Decentralization cannot be done in one step, A16z talks about three factors for the success of cryptocurrency projects

Written in front: This article was published on a well-known investment agency A16z's blog. The author defines the three elements of a cryptocurrency project's success and believes that the project team should implement these three elements in a certain order to achieve decentralization of the project. Not in one step.

Cryptocurrency company founders face a unique challenge. In addition to building the product people want, they need to think about how to successfully run the product in a decentralized way–that is, to become a protocol held and operated by the user community.


This is a daunting challenge because many of the things needed to build a successful product from the start-product leadership, rapid iteration, and a well-managed marketing strategy-complicate the path to community ownership and compliance And this guarantees long-term health.

I have talked to some founders who worked to clarify this relationship. Here, I will propose a three-step process, through progressive decentralization, as a guide to achieve this goal-in the process, the founding team will gradually give up control. Following this step will allow the team to focus and create a path to compliance, including issuing tokens that will not violate securities regulations.

Keep in mind that this process is designed for specific cryptocurrency startups that build applications on smart contract platforms. It is less useful for blockchain computing platforms, because these platforms need to be fully decentralized from the beginning to be useful.

Given that the regulatory framework surrounding the community-held network is still uncertain, the final part of this article only points to potential solutions, rather than identifying strategies that have proven effective, but only a possible path.

Three elements of cryptocurrency success

First, I assume that a successful application running on a blockchain computer has the following three elements:

Product / market match

Community participation

3. Enough decentralization (community-owned)

The need for product / market matching is obvious. Without the product people want, there will be no users, no business, and it will be difficult for the community to maintain it for a long time. Community participation and decentralized control are not very applicable to traditional startups, but they are crucial for crypto startups. Why is it so important?

The answer is that community participation and control limit platform risk—the risk that the rules of the platform will change against the wishes of its users. The Web 2.0 platform has proven the potential for such inconsistencies, for example, by strangulating an innovative application ecosystem based on its APIs, or by sacrifice user privacy or well-being. In contrast, user-owned networks can benefit from a cooperative economic model that helps ensure that cryptocurrency services are better aligned with users, even as they scale up.

Another important reason to achieve decentralized community control is compliance. According to the SEC's Howey test, cryptocurrencies that drive economic adjustment can be considered securities. For start-ups, allocating securities to users in large communities can be challenging and costly to manage-even Airbnb and Uber haven't figured out what to do. However, recent SEC comments and enforcement actions indicate that as long as a team's operations are sufficiently decentralized, information asymmetry is resolved, or the founding team is relied on to create value, the company's token can change from securities to non- Securities. A key aspect of whether an investment can be considered a security is whether the investor relies on the efforts of others and expects a profit.

As Andreessen Horowitz (A16z) managing partner Scott Kupor puts it:

"Before the network goes live, tokens are often described as a security because they are 'dependent on the efforts of others'. However, once the network is launched-as long as it is sufficiently decentralized-the nature of the token can change from securities to Non-securities because holders no longer rely on the efforts of others. "

Therefore, considering these decentralized factors, let's take a look at the specific processing framework, whose goal is to build a sustainable, compliant, community-owned product.

Goal 1: Product / Market Matching

The initial stage of building a cryptocurrency application requires all the elements of a typical startup: an excellent team, lean development, rigorous execution, and fast learning. At this stage, the only thing that matters is the degree of product / market fit. In order to find this match quickly, it is important to avoid design by the committee (or community). A product requires stubborn leadership to test and quickly update assumptions. In practice, this could mean administrative privileges for smart contracts, allowing for rapid iterations and product management, including upgrades, shutdowns, or quick parameter settings.

At this stage, you shouldn't pretend to be decentralized-in order to find product / market fit, a core team must drive all product decisions. It is not advisable to list tokens at this stage, as this may affect compliance. In the Howey test, tokens that rely on the core team may be considered securities, and thinking about it all the time distracts product development.

Controlling all aspects of the project by the core team may anger some early users, but founders should not be vigilant about this. If users complain about your desire to control, this is actually a good question! It means someone cares about what you do. Nevertheless, it is important to clearly communicate what you are controlling. Pretending autonomy is a shortcut to trust, and openness is a shortcut to trust.

Goal 2: Community involvement

Early signs of product appeal are a growing user base, developer ecosystem, and network effects-at this time more steps should be taken to promote harmony between passive users, more active contributors, and core teams .

First, the founder may increase investment in best practices to run the product like an open source project: invest in good documentation; open research and development; provide bonuses, subsidies, or other rewards for third-party development; hire community leaders to assist in managing open development; And introduce a rough consensus of the decision.

It may make sense to eliminate platform risks through technical constraints. For example, in Compound v2.2, the upgrade takes effect 48 hours after it is made public, giving users time to withdraw from the agreement, or review and express dissent. Urbit uses "Kelvin version control", that is, the version number counts down to 0, and no updates are made at this time.

For the core team, giving up control means having the opportunity to start transferring responsibility to the community. But when you start reaching out to community members, it's important to rethink incentives. Why should community members continue to contribute to the product?

