February 27, 2024
Tokenomics Tuesday

Balancing investors

Token economics is the backbone of every single crypto project. One may assume that’s an exaggeration, but a token that collapses in price or is violently unstable disinterests holders, disincentivises good actors, annoys users, prevents the team from funding operations, and cuts off investors.

Simply put, if your token’s price performance doesn’t affect your product, then either you have a useless token, or a useless product.

And it’s not an easy feat to derive utilities that are useful and align incentives, nor is it easy to design an economy that accrues value, nor to create the laws that govern the tokens supply. The last of which is what we specifically call “tokenomics”.

One of the most difficult aspects is the fundraising tranches, so let’s simplify it.

Fundraising tranches in tokenomics

There are 9 data points one has to keep in mind when designing the fundraising tranches.

  1. Valuation delta between the round
  2. TGE unlock amount
  3. Cliff length
  4. Vesting length
  5. Initial market cap
  6. Fully diluted valuation
  7. Allocation
  8. Raise amount
  9. Strategy

These are all inter-related: you change 1, you need to change the others. Getting these working cohesively is necessary to ensure your investors are happy, the public optics look good, and the overall token is healthy.

Quite the mission.

But we wouldn’t be Simplicity Group if we didn’t simplify this, so here’s the trick:

There are only two ways the numbers in each of those data points (except 9) can go: up, or down. And when you move one number up, some other numbers must go down.

The exact relationship between the data points is something that we can’t explain in one article, but we can give an overview of how to think about these things. Let’s dive in.

How to create tokenomics for fundraising

First, let’s explain what these are.

  1. The valuation delta between rounds means the difference in valuation between the seed, private, public, and whatever other rounds you have. If your seed valuation is $5M but public is $50M, the delta is 10x.

    Generally speaking, right now, a delta of 2-5x between seed and public is the standard, with other rounds falling somewhere in-between, but this can vary greatly depending on the project. The higher the delta, the less happy the later investors are because the earlier investors get relatively more tokens for their investment.

  2. TGE unlock amount is how many tokens do investors get at TGE. Right now it’s between 0%-30% with the higher end going to KOLs and Launchpads, but this greatly depends on the project’s situation. The higher the TGE unlock, the greater the sell pressure at TGE.

  3. A cliff is the length of time post TGE that no tokens are unlocked. Longer cliffs mean investors have to wait longer before the remainder of their tokens begin vesting. Longer cliffs mean more time without sell pressure, and more time without a return for the investor.

  4. Vesting is the steady unlock of tokens over a period of time, normally in the region of a couple years, depending on the tranche. Normally, “vesting” is the term used to refer to both the cliff and vesting together; we just split them up for clarity here. Like with cliffs, longer means less sell pressure, and more time without a return.

  5. Initial market cap (IMC) is the launch price multiplied by the number of tokens unlocked at TGE. This gives the investors, launchpads, retail, and everyone else a rough idea of the “pumpability” of the token on launch. The smaller the IMC, the easier it is to pump when retail starts buying on launch.

  6. Fully diluted valuation (FDV) is the valuation of the public round specifically - be that an ICO, IDO, IEO, IGO, or whatever else. The higher the FDV, the higher the price at launch, which means the harder it is to sustain that price.

    If the price of my token is $10, that means every time n tokens are released onto the market they are creating n * $10 worth of sell pressure. Higher FDVs are harder to uphold.

  7. Allocations are how much % from the total token supply are you allocating to each tranche. Generally, giving more than 30% to investors is considered heinous by everyone, despite the fact that even if you give 100% to investors, if your valuations and vestings are in order, you will be completely fine (unless the token’s utility is governance, which therefore gives investors all the power).

  8. The amount you’re raising is the sum of all tokens you allocate to each investor tranche multiplied by their respective prices.

  9. Strategy is a whole topic in and of itself, but long story short, your strategy can be to pump as much as possible and create hype on one extreme, or to list the token like nothings happened purely for its utility rather than fundraising or anything else on the other extreme. We wont go into this in this article, but have one coming soon that does.

Now that we know what they are, let’s explore how they relate to each other. It is very logical.

Let’s think about how selfish investors think: each investor wants to buy as many tokens as possible for as cheap as possible, wants to liquidate them as quickly as possible, and wants to not have other investors liquidate their tokens first.

This means the main factors to consider here are as follows:

a. investor appetite in their own tranche: these investors need to have big TGE unlocks, short-ish cliffs, and short-ish vestings.

b. investor appetite in their tranche in relation to other tranches: these investors want to have a big delta between theirs and the next round, and they want better terms mentioned in point a than the round after them.

c. investor appetite in the entire tokenomics: these investors want low IMCs and low FDVs.

And you, as the project, want to make sure that each investor is happy with their tranche*, that you don’t give too much allocation to investors, that the overall sell pressure doesn’t come quicker than you can handle, and that fundraise enough capital.

*Each following tranche must have a higher valuation for reasons too long to explain here, and this negative factor must be countered by friendlier terms using other data points.

This is the fundamental baseline for thinking about fundraising tranches in tokenomics.

The only things missing now are the market conditions and sentiment, the type of investor you’re going for, and the fact that earlier investors take more risk so should be rewarded more, but we can leave that for now.

Finally, let’s run through a quick example to bring all of these data points together.

You have 100M total tokens, and you allocate 10% to seed, at a valuation of $5M. TGE unlock 5%, cliff of 12 months, and vesting 24 months.

The private round must have a higher valuation, say $7M. However, now, you need to sweeten the deal a bit and give them slightly shorter vesting and slightly more at TGE, something like TGE unlock 8%, cliff 9 months, vesting 21 months.

But now, instead of a 5% TGE from seed and 5% TGE from private, you have 5% seed and 8% private, which increases your IMC. Some investors don’t like this, so to reduce the IMC you decide to reduce the total allocation given to seed and private so that the IMC falls.

But now you’re not raising enough, so maybe you can increase the allocation again but reduce private TGE unlock to 5%, and sweeten the deal further by reducing their cliff a bit more.

But now you notice your allocation to investors is above 25%, and you don’t want to give them that many tokens, and you can’t reduce the allocation because you wont raise enough money. So, you decrease the allocations but you increase the valuations of the seed and private tranches, therefore raising more money.

But now, the delta between seed and public, and private and public, isn’t appealing enough and you don’t want to increase the FDV because it’ll be harder to uphold the price, so you change your strategy and decide to bring the valuations back down with the new lower allocations, and finish the raise by selling NFTs.

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