Token deals are back. But VCs say they've matured since the ICO boom

Crypto in 2020 feels distinctly like crypto in 2017. But this isn't your father's token boom. 

Well, that's at least what venture capital investors are saying about the new crop of token deals that have sprung up over the past year. 

Token mania is back, and it feels eerily like the ICO boom. Some decentralized finance (DeFi) projects have launched tokens, and price-watching has become cool again. But token deals have grown since then up, according to Matt Shapiro of Multicoin Capital, a cryptocurrency investment firm. 

"Tokens themselves have gone through their own cycle; tokens today materially different from the 2017 ICO era," Shapiro told The Block. "In 2017, every token was essentially an early funding round for a product that didn’t yet exist.” Most ICO projects promised their tokens would have utility in networks that didn’t exist yet.

The game is different in 2020. In the DeFi world, traders can earn so-called governance tokens in return for providing liquidity for decentralized exchanges and lending protocols like Balancer and Compound. Governance tokens can be used to vote on improvements to the underlying protocols. 

"A key point of distinction between now and 2017 is that tokens are being used in protocols and networks that have already been built,” said Shapiro.“They already function, already have some form of product-market fit, and are designed in a way that both accrues value and drives the incentive structure of the network, which is critically important."

To be clear, that doesn’t rule out the possibility that some of these tokens could be deemed securities — the same regulatory hurdle that caused so many ICOs to stumble. A number of DeFi governance tokens that have launched guarantee cash-flow for holders — a feature that has raised red flags. If you hold YFI, for instance, then you can claim revenue generated by the protocol. As The Block previously reported, officials at the Securities and Exchange Commission are watching.

Still, the way the deals are now structured is more advanced than before. 

In 2017, venture capital investors poured money into aspiring “blockchain” projects using a legal agreement called a Simple Agreement for Future Tokens, or SAFT. Effectively, the SAFT was designed to create a regulatory compliant way for professional venture capital firms to invest in token projects. 

But SAFTs lacked many of the staples of traditional venture deals, like lock-ups and vesting schedules. When big ICO projects failed, many investors got burned — even as the project’s team members profited from the token sale’s proceeds.

"We're rarely doing SAFTs anymore," said Haseeb Qureshi of Dragonfly Capital. "Alignment between founders and investors is not great. Too many horror stories." Instead of the SAFT, VCs are using new structures, ranging from SAFES and SAFE-Ts. In short, the new token deal structures provide more security and predictability for investors. 

Vesting schedules, for instance, are now mostly three to four years for some projects, which Qureshi says benefits long-term capital. 

That’s also how it works for Pantera Capital, according to partner Paul Veradittakit. Around 50% of Pantera’s current deals are token deals.That's compared with 20% last year, he estimated. Token deals in 2020 provide investors with better legal and regulatory protections than their predecessors, said Veradittakit.

"It helps projects manage liquidity across different investor bases, helps investors have more protections both legally and regulations, and helps retail investors that come in during a public sale," he said. 

Those protections can prevent investors from getting burned on projects that don't deliver, Shapiro said. The new deal structures “tranche out risk in a different way than 2017 ICOs,” he said. “They create accountability through milestone-based funding across numerous rounds and vesting agreements to align long-term incentives.”

"We’ve now seen throughout 2020 how properly funded and well-designed tokens can thrive in the market and power incentives that bootstrap the success of a network," he continued.