I recently read an interesting book on the history of the East India Company (EIC) called Anarchy by William Dalrymple. For those unfamiliar with this chapter of European colonialism, the EIC was a joint stock company granted a royal charter and a monopoly on trade between Britain and the Indian subcontinent. Starting out as a weak and meager commercial enterprise, it struggled to survive with the arduous support of various Indian rulers, and after centuries of development, it eventually conquered the entire subcontinent and laid the foundation for British rule in India. This period of rule began in the late 19th century and lasted until 1947.
When it became known that EIC had used questionable methods to make huge profits, some members of the company were summoned to the British Parliament for questioning. Fortunately, many senior members of parliament are also EIC shareholders, so little or no fines are imposed. In fact, EIC has requested and received emergency support from the government several times due to excessive debt. EIC was the first “too big to fail” company, and politicians at the time, just as they do today, used public funds to bail out private companies for personal gain. In effect, profits are privatized and losses are socialized.
The reason EIC is relevant to cryptocurrencies is because we want to talk about the evolution of cryptocurrency project ownership structures and funding methods. We will discuss Bitcoin, ICOs, yield mining, and finally the point. The goal of this article is to explain why using points as a way to drive user engagement is a natural evolution from past engagement and fundraising methods. Many of Maelstrom’s portfolio companies are planning to launch tokens in 2024, and they can expect the Sexy Points program to entice people to use the protocol. So I want to talk about why Points exist and how they will drive adoption during this cycle.
Web 2 and Web 3
Cryptocurrency or not, the identity of shareholders/token holders and the promises they make are critical to the success of any commercial enterprise. I will specifically compare and contrast how Web 2 technology startups and Web 3 cryptocurrency startups approach funding and user acquisition.
Whether you’re starting a Web 2 or Web 3 startup, the most difficult and expensive aspect of your business is acquiring and retaining users. Web 2, which was most common between 2010 and 2020, involved venture capital funds finding startups with early momentum and then providing these startups with cash capital as accelerators to help the startups ramp up and gain enthusiastic users. This often means services that are free or much lower than their actual cost. Remember when ride-hailing apps were competing fiercely for market share and fares were incredibly cheap? All of this was paid for with billions of dollars in venture capital.
For venture capital firms, the end of the rainbow is a successful initial public offering (IPO). For the first time, an IPO allowed ordinary people to own a piece of a successful Web 2 company. An IPO is a way of selling stock to individual investors in traditional finance. In the public eye, various regulations prohibit crowdfunding for early-stage Web 2 companies. Ironically, many of the average people who create successful companies never own them.
More than 90% of new companies fail. Investing in early stage Web 2 companies is a recipe for losing all your money. Nonetheless, most investors consider themselves 3-sigma traders because they always seem to achieve average returns, but in terms of normal distributions. This means that regular users will always want to ensure their early involvement in a successful project, but will be upset when they inevitably lose money in many failure cases. At this point, ordinary people will blame the government. Because in our day and age, the average person thinks that government is something they live for. I don’t blame them for holding these beliefs. Politicians are trying to paint the picture that you can never go wrong in life if you support them. From the perspective of securities regulators, there is no benefit to allowing poor people to crowdfund early-stage companies. For every Facebook there are 1,000 MySpaces. Why do regular people get fired for spending their paychecks at crappy companies and losing opportunities for advancement? These poor companies are often purchased through the enticement of salespeople from companies with poor reputations.
This is a relatable reason why ordinary people do not allow collective investment in early stage companies. A more cynical explanation is that the gatekeepers of traditional finance make a lot of money from fees during the IPO process. Let’s list who gets paid during the IPO process.
- Investment banks that underwrite IPOs take between 2% and 7% of the capital raised.
- Attorneys earn hundreds of thousands, even millions, of dollars preparing and filing prospectuses and other offering documents. Working as a clerk has never been more lucrative.
- Auditing and accounting firms can earn hundreds of thousands of dollars per transaction by preparing audited financial reports. An improved version of Quickbooks!
Exchanges charge high listing fees. Anyone interested in trying Nasdaq Labs?
The aforementioned cartels love IPOs. Multiple successful IPOs a year can result in generous bonuses for anyone in traditional finance. However, without a zero group eager to buy but excluded from investing early at cheaper prices, there will be no buying pressure to make a successful IPO. That’s why retail participation should be saved for the end of the financing lifecycle, not the beginning.
These fees may seem excessive, but before the advent of Bitcoin, there was no efficient way to raise funds publicly. Objectively speaking, this process has given rise to many very important, useful, and profitable companies. It works. But now let’s stop being nostalgic and look forward to it.
