most crypto participants check the protocol price they use and see a sustained drop in price as a sign of weakness or a red flag. Given that the supply of tokens will constantly increase to reward participants, tokens will eventually fall if there is no demand side to balance the growth on the supply side of tokens.

Therefore, the founder can consider accumulating the value to the token. In this way, the token incentive given to participants will not only reflect the future development of the agreement, but also have relatively high value. The holder will not easily sell the token, users will be converted into loyal users, and loyal users will be converted into evangelists.

However, if all the value accumulates to the token, what drives the value of the equity? More importantly, will equity investors' stakes become worthless? Equity (even if it still has power over the token entity) will become more or less worthless, and in order to provide developers with accrual value and flexibility in economic design, equity investors should receive tokens on top of their existing equity.

But what percentage of the token should existing equity investors receive? If a pre-series investor gets 10% equity on a $1 million investment (valuing the equity at $10 million after the investment), should they also get a 10% token allocation?

The answer is no, they should get less than 10 per cent, 8, 5 or 3 per cent (based on the following assumptions) :

- Past and future equity financing

-token Indicates the percentage of the Treasury allocated

- Indicates the percentage of the community allocated by the token

-token for public sale

We build a model to compute a token allocation scale table based on the assumptions listed above. The part marked green in the form represents the hypothetical financing situation. Founders and investors can fill in the financing amount according to the real situation to obtain a series of implicit token proportion allocation values.Click to download the model.Watch the video here(The video explains how to use this model, its basic principles, etc.).

Why is it important to ensure that the token ratio matches the equity ratio? Any misallocation is likely to disappoint the team, investors, and community. Founders and investors should have a framework and model for how to properly allocate tokens. This model template is intended to be a standard framework for token allocation ratio in the future.

The fixed token supply proportional allocation is different from the equity proportional allocation. Each time the team raises capital, new shares are created out of thin air, diluting existing shareholders. On the other hand, no new token is created out of thin air whenever the team raises money -- the token is given from the limited reserves of its agreement.

3. Accumulate value on the token of equity holding

Method 2 shares the same value accrual model as Method 1, but the token is fully owned by equity. This is similar to the structural relationship between Sky Mavis and AXS generation. Since value accumulates directly to tokens rather than equity, the rationale behind the method is that equity obtains value from the ownership of its token. Make the incentives between token and equity consistent.

There are two ways to apply this pattern:

- Investors hold simultaneouslyThere are shares and tokens

- Investors only hold equity

The investor holds both equity and token

The problem with investors holding both equity (token ownership drives its value) and tokens is that investors are essentially double investing in tokens -- holding more token ownership than their equity ownership.

Let's assume that the investor owns 50% of the equity and the rest is owned by the team.

Let's assume the token allocation is as shown below, where the investor owns 20%. Remember, 20% goes to the team equity, not the founders and employees.

Assume that the equity-held tokens (worth $20 million) are distributed proportionally to shareholders (investors, founders, employees); Investors end up holding 30% of the tokens (20% directly through tokens and 10% indirectly through equity).

As a result, teams (founders and employees) end up being assigned a 10% token ratio. Assuming the value only accumulates up to the tokens, that's bad for the team, because they end up giving away more tokens than they should have based on their equity ratio.

For example,

Sky Mavis and AXS tokens are examples where the value accumulates to tokens held by equity, but equity investors also receive tokens.

The early-stage VC firm that invested in Sky Mavis received an AXS token allocation - 21% of the founding team's AXS are owned by equity rather than directly by the team. We don't know how the shares, tokens are allocated, but suppose they are allocated to shareholders on a pro rata basis.

Private investors have only received 4% of the token and we do not know the details of the investment structure. It's likely that VCS get a smaller token allocation than their equity percentage, or that some VCS don't even get any allocation. Overall, as long as the proportions are balanced properly, this may not be a very bad structure. In the case of Sky Mavis, equity investors may also have received Sky Mavis Tokens such as RON.

Iv. Accumulated value in both token and equity

In this case, the idea is to share the value between equity and token. There are many ways to apply this approach. Tokens account for a small or large portion of the overall value accumulation. It all depends on the business model, the product and the industry.

Let's look at the model of CEX like FTX and Binance -- customers with FTT and BNB can enjoy discounts on transaction fees. The intrinsic value of these tokens is driven by the exchange business, but unlike the first two models we discussed, only a portion of their overall value (determined by the developer) accumulates to the token.

Another approach is the governance token pattern of STEPN and Pegaxy. The economics of both are similar to Axie -- the key difference being that in Axie, AXS used to pay for incubation costs are automatically burned. As the supply of AXS in circulation gradually decreases through incubation, the value created by the player paying $100 of AXS to hatch accumulates to the AXS token holder, thus reducing the supply of AXS in circulation and causing the price of AXS to increase.

However, in STEPN and Pegaxy, the governance tokens GMT and PGX used to cover incubation costs do not self-destruct, but accumulate as revenue to the equity firm. The developer can then decide how many governance tokens to destroy or by purchasing governance tokens on the open market. Assuming all things being equal, neither GMT nor PGX are very perfect investment options from a fundamental perspective, as there is no 100% income accrual.

Five, the conclusion

This article focuses on how the funding team decides to accumulate value for the tokens and the ideal token allocation model. In addition, there are other forms of token proportion allocation, such as what is the ideal Treasury, community, liquidity pool, equity allocation and the ideal ownership period.

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