How Do Token Crowdsales Work?
Leon Di, Product Marketing @ WeTrust
Blockchain projects release their cryptocurrency to the general public via a crowdfunding event. People who wish to use or donate to support a new cryptocoin participate in the crowdfund by sending Bitcoins to the project’s address. At the end of the crowdfund period, each participant receives cryptocoins corresponding to how much Bitcoin they donated. The more Bitcoin that is raised during a crowdfund, the more valuable each token will be. After the crowdfund ends, the tokens might be tradable on various exchanges such as Poloniex and Bittrex, where its value is determined by supply and demand.
The vast majority of cryptocoins available as part of a crowdfund are distributed to the public, but a certain amount (often 10% to 20%) is kept by the project team. Those tokens are later sold to provide funds for investing in the future growth of the project, paying team members for their development efforts, and for further promoting the project. In the simplest example, let’s say a project launches a crowdfund with 50 million cryptocoins, or “tokens”. The project team decides to keep 20% of the total, or 10 million tokens, to fund their future efforts — leaving 40 million tokens to be distributed in the crowdfund. After a 6 week crowdfund, the project has managed to raise $20 million in Bitcoin, giving each token a value of ($20 million / 40 million tokens) = $0.50 per token. Let’s say a participant contributed $1000 to the crowdfund — that participant now has ($1000 / $0.50 per token) = 2,000 tokens. That participant can then use those tokens on the project’s network, or sell those tokens to buyers on a cryptocurrency exchange. Meanwhile, the project team has (10 million tokens * $0.50 per token) = $5 million in tokens which they can use for bounties, or sell at a future date to raise additional funds to further develop the project.
Beyond these basics, there are a few more interesting parameters that define a crowdfund. These are the concepts of a cap, floor, team vesting period, escrow, timed bonuses, and bounties. Caps, floors, vesting periods, and escrows are meant to protect crowdfund participants from unscrupulous projects trying to scam them of their hard-earned Bitcoin, while bonuses and bounties are meant to reward participants who show particular enthusiasm for a project. These crowdfund features are explained in detail below.
Cap
Though it is in the project team’s best interest to raise as much as possible through a crowdfund, attracting too many Bitcoins can hurt the early crowdfund participants by making each token too expensive and less accessible for future users. As a result, when the tokens are traded on cryptocurrency exchanges, there may be less demand for an expensive token. In this case, the initial excessive demand may be seen negatively to participants of the crowdfund.
To prevent against this, some projects institute a cap on the funds raised during a crowdfund. The cap acts to limit both the amount of Bitcoin the project collects as well as the value of each token. As an example, let’s go back to the example from above involving 50 million tokens with 10 million reserved for the project team, except this time, the project team decides to institute a $8 million cap on the project. That means that after the project raises $8 million in Bitcoin, any further funds will not be accepted. In this case, assuming the project manages to hit their $8 million target cap, each token will be worth ($8 million / 40 million tokens) = $0.20 per token.
This lower valued token makes it more accessible and therefore, likely that there will additional demand for the token when exchanges add it to their platform.
Floor
Just like raising too many Bitcoins in a crowdfund can hurt early participants, raising too little can also be detrimental to the project. If a project receives very little in funding during a crowdfund, it means that there is little public interest or confidence. It is a strong indication that the project will struggle going forward, and that as a result, the project’s tokens will be of little use or value. In this case, the early participants may end up with tokens that may have no use due to inability of the team to build out the application with the funds raised.
A floor is put in effect to protect early participants and ensure that the project has sufficient funds to build out their vision. It defines a minimum value that the crowdfund must be able to raise for the project to go on, similar to the minimum thresholds in kickstarter. Oftentimes, if the crowdfund cannot raise an amount equal to or greater than the pre-set floor, the project team will return the Bitcoins that have been contributed back to the early participants.
Team Vesting Schedule
The members of a project team are compensated for their efforts by receiving a share of the tokens, helping to keep their interests aligned with that of the early participants and users. The more a token is used, the more valuable it becomes — so it’s in each project team member’s best interest to create a successful project that has many users, increasing the value of their tokens in the process. A vesting schedule is used to help keep the team members focused on delivering a great project after the crowdfund occurs. Instead of receiving a full share of their tokens after the crowdfund, the team members receive tokens after regularly scheduled vesting periods determined by the project founders. This way, a lone unscrupulous team member can’t run off with tokens without continuing to contribute to the project.
Escrow
The team vesting schedule is an effective way for founders to make sure team members remain committed, but what guarantees the founders themselves will continue to responsibly steer the project forward? In order to keep the founders from straying, the Bitcoins raised during the crowdfund can be placed into a multi-sig wallet that includes a trustworthy third party. The founders present the third party with project goals that they will accomplish in order to release the funds. For many cryptocurrency projects, escrow third parties are founders of other successful blockchain projects, prominent businessmen, or other respected individuals in the community.
Timed Bonuses
During the early stages of a crowdfund, participants may be unsure of whether to contribute Bitcoins. They may adopt a “wait and see” attitude, holding back on participating in the crowdfund until they see others contributing to the project. To encourage participants to “make the leap” and contribute to a crowdfund early on, a project team may choose to reward the earliest participants with additional tokens. These additional tokens usually take the form of a percentage “discount” on the crowdfund. The earlier the participant donates to the project, the greater the discount they receive. For example, a six week crowdfund may offer a 25% discount on all contributions during the first week, a 10% discount on all contributions during the second week, and no discounts on all contributions after that. At the end of the crowdfund, this discount is reflected in the additional tokens received by the “early early participant.”
Alternative methods for pricing tokens such that participants are not compelled to purchase earlier are also being explored by projects such as Gnosis, and more can be read about their unique and innovative dutch auction method here.
Bounties
As talented as most blockchain project teams are, there are times when they could use a bit of help. Bounties are tokens which are awarded freely as “prizes” to early crowdfund participants who help the project in some way. For example, a project team may offer a 1000 token bounty to someone who helps them translate their project whitepaper from English into a different language. One of the most popular bounties rewards users of the popular Bitcointalk forum: members of the forum who place an advertisement for an ongoing crowdfund onto their user “signature” receive a bounty for their help publicizing the project. Other bounties take the form of contests related to the blockchain project, with the winner of the contest receiving tokens as a prize.
Note: This article explains general concepts related to token crowdsales, should not constitute or substitute for legal advice, and does not necessarily represent the views or plans of the WeTrust project.
Token crowdfunds are an exciting way to get involved with innovative new blockchain projects. To learn more about our blockchain project which leverages social capital and trust networks to improve financial inclusion and provide banking and insurance to the un-banked/under-banked. Check out https://www.wetrust.io or follow the WeTrust blog!
