By Arthur Hayes

(Any views expressed in the below are the personal views of the author and should not form the basis for making investment decisions, nor be construed as a recommendation or advice to engage in investment transactions.)

I recently read a fascinating book about the history of the East India Company (EIC) called “The Anarchy” by Wiliam Dalrymple. For those unfamiliar with this chapter of European colonialism, the EIC was a joint stock company that was given a royal charter/monopoly over the trade between Britain and the Indian subcontinent. Over a few centuries, what was initially a weak and poor commercial enterprise that survived at the whim of various Indian rulers conquered the entire subcontinent and paved the way for the British Raj, which lasted from the late 19th century until 1947.

When it became known that the EIC employed unsavoury methods to extract its immense profits, certain members of the company were called in front of the British Parliament for questioning. Fortunately, because many high-ranking members of parliament were also EIC shareholders, scant, if any, punishments were ever handed out. In fact, on various occasions, the EIC requested and received government bailouts due to its over-indebtedness. EIC was the first Too Big to Fail company, and conflicted politicians back then did as their contemporaries do today … use the public purse to bail out private companies for their own personal benefit. In effect, privatise the gains, but socialise the losses.

The EIC is apropos to crypto because I want to talk about the evolution of crypto project ownership structures and fundraising methods. I will write about Bitcoin, ICO’s, yield farming/liquidity mining, and finally, points. The goal of this essay is to provide context for why points as a way of engaging users is a natural progression that follows on from previous engagement and fundraising methods of the past. Many of Maelstrom’s portfolio companies will launch their tokens in 2024, and you can expect to learn about points programs, which all share a  goal of generating usage of their protocols. Therefore, I want to discuss why points exist and how they will drive adoption in this cycle. 

Web 2 vs. Web 3

Who your shareholders/token holders are and what they are promised is very important to any commercial enterprise's success, whether in crypto or otherwise. I am specifically going to compare and contrast how Web 2 (technology startups) and Web 3 (crypto startups) fundraise and acquire users.

Whether you are founding a Web 2 or Web 3 startup, acquiring and retaining users is the most challenging and expensive aspect of your business. In Web 2, which was most prevalent from 2010 to 2020, a VC fund looked for startups with a modicum of initial traction and subsequently provided cash money rocket fuel for the startup to go on a user acquisition spree. Usually that entails handing out the service for free or at a discounted rate, well below its actual cost of delivery. Remember when ride-sharing apps were all fighting viciously for market share, and fares were incredibly cheap? That was all paid for with billions of dollars worth of VC money. Think of it as a subsidy in return for users.

At the end of the rainbow for a VC firm was a successful initial public offering (IPO). The IPO allowed the plebes to own a piece of a successful Web 2 company for the first time. IPOs are the way to dump on retail in TradFi. However, various regulations barred the plebes from crowdfunding early-stage Web 2 companies. The irony is that the vast number of plebe users who drove the success of the company were prohibited from owning a piece of it.

Considering the law of averages, more than 90% of all new companies fail. Investing in early-stage Web 2 companies is a recipe for losing all of your money. Even though that is the case, most investors, in a normal Gaussian distribution sense, believe they are 3-sigma traders even though they always seem to earn returns around the mean. What this means is that the plebes always want in early on the sure thing ex-post but throw a fit when they invariably lose money on the myriad of failures. At that point, the plebes point the finger at the government because, in our modern age, the average person believes it's the government's job to live their lives for them. I don’t blame them for that belief; the politicians all outdo themselves to paint the picture that nothing in life can ever go wrong if you support them. From a securities regulator’s perspective, there is no upside to allowing poor people to crowdfund early-stage companies. For every Facebook, there are 1,000 MySpaces. Why lose the shot at a promotion because you got sacked for allowing a gaggle of plebes to blow their paycheck on some piece-of-shit company they got sold by a bucket shop huckster?

That’s my regulator-sympathetic reasoning behind why plebes aren’t allowed to collectively invest in early-stage companies. My more cynical explanation is that the TradFi gatekeepers earn a fuck ton of fees from IPOs. Let’s go down the list of who gets paid from the IPO process:

The cartel of trust described above loves IPOs. A few successful IPOs in a calendar year ensures that everyone in TradFi gets their phat bonuses. But without a hungry hoard of retail buyers who are excluded from investing earlier at much cheaper prices, there would be no buying pressure to create a successful IPO. That is why retail participation must be saved for the end and not the beginning of the fundraising lifecycle.

While these fees may seem egregious, before Bitcoin, there was no other efficient way to raise funds publicly. And being objective, this process created many super important, useful, and profitable companies. It worked. But fuck nostalgia, let’s move forward.

