How to legally structure token issuance/distribution?

This article outlines different models of token distribution and how to legally structure them.

Token distribution is essential for every web3 startup hoping to raise funds with investments in their tokens. An Initial Coin Offering (ICO) is often used to create and distribute tokens to the general public. Each ICO organizer must structure token issuance with models that divide the token supply among different stakeholders, including investors, the community, the ecosystem, the team, and other players. However, there are other models for token distribution other than ICO. In any case, web3 founders need to be aware of laws and regulations around each structure of token issuance. Issuing structured tokens without authorization or with inaccurate registration might result in fines, legal action, and the need to reimburse token buyers for their money. This article outlines different models of token distribution and how to legally structure them.

Token distribution

Tokenomics study includes token distribution as a key component. It details the percentages in which various users and investment groups possess various crypto tokens. Token distribution could be viewed as a pie chart, with each piece signifying a particular group’s project ownership. Such a pie chart must be made by each issuing company to show how the token supply is distributed among groups of token owners. Let us understand how issuing enterprises can structure token issuance in their token distribution strategy.

What are crypto tokens?

A crypto token is a virtual currency token or a cryptocurrency denomination. It signifies a utility or tradable asset that exists on its own blockchain and enables the holder to employ it for financial or commercial reasons. The units of value established by blockchain-based companies or projects on the current blockchain networks are known as tokens, sometimes known as crypto tokens.

Tokens are completely distinct in the crypto assets category, even though these crypto assets usually have substantial interoperability with the network’s cryptocurrencies. Tokens are created by systems that are built on top of a specific blockchain network, while cryptocurrencies are that network’s native crypto assets. For instance, the Ethereum blockchain uses the token Ether (ETH). Despite being the native coin of the Ethereum blockchain, ETH is also used by a wide variety of other tokens.

How do these tokens work?

Let’s consider a blockchain used to store information for employee data to understand how the tokens work:

  • You can have a cryptocurrency token that stands in for a certain amount of employee performance points.
  • Another cryptocurrency token can be made available to the employees to finish a certain level of task on a blockchain that can earn additional perks and rewards.
  • Another cryptocurrency token can be a reward that stands in as digital currencies, for example, a crypto token earned by an employee could be worth half a bitcoin on a certain blockchain. These digital coins may be traded and transferred between different users of the blockchain.

Remember, while crypto coins can purchase goods and services, a crypto token can serve for other things too, such as an asset or a reserve of value, among other functions.

Crypto refers to the different public-private key pairs, elliptical curve encryption, and hashing methods and cryptographic approaches that protect these entries. On the other hand, cryptocurrencies are digital payment systems that use virtual tokens as their unit of currency and enable safe online transactions. The system’s internal ledger entries serve as these tokens’ representations.

These crypto assets are often used as the basis for transactions on blockchains built using widely accepted templates, such as the Ethereum network, which enables the creation of tokens. Such blockchains operate on the principle of smart contracts or decentralized apps, where the numerous transactions that take place on the blockchain are processed and managed using programmable, self-executing code.

What is token distribution?

Token issuance and distribution to users inside a blockchain network are referred to as token distribution. Token issuance to new investors in return for money is usually done during an Initial Coin Offering (ICO). This is when token distribution normally takes place. Token distribution is even done through mining and an Airdrop. Tokens are given to participants in mining who provide the network resources, including processing power. In a crypto-airdrop, Startups distribute tokens to active cryptocurrency traders for nothing or in return for little to no promotional activity as a marketing tactic.

Importance of token distribution

A crucial step in the token sale process, which involves token issuance and offering them to investors, is token distribution. Token distribution aims to generate funding for a project’s development. This entails that tokens are often made available for purchase at a discount or with an added benefit in order to encourage investors and early adopters to acquire them.

Legally Structured Token Distribution

Once the Web3 founders determine the function of tokens, they have to consider organizing the structure of token issuance to the investors. It is crucial to stay away from scenarios where the supply of tokens surpasses the demand. This will cause the token’s worth to decrease and its price to drop right away. To avoid this, token issuance is broken into phases with a progressive distribution of tokens.

