The chaos in the cryptocurrency circle exposed by the IPO boom of crypto companies: If we don’t save ourselves, everyone will run to the next stock market

Original: Empire

Compiled/edited by Yuliya, PANews

In the crypto market, the uncertainty faced by token investors far exceeds that of the traditional financial market. The frequent occurrence of secondary token issuance by the founding team, opaque related transactions, and shady market maker agreements has led to serious information asymmetry between the true value of the project and the return on investment. In this context, the Blockworks team launched the Token Transparency Framework, which aims to guide project parties to disclose key information through an open source standard tool and promote the industry towards an open, credible and long-term development path. This episode of Empire Podcast is hosted by Jason Yanowitz, and invites the framework initiator Blockworks Data Director Dan Smith, Thea Chief Investment Officer Felipe Montealegre and L1D Investment Partner Louis T to explain the framework design concept, scoring method and future vision in depth. PANews compiled and sorted out this dialogue.

Why do we need a token transparency framework?

Yanowitz:

The cryptocurrency industry is 15-16 years old and is at an important turning point. While crypto companies are IPOing, there is a major problem in the token market that is holding the industry back: lack of transparency. Tokens are considered the future of capital formation, but they cannot move forward without addressing the transparency issue.

Felipe:

Many of us liquidity token investors are concerned that the token market is turning into a "lemon market." This term originated from an economics paper in the 1970s, which stated that the used car market lacks effective signals to distinguish between "peaches" and "lemons," resulting in all cars being priced equally. As a result, good car owners are reluctant to sell, and the market ends up with only "lemons."

The token market is also facing similar problems. Without a standardized transparent disclosure mechanism, investors cannot judge whether a project is good or bad. As a result, high-quality projects are reluctant to issue tokens, while speculative projects are rampant, causing the quality of the entire market to decline.

In the token market, investors face many issues that equity investors do not have to worry about:

• Insufficient legal protection: Token holders have far less legal protection than equity holders. This is not theoretical, but often happens in practice.
• The multi-token problem: Equity investments in early-stage projects (like Amazon or Apple) benefit from their subsequent successful products (like AWS or the iPhone). But in the crypto space, teams often issue a second token for a new business line, which harms the interests of early investors.
• Parasitic equity problem: Token holders are unsure whether cash flows will go to tokens or equity. A famous example is Uniswap, which generated about $90 million in fees on the front end, which went to equity holders instead of UNI token holders, who are still waiting for the fee switch to be turned on. If even a top project like Uniswap is like this, it shows the general situation in the market.
• Founder behavior: Founders may sell a large number of tokens through OTC (over-the-counter transactions) during a bull market and abandon the project after achieving personal wealth freedom.
• Foundation abuse: Some teams will transfer project cash flow to the foundation, and then withdraw $5 million to $10 million from the foundation into their own pockets in the name of consulting fees, logo design, etc.

These structural problems have raised the "risk premium" of tokens, which is as high as 20%, much higher than the 5% of stocks. According to the pricing logic of the capital market, this high premium has led to an 80% discount in token valuation.

Yanowitz: Felipe, you mentioned a 5% equity risk premium and a 20% token risk premium, which results in a roughly 80% discount to token valuation. Can you explain the math for us?

Felipe:

All capital is competing. Assume that a company has a long-term growth rate of 5% and the current 10-year U.S. Treasury bond yield (risk-free rate) is 4.5%.

• For equity: The minimum return required by institutional investors is 9.5% (5% equity risk premium + 4.5% risk-free rate). Minus the 5% growth expectation, investors need a 4.5% cash yield. The corresponding P/E ratio is about 1 / 4.5% ≈ 22 times.
• For tokens: The minimum return rate required by institutional investors is 24.5% (20% token risk premium + 4.5% risk-free rate). Similarly, minus the 5% growth expectation, investors need a cash return of 19.5% (about 20%). The corresponding P/E ratio is about 1 / 20% = 5 times.

The huge difference between a 22x P/E ratio and a 5x P/E ratio reflects a valuation discount of about 78% (I call it 80%). In this case, good founders who want to build a long-term business may choose to issue equity instead of tokens when they see such a large valuation difference between the equity market and the token market. This forms a vicious cycle, with fewer and fewer good projects issuing tokens, and the market may eventually collapse.

Yanowitz: Dan, what do you have to add to Felipe's point about the lemon market?

Dan:

Yes, the situation is even worse than Jason described. Because it is not just the "car owners" (project parties) who hold the information, but the "car manufacturers" (early teams) who hold the core information, and there is currently a lack of a standardized tool or format for them to disclose this information. This is where we see the opportunity. Those teams that operate legitimately and try to avoid the scam methods described by Felipe are eager to have a tool to explain their practices.