From a user perspective, the main problem with the way Web 2 companies are formed is that using a product or service does not increase the assets of the company providing it. You won’t get the meta shares you see on Instagram. You also can’t share ByteDance by watching teens dancing like Cardi B on TikTok. These centralized companies capture your attention, your actions, and your money. That’s right. They provide a service or product that you enjoy, but nothing more. Even if you want to invest, you can’t do it unless you have a lot of money and are well-connected.
Participation ≠ Ownership
Bitcoin Paradigm Change
Bitcoin and the subsequent evolution of cryptocurrency capital markets have changed this. Since the Bitcoin Genesis block in 2009, it has been possible to reward participants with equity. This is what I call a Web 3 startup.
Before Bitcoin could be purchased on exchanges in 2010, the only way to obtain Bitcoin was through mining. Miners create and maintain the network by consuming electricity and validating transactions. For this activity, they are rewarded with newly minted Bitcoin.
Participation = Ownership
Now the participant or user has a stake in their participation. As with the East India Company example, once you participate, we will do our best to protect your investment. For the EIC, this meant turning a blind eye to war and famine in favor of profit. For Bitcoin, this means that Bitcoin owners want to convert as many people as possible into Bitcoin users. Look at my laser eyes, you idiot!
Initial Coin Offering (ICO)
Cryptocurrency capital markets quickly recognized how to provide crowdfunding to technology startups in a way that was not available to Web 2 startups. If Web 3 startups eschew fiat as payment for ownership or governance rights and only accept Bitcoin, they can bypass the entire legacy financial cartel that protects the dirty fiat financial system. To raise funds, the project launches a website announcing that if you give Bitcoin, you will be given a token that will do something or grant you economic rights in the future. If you believe in this team’s ability to realize the vision they preach, you can own part of an exciting new network in less than an hour.
The first major project to conduct an ICO was Ethereum in 2014. The Ethereum Foundation is pre-selling Ether, the powerhouse of virtual distributed computing, in exchange for Bitcoin. In 2015, Ether was distributed to buyers. This was a successful ICO and the foundation raised funds through a pre-sale of tokens, which were used to further develop the network.
The number of ICO transactions and the amount raised increased exponentially. The most successful ICO was conducted by Blockone, the creator of EOS. They ran an ICO for a year and raised $4 billion of Ethereum at the price at the time. EOS is a good example of the ICO craze. Because it was the most funded and completely crappy blockchain that barely worked.
As time went by, the project became more difficult, but the amount raised grew. That’s because, for the first time, anyone with an internet connection and cryptocurrency can own what’s being billed as the next big tech startup. Retail entered the game and made many of the crypto brethren very rich.
The ICO craze reached its peak in the fall of 2017, when Chinese regulators explicitly banned ICOs. Exchanges like Yunbi shut down overnight, and many projects that had raised funds from Chinese private investors returned their funds. Regulators around the world are working to protect competing cartels. ICOs are undoubtedly a step forward, but we can do better.
ICO investors contributed money and became active marketing agents for the project. However, selling tokens at a high price does not mean that anyone will actually use your product. Ownership is simply a function of money, not use of the protocol. ICOs are definitely a step forward, but we can do better.
liquidity mining
From a Northern Hemisphere perspective, the DeFi summer began in mid-2020. A series of projects launched deep into the 2018-2020 bear market are starting to be used in meaningful ways. Tokens from these projects have been listed since many of these projects conducted ICOs or token pre-sales followed by public token generation events (TGEs) in mid-2020. The project foundation allocates a large amount of tokens as rewards to community members who perform valuable activities.
Many of these projects focus on lending, lending, and trading, such as Uniswap, AAVE, and Compound. They want users to borrow, lend, or trade cryptocurrency assets using the protocol. In return, the protocol immediately issues freely tradable tokens. And so liquidity mining was born. Traders borrow, lend, and trade cryptocurrencies on these platforms, specifically to earn the protocol’s governance tokens. In many cases, traders lose money just to “mine” or gain more coins. Since the token price rises, traders appear to profit based on market value calculations. Of course, all of this assumes you sell for top price. Of course, many people do not and all this activity is in vain.
From a project perspective, all of these activities increase transaction volume, total value locked (TVL), and the number of unique wallets interacting with the protocol. This is an indicator that reassures investors that DeFi is creating a parallel financial system consisting solely of code running on decentralized virtual machines.
Participation = Ownership
That’s all good, except that the supply of unlocked tokens is growing very quickly for many projects. Inevitably, projects will have to slow emissions and markets will begin to ask, “What’s next?” If all activity is based on an aggressive token emission schedule, what happens if the token price falls or there are no more tokens available for potential users? What happens if the project token price plummets with activity?
The lesson we learned is that while yield mining is a good way to encourage usage, it can be problematic if pursued too aggressively. The question then becomes how to issue tokens in a more sustainable way.
complete
As the cryptocurrency bull market ends in 2021, yield mining as a user acquisition tool is disappearing. However, the current bull market cycle has seen the rise of Points, which has become a pseudo-ICO fundraising and user acquisition tool for projects.
