Web3 Public Legal Education | Why is it best for blockchain startups to not issue tokens?

Web3 Public Legal Education Why Blockchain Startups Should Avoid Issuing Tokens

In the past two weeks, I had a conversation with an entrepreneur who does financial audits for crypto funds. The topic turned to the differences between blockchain startups and traditional internet startups.

In my opinion: if traditional internet startups are playing with fire, then blockchain startups are definitely playing with 9.9 fires out of 10.

Why do I have this opinion? Doesn’t blockchain represent advanced productive forces and relations of production?

Friends familiar with Lawyer Honglin know that I personally highly value blockchain technology and I am a Bitcoin enthusiast. But this doesn’t stop me from seeing the problems in the current blockchain startup industry: projects that utilize blockchain technology and user incentive thinking are easy to succeed, but projects that issue coins, especially those listed on exchanges, are more likely to fail.

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Based on my past experience in internet startups and my observations of the current blockchain industry, projects that issue coins seem to have added a booster, making success or failure happen even faster.

01. Creating Trouble by Issuing Coins, Digging One’s Own Hole

Around the end of 2018, during the cold winter, I spent several days in Beijing attending a course on token economics design organized by Meng Yan. Originally, I was hoping to learn this skill so that I could better convince investors when I returned to Shanghai.

After completing the course, my biggest takeaway was that blockchain startups are definitely not something that a startup team can handle.

Because of token design, in the broader sense, this involves the formulation of macroeconomic policies such as monetary economics (although in a mini-version), and in the narrower sense, you also face various microeconomic incentive designs for user behavior within the ecosystem. These are troubles that traditional internet entrepreneurs don’t even need to worry about.

Traditional internet entrepreneurs only need to focus on user demand, product development, market promotion, revenue growth, etc. For blockchain entrepreneurs, in the early stage of startup, they face a “economic model” design pit.

You could say that the existence of tokens theoretically reduces user acquisition costs or increases the efficiency of market promotion, but the reality that slaps you in the face is that many users attracted through token means are often not really the target customers, but just there to take advantage of the system.

I have seen many blockchain entrepreneurs, after completing the product and business model of their traditional Web2 projects, go outside to find service providers to design their own economic models. Although the final whitepaper design they deliver may be the work of a fresh graduate intern that you’ve paid a hefty price for.

Of course, this is only possible if you have a sufficient budget. For friends who don’t have much budget in this area, it may be like copying and adjusting the parameters of a competitor’s website’s “Terms of Service” and “Privacy Policy.” After all, besides those academic observers in the industry, nobody really reads the project’s whitepaper seriously, let alone those incomprehensible economic models.

So it’s not surprising to see coin projects that go online but quickly fall into a death spiral. From a mathematical perspective, it is an absolute probability event for entrepreneurs who have launched coins and are listed on exchanges to experience project collapse. It doesn’t matter much whether the team has a good product or how quickly they can attract new users.

But when the collapse happens, it depends not only on luck but also on the endurance of the project team. For example, how long can the project narrative be sustained? Either the entrepreneur quickly brings in a new financing party to take over, or the project team aggressively manages the market value in the secondary market.

Listing is not the goal, it is a major milestone event, just like issuing coins. However, for entrepreneurs who are traditionally listed, they have at least gone through several years of training before listing and have gained some experience both mentally and physically. This is not necessarily the case for the project teams that issue coins.

Why do coin projects worry about managing the secondary market? On the surface, it is to create liquidity, but the truth is that if the secondary market experiences massive sell-offs and the project team does nothing, the project could collapse in minutes. And this awkward situation often arises because of the project team’s own fault – yes, those investors who were attracted by the project team’s initial coin offerings (ICOs).

Friends familiar with the operation logic of cryptographic funds know that as fund managers, they make money from two main sources.

The first is the management fee, which covers the fund’s daily expenses. To make a substantial profit, they rely on the returns from projects after they exit. Therefore, for fund managers, unless 99% of the money in a fund is their own, they will not be emotionally attached to it. The reason they are willing to invest in a fledgling project like yours, even at the risk of losing their pants, can be summarized in one word: the hope of making money quickly and leaving. After all, it’s only when they have the money in their hands that they can distribute bonuses.

For entrepreneurs who raise tokens, they may find it relatively easy to raise funds, but from the perspective of cryptographic fund investors, which fund manager would hear that a project can exit in just 9 months and not be confused?