From a user’s perspective, the major issue with how Web 2 companies are formed is that using the product or service doesn’t accrue equity in the company providing it. You don’t get shares of Meta by ogling Instagram thirst traps. Nor do you get shares in ByteDance while you destroy your brain watching pre-teens dance like Cardi B on TikTok. These centralised companies take your attention, your actions, and your money, and yes, they provide a service or product you enjoy, but that’s it. And even if you want to invest, you can’t unless you are rich and well-connected.

Participation ≠ Ownership

Bitcoin Paradigm Change

Bitcoin and the subsequent evolution of the crypto capital markets changed this. As of 2009 – the genesis Bitcoin block – it became possible to reward participants with ownership in the startup. This is what I will refer to as Web 3 startups.

Before you could purchase Bitcoin on an exchange starting in 2010, mining it was the only way to acquire it. Miners, by burning electricity, validate transitions, which creates and upkeeps the network. For this activity, they are rewarded with newly minted Bitcoin. 

Participation = Ownership

The participants or users now have skin in the game. Similar to the EIC example, users with skin in the game will do whatever they can to protect their investment. In the EIC case, that meant looking the other way as war and famine were visited upon a population in the name of profit. In the Bitcoin example, it means owners of Bitcoin want to convert as many people as possible into Bitcoin users as well. Look into my laser eyes, bitch!

The Initial Coin Offering (ICO)

Quickly, the crypto capital markets recognised a way to crowdfund technology startups in a way that was unavailable to Web 2 startups. If a Web 3 startup eschewed fiat as payment for ownership or governance rights and only accepted Bitcoin, it could sidestep the entire TradFi cartel of trust that “safeguards” the filthy fiat financial system. To raise funds, a project launched a website announcing that if you gave them Bitcoin, they would give you tokens that did something or gave some sort of economic rights in the future. If you believed this team had the ability to execute their advertised vision, in less than an hour, you could own a piece of an exciting new network.

The first major project that conducted an ICO was Ethereum in 2014. The Ethereum Foundation pre-sold Ether, the commodity that powered its virtual decentralised computer, in exchange for Bitcoin. In 2015, Ether was distributed to buyers. It was a successful ICO. The foundation pre-sold its token for funds that were used to develop the network further. 

The amount of ICO deals and the amounts raised went asymptotic. The best ICO ever done was by Block.one, the creators of EOS. They conducted an ICO over a whole year and raised $4 billion worth of Ether at prices back then. EOS is an excellent example of the ICO craze because it raised the most money, and it was a complete piece-of-shit blockchain that barely worked.

As time went on, the projects got shittier, but the amounts raised grew larger. This was because for the first time ever, anyone with an internet connection and some crypto could own a piece of what were sold as the next hottest technology startups. Retail entered the game and made a lot of crypto bros filthy rich.

The ICO mania peaked in the fall of 2017 when the Chinese regulators explicitly banned them. Exchanges like Yunbi were shut overnight, and many projects that recently raised money from Chinese retail investors returned the funds. Around the world, regulators keen to protect the cartel of trust from competition in how early-stage ideas are fundraised swung into action, and ICO issuance disappeared.

ICO investors gave money and became motivated marketing agents for the projects. However, just because you sold tokens at a high price didn’t mean anyone would use your product. Ownership was just a function of money invested but not usage of the protocol. ICOs were a step forward, but we could do better.

Yield Farming

DeFi summer, from a northern-hemispheric perspective, started in mid-2020. A slew of projects launched during the depths of the 2018-2020 bear market started being used meaningfully. The tokens were already listed as many of these projects had either done an ICO or a token pre-sale followed by a public token generation event (TGE) by mid-2020. The project foundations allocated a large amount of tokens to be awarded to community members who performed valuable activities.

Many of these projects, like Uniswap, AAVE, and Compound, were focused on borrowing, lending, and trading. They wanted users to borrow, lend, and/or trade their crypto assets using their protocols. In return for doing said actions, the protocols would instantly emit freely tradable tokens. And thus, yield farming was born. Traders borrowed, lent, and traded cryptos on these platforms for the specific purpose of earning the governance token of the protocol. In many cases, the trader would lose money just so they could “farm” or earn more tokens. Because the tokens went up in price on a mark-to-market basis, the traders appeared to be in profit. All of this assumes you sold at the top; many didn’t, and all that activity was for naught.

From the project’s perspective, all this activity juiced their trading volumes, total value locked (TVL), and number of unique wallets that interacted with the protocol. These metrics convinced investors that DeFi was working and creating a parallel financial system governed purely by code run on decentralised virtual computers.

Participation = Ownership

All was good, except the unlocked token supply grew too quickly for many projects. Invariably, the projects had to slow emissions, and the market started to ask, “What’s next?” If all activity is predicated on aggressive token emissions schedules, what happens if the token price falls and there are no more tokens available to give prospective users? What happens is the price of the project’s token plummets alongside activity.