Point combines the best aspects of ICOs and liquidity mining.
ICO
- Allowing millions of retail cryptocurrency holders to purchase pieces of the new protocol.
- But when you sell goods to retailers, some regulators call them “collateralizing” them and require them to do a lot of things they don’t want to do – namely, stop selling goods to poor people.
liquidity mining
- Issue tokens to users using the protocol.
- However, pushing too aggressively can cause the limited token supply to become inflated too quickly, and if the token price falls, users will no longer have any incentive to use the protocol.
What if a project gave you points for interacting with the protocol, and those points were later converted to tokens and then airdropped to the user’s wallet for free?
What if the point price for airdrop tokens was completely opaque and left to the sole discretion of the project?
What happens if there is no actual promise that the points will be converted to airdrop tokens in the future?
Let me explain with a simple example. Let’s say Sam Bankman-Fried (SBF) is offered a points system by his roommate. His roommate had access to an unlimited supply of Emsam, an amphetamine that SBF claims is needed to treat ADHD symptoms. His roommate really loved the back massage. He reached an agreement with SBF. For every back massage SBF gives, his roommate will give him points. Points can be converted into a specific quantity of Emsam pills at a future date chosen by the roommate. SBF needed the drug so badly that she was willing to trade a hefty massage for the vague promise of future Emsam pills.
Are points a contract between the project and the user for tangible rewards in the future? no.
Will any form of fiat, cryptocurrency or other currency be exchanged for points or tokens between users and the project at any time? no.
Does the project have full flexibility in terms of points-token conversion price and timing of token airdrops (if any)? yes.
Let’s make some additional assumptions and observations. If you have a small and talented engineering team, you don’t need many other employees. That’s the beauty of software. Network security is handled at the first level by the blockchain itself. Users pay gas with native tokens, a portion of which is used to pay validators or miners to secure the network. Do you need an in-house lawyer? If your project is truly decentralized, this may not be the case. And, after the foundation is created, is there any other important work that expensive lawyers need to do? The biggest question is how to get more users, your marketing and business development efforts. Assuming you build good technology, all the money will go into getting users to use it.
It’s entirely possible to build an amazing project without a lot of venture capital funding. Where a project needs money is to acquire users. Points are a new and exciting way to guerrilla market.
Using points ensures that projects are not locked into overly aggressive token issuance plans. This is because the ratio of points and tokens can change at any time. There is no contract stipulating that a project must match a specific points-to-token ratio.
Through points, projects generate usage in specific ways that they believe will increase the long-term value of the services they provide. Many of the most influential cryptocurrency projects are some type of two-sided market. Points help you kickstart your network activity and overcome the cold start or chicken and egg problem. Being able to surgically and dynamically calibrate point emissions for specific tasks within a project’s ecosystem means that it can be very efficient at generating the exact type of user interaction that a project expects.
Lastly, with Points, projects do not have to rely heavily on signing token pre-sale agreements with VCs and other high net worth investors. The main point of venture capital is to pay for user acquisition, and points can do this. The best part is that projects can implicitly sell tokens through an opaque points program at a higher price than in transparent pricing rounds.
Points are great for projects, but what about retail users?
Since ICOs haven’t caught on, retailers have to be extremely vigilant about venture capital unlock timelines. If retail is flooded with tokens when the venture capital portion is unlocked, then the portfolio of retail is REDRUM REDRUM REDRUM. Using points eliminates the need for projects to conduct large-scale pre-sale token sales. Points allow retailers to “invest” at an early stage and hopefully get cheaper prices than if they waited until after TGE. Although there is ambiguity surrounding airdrop timing and points-to-token ratios, points may represent a fairer way to reward user participation.
Points programs only work if there is a high level of trust between users and project founders. Users trust that after interacting with the protocol, their points will be converted to tokens at a reasonable price and within a reasonable time. As loyalty programs proliferate, there will be malicious actors who abuse this trust. Ultimately, a serious breach of trust involving large sums of money could kill Point as a fundraising and user engagement tool. But we’re not there yet, so I’m not worried.
all aboard
Like it or not, every successful project, i.e. a successful token price increase, will implement a points program before TGE. This will drive usage of the protocol and generate hype for a possible token airdrop and subsequent public listing.
I am a businessman, not a pastor. The only credo I follow is “The numbers go up!”
If points improve consistency between users and protocols, I’m all for it.
If this further weakens the cartel’s control over the financing of emerging innovative technology startups, I’m all for it, as points are seen as a better mechanism for user engagement and fundraising.
We hope this article provides some context on what Points are and why we believe they will drive the best-performing coin issuances this cycle. Maelstrom has baggage, and he’s not ashamed to tell his readers. Stay tuned for more articles about exciting projects in our portfolio as we launch a points system soon. My body is ready, what about yours?