Each token distribution scheme needs legal approval. Unauthorized or incorrectly registered structure token issuance leads to penalties from authorities, litigation, and repay payments to token purchasers. Web3 founders must conduct legal research for each token distribution scheme in the Token Cap Table to avoid the likelihood of these effects. Founders must also secure governmental approvals and execute verification methods for their token distribution strategy.

Types of token distribution models

There are two types of token distribution models: paid and free of charge. Founders must pay careful attention to the paid token, and token issuance strategies. In many jurisdictions, paid token distribution strategies need compliance with particular legislative standards as well as the usage of certain legal instruments throughout the token distribution process. Let us look at each model of token distribution in detail:

  • Token airdrops – Token airdrops are promotional campaigns and an example of a free token issuance strategy in the community pool. It aims to promote the Web3 project. Active members of the Web3 community are provided with the chance to complete many tasks (i.e., promote the project on social networks, make a video tutorial, translate a White Paper into regional languages, uncover a flaw in the system, etc.) in exchange for tokens. Token airdrop initiatives provide tokens for free. As a result, they are subject to fewer legal constraints than paid distribution, although Web3 creators must offer explicit Terms & Conditions for the campaign and publish them on the website.
  • Token launchpad – For Web3 projects that use tokens, the token issuance done through a launchpad or a Public Token Sale are both different types of crowdfunding. Crowdfunding is organized by a third party when token sales are done through a launchpad. Usually, this is a cryptocurrency exchange, which is where launchpads are usually run. However, in a Public Token Sale, the project itself is in charge of the crowdfunding campaign. The project will need to go through onboarding for a token posting on the launchpad in order to participate in a launchpad token sale, which includes delivering a Token Legal Opinion. In addition to managing the PR and marketing efforts for the sale of tokens, the designated cryptocurrency exchange will also handle the full KYC process for token purchasers on the launchpad.
  • SAFT or private token sale – When tokens haven’t yet been distributed, and the Token Cap Table isn’t established, Web3 projects often employ Simple Agreement for Future Tokens or SAFT as a token distribution model for fundraising. The SAFT often reflects the relative quantity of the investor’s token allocation since entrepreneurs at this point only have a cursory comprehension of the Token Cap Table (in percentages). A Token Sale Agreement must be utilized when tokens have previously been issued, and further token allocation from the investor pool is intended. The creators must carry out a thorough investor verification for both SAFT and Token Sale situations in order to comply with Anti-Money Laundering (AML) regulations.
  • Token incentive scheme – Founders often designate a special token pool for the team and advisers in order to inspire and motivate the Web3 project team. Token issuance is carried out by implementing a Token Option Agreement. The agreement specifies the token vesting or a schedule of the accumulation of tokens and the metrics that the team must meet or the time period within which the employees must work to get these tokens vested. To prevent token supply and demand mismatches when the workers’ tokens become accessible and they seek to sell tokens on exchanges, a token lockup is often offered for a certain amount of time once token vesting is complete.
  • Token Distribution for ICO/TGE – The following legal work must be completed if the Web3 project’s founders separately conduct a public token sale, also known as a token generation event (TGE) or initial coin offering (ICO):
    • Examine and follow any legal restrictions that the country issuing firm is registered may have for the public token sale.
    • Implement KYC and AML or other verification processes for token purchases and a token legal opinion to avoid securities and stock market legislation.
    • Founders must present a legal review of PR and marketing activities. These PR efforts encourage token crowdfunding. Thus a careful legal examination is needed to verify that public invitations to acquire tokens and promises to earn profits through tokens don’t really violate financial market regulations.