The lesson learned is that yield farming or liquidity mining is a great way to incentivise usage, but if it is pursued too aggressively it becomes a liability. The question then becomes, how do you emit tokens in a more sustainable manner?

Points

Yield farming as a user acquisition tool died alongside the 2021 crypto bull market. But points were created in its wake, and have quickly become the go-to pseudo-ICO fundraising and user acquisition tool for projects in this current bull cycle.

Points combine the best aspects of ICOs and yield farming.

ICOs

Yield Farming

What if a project gave you points for interacting with the protocol? These points would be converted into tokens, which would then be airdropped free of charge into users' wallets. 

What if the points to airdrop token price was completely opaque and at the discretion of the project? 

What if there was actually no promise that points would even convert into future airdropped tokens?

Here is a simple example to bring it home. Suppose that Sam Bankman-Fried (SBF) is offered a points program by his bunkmate. His bunkmate can get an infinite supply of Emsam; this is the amphetamine SBF claims he needs for his ADHD condition. His bunkmate really likes back massages. He makes a deal with SBF. For every back massage SBF administers, his bunkmate will give him a point. At a future date of his bunkmate’s choosing, the points might convert into a certain number of Emsam pills. SBF wants his meds so bad he is willing to agree to a lot of rubbing in exchange for a soft promise of future Emsam pills.

Are points a contract between the project and the user for a tangible reward in the future? No.

Is there any form of money, fiat, crypto, or otherwise that is exchanged between the user and the project for points or tokens? No.

Does the project have complete flexibility regarding the points-to-token conversion price and the timing of a token airdrop, if one happens at all? Yes.

Let’s make some other assumptions and observations. If you have a small, talented engineering team, there is no need for many other employees. That is the beauty of software. The layer-one blockchain itself handles cybersecurity; users pay gas in the native token, such as Ether, in part to pay validators or miners to secure the network. Do you need in-house lawyers? If your project is truly decentralised, maybe not. And furthermore, after your foundation is created, what other major work is there for expensive lawyers? Your biggest problem is how to get more users and that is a marketing and business development effort. Assuming you built good tech, all your money will be spent doing things to attract usage.

Building an amazing project without little, if any, VC funding is entirely possible. The project needs money to acquire users, and points are the new and exciting way to guerilla market.

With points, the project doesn’t lock itself into an aggressive token emissions schedule. That is because the points-to-token ratio can be changed at any time. There is no contract that says the project must match a specific points-to-token ratio.

With points, the project generates usage in the specific ways it believes will increase the long-term value of its service. Many of the most impactful crypto projects are some sort of two-way marketplace. Points help jumpstart network activity and overcome the cold-start or chicken-and-egg problem. The ability to surgically, dynamically calibrate points emissions to specific actions throughout the project’s ecosystem means that the project can be very effective in generating the exact type of user interaction it desires.

Finally, with points, the project doesn’t have to lean as heavily on signing token pre-sale deals with VCs and other high-net-worth investors. The major purpose of VC capital is to pay for user acquisition; points can accomplish this. The best part is that the project can implicitly sell its token at a much higher price via the opaque points program than a transparently priced round. 

Points are great for the project, but what about retail users?

Since ICOs went out of favour, retail must be super wary of VC unlock schedules. If retail apes into a token at the same time a VC’s portion unlocks, it’s REDRUM REDRUM REDRUM for retail’s portfolios. Using points, projects don’t need to engage in pre-sale token sales to such a large extent. Using points, retail can “invest” earlier and hopefully get a cheaper price than if they waited until after the TGE. While ambiguity surrounds the timing of the airdrop and the points-to-token ratio, points might represent a more equitable way to reward users for their participation.

A points program is only effective if there is a high degree of trust between users and the project’s founders. The user trusts that after interacting with the protocol, their points will convert into tokens at a reasonable price in a reasonable time frame. As points programs proliferate, there will be bad actors who abuse this trust. Ultimately, an egregious breach of trust that encompasses a large amount of money might be what kills points as a fundraising and user engagement tool. But we aren’t there yet, so I ain’t fussed.

All Aboard

Whether you like it or not, every successful project, and by success I mean, token number go up, will enact a points program before their TGE. This will create usage of the protocol, hype around the probable token airdrop, and a Pump Up The Jam! public listing. 

I am a businessman, not a priest. The only dogma I subscribe to is “number go up!” 

If points create better alignment between users and the protocols, LFG.

If the cartel of trust’s hold on fundraising of the new and innovative technology startups further erodes because points are considered a better user engagement and fundraising mechanism, sign me up.

I hope this essay provides some context on what points are and why I believe they will power this cycle's best-performing token launches. Maelstrom’s got bags, and I’m not ashamed to tell readers about them. Expect many more essays on exciting projects in our portfolio that launch points programs before their eventual TGE. My body is ready, is yours?