OK, this one has been building for a while so strap in. I talk to at least 2-3 seed stage founders/teams every week. Without fail every single one of them is fucking up some aspect of capital formation for crypto protocols. Every. Single. One.
I kind of hoped someone was paying attention to me… I thought I had been really explicit and clear about my thoughts on this across a number of blog posts over the years but clearly no one was reading them, maybe a tweet storm will be more effective.
This is all just my opinion and perspective, but it is an opinion forged in the fires of my own idiocy, so it has been somewhat well earned.
I talked to a founder this morning, I said listen, when it comes to traditional startups, apps and other marketplaces etc there is a playbook. You can have a couple of founders one operational/capital and one deeply technical. You simply execute the capital formation playbook.
Traditional startup risk is all on the go to market and tech execution side. There is no playbook in crypto, you CANNOT just focus on the tech and ignore capital formation. If you want to start a protocol you need to have a holistic approach or you will fuck yourself later.
If you want to go to a lawyer/accountant they will start talking to you about The DAO decision and Munchee, that is the cutting edge of the regulatory landscape for them. They will not start talking about YFI and COMP tabula rasa governance tokens.
I like lawyers and accountants as people, but even the absolute best need to incorporate their advice into a framework that adheres to the real world in some sense. We left the real world in DeFi a while ago, so they are just not going to be able to advise you on all options.
You as the founder must be aware of these innovations, crypto is moving so fast that if you do not keep abreast of the latest experiments and ruthlessly cherry pick the best parts someone else will and they will fucking steamroll you.
The Overton window of capital formation has been blown wide open in the last six months. There are so many incredible lessons to take away. You must learn them and incorporate them into your world view, others will and they will have a huge advantage.
The good news is that most are not yet there, as I pointed out in the first tweet, basically everyone is fucking this right now, so you have time.
There is a trade-off when you do weird shit in capital formation, people typically are less willing to give you money. But not always. @matt_levine used to talk about this all the time wrt the “Enchanted Forest" and tech unicorns.
Weird 8 layer equity structure where your great-grandmother controls 30% of the voting power from beyond the grave and you need to get out a special ouija board for proxy votes. Sure why the fuck not, said every tech investor from 2012-2019.
A similar dynamic is present in DeFi right now, and you as the founder(s) should be optimising for it. Giving immediate control of all governance to token holders as soon as the token is issued, sounds scary? Not anymore.
Leverage is now in the hands of protocols so people looking to create them should be optimising for getting as much control of the meta-governance of the protocol in the hands of the token holders as possible. It doesn't need to be direct token voting but it should be open.
So if I were creating a new protocol today what would I do? It is a coordination game, so step one is setting up the rules for the initial arrangement of the board. Mainly this means the token distribution and capital requirements.
We want to set up a new game and everyone needs to contribute something. Some contribute upfront effort to organise the game, some contribute capital, some contribute technical knowledge and all kinds of other stuff. So we slice up the initial allocation.
Founders of protocol have been retaining progressively less control in recent years, this may change, but we don’t see many Google/Facebook scenarios where founders control 50%+ of voting power. Most founders get low single digits tokens.
We also need to work out how much we are going to allocate to incentivise early participation and further capital contribution. Opportunity costs are high in the yield farming game these days, so if you want seeds sown in your field you need to get this right. Maximise it.
So we set up a DAO and deploy it with these initial rules and allow anyone to join by sending the requisite amount of ETH/USDS.
Now we have the board set. Time to start the game. We must test market interest, we got an initial contribution to form the DAO. But we need to ensure there is some price discovery in market. Just because Masa Son bought our token at a 48b val doesn't mean anyone else will…
Now we can do the optimally dumb thing here if we are so inclined, which is put a few dozen tokens on uniswap and walk away. Or you can try to find a clearing price for a decent % of the network, for that you need @gnosisPM Protocol. Ping @koeppelmann he will help for a few Pax.
Once we have a clearing price we can then all vote to determine the distribution curve for protocol incentives. If we do that first before we have any market sentiment we could end up paying out tens of millions in a few weeks without any long term benefit, oops.
But wait, you are probably saying, plz sir muh familie. Yes we need people to stop doing whatever the market is currently paying them to do and get them to do things the protocol needs. Like writing and deploying code. How do we do that?
Pretty simple, we get people to request grants from the DAO and we pay them if they are good and we don't if they are bad. We the governance token holders have sole discretion over which grants are paid and which aren't. Critically, there are no privileged positions!
Everyone serves at the pleasure of the DAO. Do a bad job, no grants for you. Do a good job, more grants. Start small and based on reputation and past performance make larger grants. Twitter is telling me to wrap this up. So I will leave it there for now. Don't do dumb shit!
