Models of Token Distribution and How to Legally Structure Them
Models of Token Distribution and How to Legally Structure Them
In this article, we will cover different models of token distribution depending on the pool (investor's pool or founders pool, etc.) and what legal considerations should be made by founders of Web3 projects when using each distribution model.
If you haven't registered a token issuer company for your future token launch, we recommend you read this guide on choosing the best jurisdiction for such a company.
How to organize token distribution
Work on the tokenomics of a project includes elaborating token use cases (token utilities) and preparing a Token Cap Table. Once the token functions have been determined, and the total token emission has been calculated, Web3 founders usually start thinking about organizing the token distribution among the ecosystem members.
If you want your tokenomics to work, it is essential that you avoid situations where the supply of tokens exceeds the demand. This will immediately lead to the depreciation of the token’s value and a fall in its price. To prevent this from happening, the distribution of tokens is divided into stages, whereby tokens are gradually distributed.
Models of token distribution
We can divide all token distribution models into two types: paid (when tokens are sold for money) and free of charge (when tokens are distributed free of charge).
Paid models include distributing tokens from the investor token pool (SAFT, Private Token Sale) and distributing tokens from the community pool (launchpads, Public Token Sale). Free of charge models of token distribution include distribution of tokens from the founders' and team's pools (Token Transfer for founders, Token Incentive Schemes for team and advisors) and distribution of tokens from the community pool (airdrops, staking/yielding rewards, etc.).
Founders need to pay special attention primarily to paid models of token distribution. In many countries, paid models of token distribution require compliance with certain regulatory requirements, as well as the use of certain legal mechanisms during the process of token distribution.
SAFT or a Private Token Sale
SAFT (Simple Agreement for Future Tokens) is often used as a fundraising tool for Web3 projects when tokens have not yet been issued, and the Token Cap Table has not yet been formed. At this stage, founders have only a rough understanding of the Token Cap Table, so SAFT usually indicates the relative size of the investor's token allocation (in percentages).
In instances where tokens have already been issued and there are plans to distribute further tokens from the investor pool, a Token Sale Agreement must be used. For both SAFT and Token Sale cases, founders need to conduct a detailed investor verification to meet AML requirements.
Read more: How to prepare a Web3 startup for fundraising.
Token Incentive Schemes
To motivate and encourage the Web3 project team, founders often allocate a separate token pool for the team and advisors. The distribution of tokens from such a token pool is organized by signing a Token Option Agreement, which determines the token vesting (a calendar schedule of the accrual of tokens) and the KPI to be achieved by the team or the period during which the team must work to get such tokens vested.
After token vesting is completed, a token lockup is often provided for a certain period to avoid token supply/token demand imbalances when the employees' tokens become liquid and they want to sell tokens on exchanges.
Both sales of tokens via a launchpad and via a Public Token Sale are subtypes of crowdfunding for Web3 projects using tokens. An important difference to note is that with token sales via a launchpad, this crowdfunding is organized by a third party (usually, a cryptocurrency exchange where launchpads typically operate). In the case of a Public Token Sale, the crowdfunding campaign is organized by the project itself.
This, in turn, affects the amount of legal work required for each type of crowdfunding. For a launchpad token sale, the organizer (a cryptocurrency exchange) will require the project to undergo onboarding for a token listing on the launchpad, which includes providing a Token Legal Opinion. At the same time, the chosen cryptocurrency exchange will take over the entire KYC procedure of token buyers on the launchpad and will also manage the PR and marketing campaigns for sale.
Public Token Sale (TGE, ICO)
If the founders of the Web3 project independently organize a Public Token Sale (sometimes called a Token Generation Event or an Initial Coin Offering), then they have to do the following legal work:
- analyze and adhere to any regulatory requirements for the Public Token Sale in the country where the token issuer company is registered (for example, if the Token Issuer Company is registered in the Cayman Islands, obtaining a VASP Authorisation for the Public Token Sale is mandatory);
- implement verification procedures for token buyers (KYC and AML procedures), as well as conduct a legal analysis of the token (Token Legal Opinion) so as not to violate securities and stock market laws;
- provide a detailed legal analysis of any PR and marketing campaigns that they, as founders, must organize. These PR campaigns aim to promote crowdfunding of tokens, so a detailed legal analysis of these materials is necessary to ensure that public calls to buy tokens and any promises to make money via these tokens do not violate financial market legislation.
Token airdrops are public campaigns for the free distribution of tokens from the community pool, which are aimed at achieving a network effect of promoting the Web3 project (i.e., going viral). The idea of airdrops is that active members of the Web3 community are offered the opportunity to perform several tasks (i.e., to post on social networks about the project, record a video manual, translate the White Paper of the project into a local language, find a bug in the system, etc.) and receive a reward in the form of tokens for their actions.
Because token airdrop campaigns provide free distribution of tokens, they have fewer regulatory requirements than paid distribution, but Web3 founders need to provide detailed Terms & Conditions of the airdrop campaign and place them on the project website.
Get legal support for your token distribution
Each model of token distribution requires the performance of legal work for its authorisation. The crypto industry has already seen several cases of unauthorized (or improperly registered) token distribution, which resulted in fines from regulators, lawsuits, and obligations to return all funds raised to token buyers.
To reduce the risk of these kinds of consequences, it is crucial for Web3 founders to do the legal work, especially for each token distribution model provided for in the Token Cap Table. Founders must also obtain any necessary regulatory authorisations for their token distribution model, and implement the appropriate verification procedures.
Here at Legal Nodes, we help Web3 founders structure their token distribution in one single place, removing the need for founders to seek out legal experts in multiple jurisdictions. We start by conducting a Legal Discovery Session to better understand all the legal needs of your project–from registering a token issuer company to preparing all the necessary agreements for distribution. These tasks are then mapped into a timeline and we assign a Virtual Legal Officer to your account, who manages your legal tasks and updates you on the progress, meaning your token distribution will be correctly legally structured.
Disclaimer: the information in this article is provided for informational purposes only. You should not construe any such information as legal, tax, investment, trading, financial, or other advice.