Understanding the Original Sin of Crypto Networks: How to Make the World of Cryptocurrency Fairer

This article was published on placeholder, author: Captain Hiro, translated by Captain Hiro from Babbit.

In a recent conversation between the Placeholder and USV teams, Fred Wilson stated that over time, the organizations he has experienced have gradually moved in the wrong direction, often traceable to the initial original sin (team, method, economics, or any other key decision). For cryptocurrencies, one original sin we often observe is that internal investors hold too much of the so-called public, equitable network's shares.

While "fair distribution" is a normative understanding, it actually stems from a consensus within the cryptocurrency space: to create a fair playing field where everyone has the opportunity to achieve financial sovereignty. If the goal is merely to make a small group of people wealthy, allowing them to take most of the benefits (which is common), we severely undermine the redistributive effect of this technology. In fact, these individuals can still achieve decent returns even with relatively smaller gains, but they instinctively try to take as much share as possible, justifying their actions with "that's how things have always been done" or the so-called "many fiduciary responsibilities."

We are striving to build permissionless, open technology. Most of the processes are open, but the most closed and mysterious part of this process is early financing. While this is driven to some extent by regulation and social norms, what is more frightening is that internal investors may disproportionately tilt towards what benefits them (making more money), while simultaneously hiding the details from public view. The more impatient early investors are to profit, the bolder and more reckless they become, to the extent that their actions can adversely affect the healthy development of the entire industry.

Under this veil of opacity, the same norms and structures that have historically led to imbalances in wealth and power distribution are at play. If we do not openly address what happens during the initial financing phase of cryptocurrency networks, we will inevitably repeat the same social mistakes of the past.

Where there is capital accumulation, there is power accumulation.

The two groups most closely involved in the initial creation and distribution of capital are entrepreneurs and early investors (whether VC, HF, or the investor structure in cryptocurrency). If entrepreneurs want to do something, unless they have enough funds to independently support themselves and their teams, they will turn to early-stage investors, who provide venture capital to fund their entrepreneurial journey. Although cryptocurrency often demonizes this process, it can be a healthy and beneficial one that allows entrepreneurs without any wealth accumulation to take risks on an idea, with the potential for high returns if it succeeds, while also being able to live normally under contractual protections if it fails.

However, in another world, this relationship can become very unhealthy, especially when an opportunistic investor realizes the information asymmetry between investors and entrepreneurs, compounded by the entrepreneur's lack of experience. First-time entrepreneurs need to be very cautious. We have seen this in enough transactions to know that in the cryptocurrency space, early predatory behavior should be more prevalent.

This asymmetrical advantage gives early investors a "home field advantage," as long as they can get entrepreneurs to agree to relevant legal agreements earlier, the risks after the network goes live will remain perpetually unbalanced due to this original sin.

As an entrepreneur, a good channel for protecting yourself is to connect with other entrepreneurs who have already gone through financing. Ask about the reputations of other investors, what they regret, what they consider fair, and so on. If you are considering a major investor, you should be able to talk to any network in that investor's portfolio to get a reference for that investor—references do not need to be one-sided. Additionally, if possible, try to secure as many letters of intent as you can. These are some simple steps to protect yourself as an entrepreneur.

If we want to achieve structural social change, then entrepreneurs and investors need to work together to realize the changes we hope for. If we do not do this, the default way will continue to be the way things have always been done. While cryptocurrency is a technology open to capital, how cryptocurrency is redistributed will depend on the social norms we tolerate and recognize.

For Placeholder, our goal is to have 1-5% network ownership based on fully diluted cryptocurrency, and Placeholder's largest position is only 7% of fully diluted cryptocurrency ownership. Some may argue that this figure is still too high, but compared to companies where private investors hold 10-20% equity, this number is still far lower. This figure is appropriate for cryptocurrency, as cryptocurrency networks are a new type of economy that uses protocols instead of companies or governments, focusing on a limited set of services and having global scale from the outset. We assume that compared to companies, cryptocurrencies require a more even distribution of ownership to maximize efficiency, as companies do not use equity to accelerate supply-side and demand-side growth, which is often how crypto networks utilize their crypto assets.

From our perspective, when capital is initially allocated, Placeholder advocates for "internal investors receiving 25%, while secondary market investors receive 75% (the amount received by secondary market investors is three times that of internal investors)." By internal investors, we refer to the core team, pre-IPO investors, and advisors—all of whom take risks that their investments may go to zero, and their labor and capital may be lost. For some internal investors, 25% may seem too high. For example, Zcash allocates 20% of block rewards to non-mining network donations, which Bitcoin enthusiasts have long complained about, but compared to the more common practice of allocating 40-50% rewards to internal investors, 25% is relatively low.

However, the approach of Placeholder may not be perfect. We do not always achieve this goal, and when we do not (for instance, when more than 25% of assets are allocated to internal investors), it is usually based on expectations of long-tail inflation and is seen as a strategy for redistribution and long-term growth. Additionally, when governance rights are transferred to token holders, the planned supply allocation can be adjusted accordingly (ironically, when secondary market investors receive tokens, they can quickly exhibit a degree of internal behavior).

Another way to observe token distribution is to analyze the multiples of tokens received by outsiders relative to internal investors. For us, we believe that within today's feasible range, this will help society move towards a fairer direction, with secondary market investors receiving 2-4 times the amount of internal investors. The group represented by internal investors is much smaller in number, so there needs to be a greater share of network tokens available to the unpermissioned public.

To achieve this goal, it is reasonable for internal investors to be allocated 20-33% of fully diluted network tokens to get the network started. In this internal configuration, our goal is for entrepreneurs to receive twice the number of tokens as investors; because the team is more important than the investors and should receive equal consideration. The unpermissioned public will receive 67-80% of the initial distributed supply (with internal investors receiving at least twice, or a minimum of four times).

Some may argue that, like Bitcoin, there should be no private placements at all. Depending on the project's goals, this may indeed be a viable option for some networks and entrepreneurs (refer to how Decred financed itself). We look forward to seeing more similar experiments and potentially supporting them in the public market.

As an entrepreneur, it is most important to remember that you need to decide on the fairest distribution for the network you are creating and then find investors who align with those values. If you prefer a more centralized ownership model, seek out investors with similar preferences. If you want to achieve a more balanced distribution of capital in the world, do not hesitate to clearly communicate your thoughts to potential investors; we at Placeholder would be happy to talk with you. Once you complete the founding and initial issuance of the network, the design of your network mechanism will give you a second chance to shape power and resource accumulation.