Circle's IPO is an interesting sidebar. Its IPO was priced at about $30-31, opened at about $70 on the first day, and traded at $120 a few days later. Stablecoins are all the rage right now, which may partly reflect the market's preference for equity, because equity has clearer guarantees, even if only looking at financial statements may not give such a high valuation. This indicates that more companies that should have issued tokens on the chain may choose IPOs in the future.

Yanowitz: Louis T, can you elaborate on the structural issues in the token market?

Louis T:

I completely agree with Felipe's point. In addition to what he mentioned, a core structural problem in the current token market is the unclear relationship between equity and tokens. For example, many GameFi projects failed in part because tokens were used to incentivize user behavior (such as trading, playing games and paying fees), and users invested real money (ETH, stablecoins), but most of the final returns went to equity holders, while the value of the token itself (FDV) may tend to zero. Token holders are unclear about their rights and interests, and they are also unaware of the rights and interests of equity holders, which creates potential conflicts of interest and competition.

In addition, the VC bubble in 2021 has further exacerbated the supply of "lemons". A large number of early private equity projects have received investment, and their deployment plans force funds to continue investing, which makes the market flooded with more projects that may lack real value but are eager to enter the market to create value (usually lacking transparency).

Felipe:

How did we get here? A lot of it is because of the “everything bubble” period of 2020-2021. At that time, global interest rates were almost zero, and massive money printing and fiscal stimulus led to token prices rising without the support of fundamentals, revenue or cash flow, and no one talked about the cost of capital. The industry learned the wrong lessons from that period. After the bubble burst, market participants have spent the past few years waiting for the next “big cycle”, a period when fundamentals are irrelevant again and all tokens can rise for no reason. But over time, people gradually realized that they need to give investors something substantial before they will buy your token. Only now are we starting to really face these difficult questions, such as project revenue and fundamentals.

Dan Smith:

There have also been some positive shifts in the industry and at the regulatory level in response to these issues. For example, Morpho Labs recently announced that it will become a wholly owned subsidiary of the Morpho Association (a shareholder-free entity) to ensure that value flows to tokens. Miles Jennings of a16z also expressed his views on the "end of the foundation era" and mentioned emerging legal structures such as "DUNAs" and "BORGs" that are designed to address the needs of off-chain entities (such as foundations) to conduct commercial activities (such as signing contracts).

In terms of regulation, Hester Peirce, a member of the U.S. Securities and Exchange Commission, proposed the "Safe Harbor 2.0" proposal, which provides a three-year grace period and guidelines for projects to transition from centralized entities to decentralized networks. At the same time, the "Market Structure Act" being promoted in Congress is also providing a basic framework for disclosure standards.

Industry chaos

Yanowitz: Can you share some real-life examples to help people more intuitively understand the current problems in the token market?

Felipe:

We once invested in a project with FDV of only $40 million, and spent a lot of time helping them deploy to Solana. Eventually, they began to achieve a cash flow of about $40 million per year, which was a very successful investment. One day we received a notice from the team saying that they "wanted to give up the token." The actual situation was that they decided to separate the IP from the token and leave the cash flow entirely to their small team of four. This is very common in the crypto industry and is called "Rug Pull." But if Tim Cook treats Apple shareholders like this, it would absolutely not be tolerated in the public market.

For another example, Aave had previously explored issuing new tokens for its real-world asset (RWA) business line, and this news sparked widespread discussion and concern in the community. Investors are worried that as Aave token holders, they may not benefit from the issuance of new tokens. Especially when Aave already occupies about 70% of the existing EVM market, expanding into new markets has become a key strategy. Fortunately, the founder of Aave publicly stated a few weeks ago that he would not issue new tokens for the RWA business.

Uniswap is another example where investors believed that its strong moat would eventually bring returns, and indeed, they cashed out through the front end. But UNI holders did not receive a penny of income.

Yanowitz: How many of these problems are due to the founders doing evil, and how many are structural problems due to regulatory gaps?

Felipe:

Indeed, if the founder "Rug Pull" the agreement, this is illegal in the securities market. However, not feeding back the revenue to the token is not necessarily illegal, it may just be that the regulatory mechanism is not yet perfect. My point is not to blame the founder, but to point out that under the current structure, the token is extremely unattractive to institutional investors.

Yanowitz: Dan, Louis, do you have any other examples of founders cashing out in the secondary market, or opaque transactions with market makers?

Dan:

We are not against founders cashing out in the secondary market, but some people cash out too much in advance, which leads to the death of the entire project. This is especially common in the token market.

There are also related transactions, such as the foundation paying "advisory fees" or development fees to the core team. In traditional finance, these need to be disclosed, but in the crypto market, almost no one knows about them. In the disclosure framework we proposed, this type of information is also specifically required.

Many teams have less than 10 people, which is actually an advantage of blockchain capital formation: projects can be launched quickly and at low cost. However, this also creates a breeding ground for abuse. Traditional market investors evaluate intrinsic value and predict the future, while in the token market, they also need to deal with projects that attempt to deceive. The foundation system is often abused, and the core team charges high consulting fees to the foundation to accelerate the unlocking and cashing out of tokens.