ICO token distribution structure

Below are a few of the token issuance structures that have been used that can be introduced in your strategy:

  • Capped auction – On the issued tokens, bidders specify their desired price and overall spending. In accordance with each buyer’s committed total spending, a variable amount of tokens can be sold at the lowest successful bids. This framework may be either a blind or a dutch auction. The overall amount that can be raised is capped, and based on how many tokens are sold during the sale, insiders get a varied portion of the total token supply.
  • Uncapped auction – Buyers place a bid with their preferred price and number of tokens in this structure. Until all of the tokens are sold, a certain number of them are sold in decreasing price order to the highest bidders. The amount that can be raised is unrestricted, and insiders get a set portion of the overall token supply.
  • Capped first come first serve – To date, this has been the token sale structure that is most often employed. To entice early participation, certain promotions provide a discount for a brief time. First-come, first-served sales of a given number of tokens at a specified price continue until all tokens have been sold. The sum that may be raised is limited, and it is stated as a limit on the number of tokens that can be sold. A predetermined portion of the total token issued is distributed to insiders, including the investors, development team, and foundation.
  • Uncapped – In this structure, a limitless number of tokens are sold for a set price over a protracted period of time. Any buyer may purchase an unlimited number of tokens. The total amount raised does not have a cap. A certain portion of the overall token supply is given to insiders.
  • Capped with redistribution – This system ensures that everyone can engage in token issuance in some way. A known quantity of tokens is sold at a predetermined price, in proportion to each buyer’s promised total expenditure, after buyers place a bid for the total amount they want to spend. Buyers’ extra payments are reimbursed in this. The sum that may be raised is limited, and it is stated as a limit on the number of tokens that can be sold. As a result, purchasers will get fewer tokens than they anticipated and a partial refund if the auction is oversubscribed. A certain portion of the overall token supply is given to insiders.
  • Capped with parcel limit – If this strategy is successful, it could encourage a more fair token issuance, reducing accumulation in the clutches of “whales” while also offering a set amount of tokens with a capped rise. A known quantity of tokens is sold at a predetermined price on the basis of whoever claims it first up until all tokens are sold capped with a parcel limit structure. The total quantity that one customer can purchase is restricted. A limit on the value of each incoming transaction might be used to accomplish this, as well as restrictions on a buyer’s ability to make numerous transactions. The sum that may be raised is limited, and it is stated as a limit on the number of tokens that can be sold. A certain portion of the overall token supply is reserved for insiders.

Important considerations for distributing tokens

The amount of money you raise and your appeal to prospective investors depend on your token issuance structure. So, consider the following while you structure the token issuance for your web3 project.

Important considerations for distributing tokens

  • Set price – Your token pricing should reflect your project’s worth. You can demand more if your enterprise is more valuable. Setting a token price affects how you are able to raise it. If you overprice your tokens, you may not sell them altogether. If you underprice your tokens, you may sell more than you’ve got.
  • Set hard cap – Create a hard cap for your token sale so it becomes the most money you’ll raise in your token sale. Setting a hard cap prevents you from overselling tokens and generating more money than needed. Setting a hard cap can reassure investors of your project. They’ll be more willing to invest if they realize you won’t raise a limitless quantity.
  • Decide how many tokens to sell – After setting a hard cap, select how many tokens to sell. You must not sell more tokens than you currently have. The number of tokens you sell will affect their price. Too many tokens sold will lower the price, and lesser tokens will raise the price.
  • Create a vesting schedule – Creating a vesting schedule for your team can help assure project success. Vesting schedules indicate when team members can sell tokens. Create a vesting plan that enables employees to sell tokens after 6 months or a year. This ensures that your teammates are dedicated to the project and can’t sell tokens right after the launch.
  • Comply with blockchain – Ensure your token is blockchain-compliant. You do not want the blockchain to invalidate your token due to compliance issues. If this happens, your token sale will fail, and you’ll need to reimburse all the investment.

Why choose Eqvista for your token valuation?

Determining the right price for your token and offering them to the investors will require a thorough token valuation. The valuation of crypto assets is difficult since they are a novel concept facing many difficulties due to legalities. To determine the economic worth of any crypto asset, you can use business valuation to estimate the value. Eqvista’s highly qualified valuation specialists can help you determine the worth of your tokens. For more information about our valuation services, get in touch with us today.

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