Incentives (expenses)

Economic incentives are a way to drive community contributions. But where do economic incentives come from? A practical and familiar business model for cryptocurrency services is call-based charging, similar to API microservices (such as Twilio or Stripe). Allocating this cost stream to active contributors enables the community to consistently pursue project success.

That said, costs are not always meaningful at the beginning of a project. Considering that cryptocurrency services are open source, it is best to introduce a charging mechanism only when strong network effects occur, so as to improve defense capabilities through conversion costs.

Uniswap is a decentralized exchange and is an example of the use of network effects to protect paid password applications. In Uniswap, the more users who provide liquidity to a trading pair, the better the trader will be priced. In order to provide the same pricing in a no-forking fork, all liquidity providers and third-party services that access the original version need to be coordinated to start using the spread. The cost due to coordination is the conversion cost. Although this conversion cost is lower in an open data encryption environment, it still exists. However, in the cryptocurrency world, protocols must remain minimally extractive (in other words, they need to cover the associated costs, rather than seeking maximum profit) to motivate the community's contribution.

Distribution (tokens)

Tokens are a tool to effectively distribute the basic value of a project, including the cost stream. Although token distribution can stimulate participation and help build defensiveness, it is important to consider how to build a fair and effective distribution model.

Many ICOs and airdrops are not the best choices because their community participation is not high and it is easy to cause regulatory review. Crypto applications focused on product / market matching have the opportunity to do better by distributing tokens to already active user groups.

First, the team can select a group of community members to test the token distribution. Many teams have chosen to do this by allocating a portion of future tokens to early contributors, for example, through a testnet, independent community members can register and become nodes. A well-defined and managed token distribution model can help eliminate the community's dependence on the work of the founding team.

Next, the team needs to plan how to distribute the remaining tokens to the participants, both fairly based on past contributions and effectively distributed to future participants. Assignment design needs to consider the core team that builds the product and the users who make it useful. This is difficult and always limited to a specific application, but some common issues to consider are:

  • What percentage of tokens should be allocated to the initial team and shareholders?
  • How will you reward different types of product or service contributors in the past and future?
  • How will future technology leadership pay off?

To answer these questions requires an analysis of community behavior, a model of reasonable outcomes, and discussions with community members on possible solutions.

Goal 3: Sufficient decentralization

If you are the founder of a cryptocurrency and are ready for this stage, it means that you have achieved early product / market matching, built a strong community, can successfully maintain applications, and have developed A model that is reasonably motivated and sustainable.

Now is the last step to achieve decentralization: a wide range of token distribution.

In practice, I think the team will “drop the community” by airdropping tokens to users and contributors based on previously set goals. This will be initiated when a smart contract is issued and a token is distributed. Ideally, many things will happen once this function is triggered:

  • The core team will relinquish most of the application's ownership (expenses and controls) and ensure that the product is owned and operated by the community, thereby reducing platform risk.
  • Considering that the service is sufficiently decentralized, that is, independent of a single entity that may cause information asymmetry, the token may have been converted into non-securities.
  • The company is sustainable, retaining enough tokens to benefit from fees and development.
  • The user owner realizes a proportionally increasing return because the cooperative economy of the service allows for consistency of goals and growth in value (defined by the user rather than the shareholder).

This goal marks a particular moment when a cryptocurrency product company completes its journey from a traditional product team to a sustainable community holding and operating network. (Detailed legal review is required for token distribution. The situation I described has almost no precedent, so please consult a lawyer first!)

How to avoid getting stuck

Many teams are in trouble because they deal with these goals in the wrong order, "pretend" to be decentralized, or try to do everything at once.

For example, an app team pursuing community ownership first (starting with a wide range of token distributions) may generate a community of speculators rather than real users. Without a product available, ownership is worthless and the community will not last long. Many teams doing this cannot readjust to the product / market, so it is difficult to have meaningful community involvement.

Another risk is to jump directly from the early stages of product / market matching to decentralized community ownership (Goal 2 skipped, community involvement). Without real community involvement, the project would fall into a decentralized valley of terror. A symptom of being trapped here is the indifferent community, the low participation rate, and the heavy dependence on the founding team. In this case, formalizing control (for example, through authorization) may be a better way to build trust, and using decentralization as an excuse to cover up any fact is a shortcut to breaking trust.

Another way to get into trouble is to do all three things at the same time. Lack of attention is fundamental to the failure of most startups, and so is crypto applications. Each of these goals is overlapping and needs to be considered as a whole, but execution needs to be sequential and prioritized, rather than trying all at once.

Finally, it is worth noting that even if these steps are performed sequentially, once you switch to full community ownership, you are still in a rather unknown area in terms of managing applications. Expanding effective community decisions is challenging, but if the Internet community can accomplish feats like Wikipedia, I'm optimistic that experiments and risky investments (through valuable ownership) can lead to unprecedented collaborative decision-making.

So far, we haven't seen crypto applications executing every goal in order, but the most promising project team I have come across has found a way. Through relevant conversations, I began to believe that progressive decentralization provided the team with the most favorable path for them to find product / market fit, financial sustainability, community engagement, and compliance.