Louis T:

In many projects, the foundation is responsible for managing most of the tokens for ecological development. Labs is an entity composed of founders and core developers, responsible for daily operations such as development and updating the front end. The problem is that the two are usually controlled by the same group of people. Therefore, the foundation can "pay" tens of millions of dollars in tokens to Labs every year in exchange for some marginal front-end changes in the name of "consultancy fees."

This information is often not disclosed publicly, but we hope to at least disclose it so that investors can make their own judgments.

Dan:

I would also like to add a point about market makers and centralized exchanges listing tokens. Currently, the liquidity of tokens at the time of issuance is mainly concentrated in centralized exchanges, but some top exchanges will impose harsh listing conditions, including requiring the project party to provide 2%-5% of the supply and high cash listing fees. These are all signed with confidentiality agreements and are not reflected in the official token release plan at all.

On the other hand, although there are excellent market makers providing liquidity, there are also many cases of abuse of privilege. Some projects with only foundations and tokens have seen their market value hyped up to tens or even hundreds of billions of dollars, and then the price plummeted by 50-90%, leaving investors unprepared. Later document leaks revealed that the crazy option clauses in the market maker agreement were the cause of the price collapse. The market needs to understand these agreement terms and listing conditions to reduce losses.

Conception and design of token transparency framework

Yanowitz: The industry clearly has a serious lack of information disclosure. How do you plan to address this? Is it a bottom-up approach or is it regulatory enforcement?

Dan:

We took a bottom-up approach and launched the Token Transparency Framework, an open, standardized self-disclosure template. Projects only need to fill in this form to clearly communicate their structure information to the market. This framework is not intended to judge "good" or "bad", but to let the market know what the project is doing.

This is also an important supplement to the US Market Structure Bill. Currently, the information disclosure part of the bill is very brief and far from enough to solve industry problems. We hope to provide a tool for expression for teams that are truly "doing the right thing" through this framework.

Yanowitz: Could you please give us a brief overview of what this framework is. What information does it contain?

Dan:

You can think of it as a "crypto-native S1 form". When a company wants to go public, it must fill out the S1 form to disclose basic information such as the company's business and financial status. Ideally, when a token is issued, such a form should also be submitted. Of course, for existing tokens, this will be a retroactive process. It is essentially a form or a set of evaluation criteria that looks like an Excel document or a large table. The framework requires the project party to fill in about 20 questions, covering business descriptions, supply schedules, and agreements with exchanges, and provide relevant supporting materials. The scoring mechanism assigns different weights based on the importance of the questions, and finally generates a simple and easy-to-understand grade. For information that cannot be disclosed due to confidentiality agreements, the scoring mechanism will also be adjusted accordingly to prevent the project party from being unfairly punished. The entire framework is open source, and the public can view the complete response content. It also provides concise scoring results to facilitate quick evaluation or in-depth research of the project.

Yanowitz: What if the project lies? For example, they say the team does not sell coins OTC, but they actually do?

Dan:

The framework gives priority to linking on-chain data, such as tagging team wallets, public transaction records, etc. For parts that cannot be verified, it depends on the project party to declare themselves. However, the risk of lying publicly on the framework website is much higher than not making a statement, because if it is found out that you lied in the future, it will greatly damage the reputation of the project and even lose the ability to raise funds and recruit. In the long run, the reputation mechanism will drive projects to disclose honestly.

Expected impact

Yanowitz: Felipe, how do you think this framework will affect token prices?

Felipe:

Teams that participate and receive reasonable scores (above 60-70%) may see their tokens receive a premium in the long term due to transparency. Although this change will not be immediately apparent, the increase in transparency will attract more attention from liquidity token funds, as these funds typically have capital pools that are authorized to hold for several years. Analysts believe that liquidity fund managers attach great importance to transparency standards and are dissatisfied with the lack of transparency in the current market, so projects with complete information disclosure are more attractive. If this framework is widely adopted by the market, it may drive more institutional capital into the liquidity token market, thereby alleviating the lack of transparency, which is the main problem that hinders the entry of institutional capital.

Louis T:

In the short term, projects with good fundamentals but ignored due to market noise, narratives or hype will be the main beneficiaries of the new framework. By applying the framework to their own tokens and projects and publishing the results publicly, these projects can more clearly show their true fundamentals to institutional investors, liquidity investors, large investors and token holders, thereby increasing market awareness and attention. This approach will help projects stand out more easily from market noise and achieve rapid development.

Yanowitz: Which projects would object to this framework?

Felipe:

Projects that use tokens as arbitrage tools, lack real products, or abuse market structure will be sidelined due to lack of transparency. The emergence of the framework will put an end to the high valuations of "fraudulent tokens" and allow resources to flow more efficiently to projects that truly have product-market fit.