By applying the short-term investment strategy of the secondary market to the traditional primary market, successful entrepreneurs who are listed on exchanges may find their happiness on the day of listing, but then they face the frenzy of selling by investors during the unlocking period. If the token price drops even slightly, uninformed retail investors will naturally follow suit. Thus, the death spiral gradually forms, and the growth flywheel of a project towards failure begins to spin.

How can we avoid the rapid development of this growth flywheel? There’s only one truth: protecting the market for the country. Find teams in the industry who specialize in managing market value through personal introductions. As for how long they can stabilize the market, it usually depends on the project team’s budget and psychological tolerance. So, raising tokens may seem fun, but it’s only when you start managing market value that you realize it’s actually a crematorium.

02. Investing outside while the main business is unstable, digging one’s own grave

Another reason that easily leads to the collapse of blockchain startups is the inflated ego of the founders. They are not content with being mere “financial leeks” (a metaphor for capital providers), and attempt to become a mature sickle.

There are two ways to turn the money raised by a project into more money.

The first way is to focus on the core business, overcome technical difficulties, conduct user research, develop good products, build a strong connection with users, and carry out effective marketing. Although this method has a higher success rate, it is relatively slow in terms of wealth accumulation. If the blockchain startup team doesn’t possess extraordinary talent, they will need at least 3 to 5 years to establish a solid foundation by following the path of traditional internet companies.

The second way sounds more enticing, which is to invest. By using their project as the exclusive name for an ecological fund, they invest in projects that they believe have the potential to bring them wealth. After all, the money is not hard-earned and therefore not worth shedding tears over. This mysterious operation is completely incomprehensible to friends in the traditional internet startup field.

To be honest, it is bewildering to see many blockchain entrepreneurs who have raised only tens of millions in funding, yet they all suddenly establish their own investment funds and start investing in other projects. It’s as if they consider venture capitalists to be their limited partners (LPs), and they themselves create a project to raise funds and act as the general partner (GP) to make investments.

In the history of commerce, which successful company didn’t focus on their core business in the early stages and work tirelessly to become industry leaders or frontrunners before venturing into financial investments for stability?

For blockchain entrepreneurs, to start making financial investments externally when their core business is not yet stable and their projects cannot sustain themselves, is this not self-destruction?

Some might argue that this is the project team’s ecological layout. But that’s a bit ridiculous. After all, the majority of blockchain products have yet to achieve daily, weekly, or monthly active users.

One important reason for this phenomenon is the impatience of blockchain entrepreneurs. It is too easy for them to raise funds in the market, so they want to learn from capitalists and use other people’s money as leverage to chase even greater profits in the market. After all, it’s exhausting to focus on product development and operations to attract users. It’s much more thrilling to see sudden spikes in the market overnight.

This has resulted in the majority of blockchain projects becoming layers upon layers of leveraged financial games. Over the past decade, the blockchain industry has developed slowly, and those in the blockchain project community who enjoy playing financial games should also reflect on the origins of their money.

03. Don’t use limited Chinese regulations as an excuse

When things succeed, people claim they are talented and amazing. When things fail, they blame it on the unfavorable environment and policies. Is this really the truth?

In the minds of many practitioners, starting a blockchain venture in China seems impossible. But I don’t think so.

Those blockchain practitioners believe that the government restricts their activities. But in reality, it’s the same in any other industry. Take the example of ICOs, a familiar concept to everyone. People may not realize that during any stage of development in China, start-ups in any industry seem to be unable to directly raise funds from the public. So when it comes to cracking down on illegal activities, blockchain entrepreneurs shouldn’t easily blame themselves. In the eyes of regulators, they are not particularly concerned about you.

04. Conclusion

In one of Mr. Mu Xin’s poetry collections, there is a line that says: “Curves are sweet, lines are salty.”

Some of the words in this article may seem harsh, but as someone who was once an internet entrepreneur aspiring to attract venture capital, and who has burned through millions of investment funds and stepped into numerous pitfalls, I hope that after witnessing many blockchain entrepreneurs’ lofty plans fall apart, everyone can reflect on the reliability of their own entrepreneurial projects. Is it really necessary to issue tokens? After all, once the arrow is shot, it cannot be retrieved. In this rough world, you’ll eventually have to pay your dues.

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