John Gilbert

Aptos led the January bull run with a 470% return for the month. With little on-chain activity and only $60 million in TVL, you may be asking why. 



Advocates argue that these gains were the result of ecosystem announcements. Critics point to its opaque token distribution as a sign of predatory tokenomics.



But what tokenomic clues signal predatory behavior? And why is it a common accusation?



Tokenomics turn predatory when project insiders use supply controls to artificially drive demand and take profits at the expense of others.



These insiders are like wolves in wolves clothing — a mixed bag of venture capitalists and angel investors. The flock, conditioned to follow the flow of smart venture capital, chase the momentum despite warnings.&nbsp;&nbsp;



Some find a distinct joy in arguing that all crypto tokens fall under this model. But the economic incentives, supply controls, utility and revenue sharing vary greatly between digital assets. Our previous <a href="https://blockworks.co/news/what-is-tokenomics">Investor&#8217;s Guide on Tokenomics</a> explains the different models in more detail. In this article, we will explain how some models are more prone to exploitation than others.



<h2 class="wp-block-heading">Tokenomics gone wrong</h2>



A project&#8217;s tokenomics is a blueprint that outlines the key characteristics and factors that influence its value and price. A token issuer, just like a house architect, may include exploits in its design.&nbsp;



But because the number and severity of these exploits exist on a spectrum, it is hard to pinpoint exactly when they turn predatory. Unfortunately, an accusation can only prove conclusive if someone makes it after project insiders use a design exploit. And even then, the charge still requires evidence of intent to qualify.&nbsp;



This article in no way makes such an accusation against the examples listed. And it should not be interpreted as investment advice. Instead, it explains the most recent concerns and extrapolates a list of red flags to avoid.&nbsp;&nbsp;&nbsp;



<h3 class="wp-block-heading">Flag 1: Misleading distribution disclosures</h3>



Token distribution disclosures are essential to understanding the risk of when, who and why insiders will take profits. An issuer with predatory intent may make the disclosure appear less risky to attract investors.



For example, many could perceive Aptos&#8217; supply schedule disclosure as misleading. The project started with a total of 1 billion tokens (none of which were made available through public sale). Here is how they distributed the total supply:



<figure class="wp-block-table"><table><tbody><tr><td>Community</td><td>51.02%</td><td>510,217,359.77</td></tr><tr><td>Core Contributors</td><td>19.00%</td><td>190,000,000.00</td></tr><tr><td>Foundation</td><td>16.50%</td><td>165,000,000.00</td></tr><tr><td>Investors</td><td>13.48%</td><td>134,782,640.23</td></tr></tbody></table></figure>



The <a href="https://aptosfoundation.org/currents/aptos-tokenomics-overview" target="_blank" rel="noreferrer noopener">post</a> stated, &#8220;All investors and current core contributors are subject to a four-year lock-up schedule with no <a href="https://blockworks.co/price/APT">APT</a> available for the first twelve months.&#8221; These two categories amount to 32.48% of the total supply.&nbsp;



The project made the distribution schedule of the other two categories vague. The post states that &#8220;these tokens are anticipated to be distributed over a ten-year period&#8221; and that after an immediate distribution of 130M tokens, 1/120 of the remainder &#8220;are anticipated to unlock each month.&#8221;&nbsp;&nbsp;



Using hedging language like &#8220;are anticipated&#8221; may seem irrelevant at first glance, but it creates ambiguity shielding the project from making a firm commitment not to sell.



It also stated that insiders across all categories were staking 82% of the supply. Consequently, popular sites have used the staked data to calculate a circulating supply of roughly 15% to 18% (currently 162,086,803).&nbsp;



This adds to the confusion because CoinGecko&#8217;s circulation supply definition states, &#8220;It is comparable to looking at shares readily available in the market (not held &amp; locked by insiders, governments).&#8221;



But according to Aptos co-founder <a href="https://twitter.com/moshaikhs/status/1582470822886637568?s=20&amp;t=RUz9LN39xHYMg6cyUA2mSQ" target="_blank" rel="noreferrer noopener">Mo Shaikh</a>, stakers can unlock tokens every 30 days.&nbsp;



This distribution is not evidence that the project intended to mislead investors. But, when combined with the supply schedule graph, one could argue that they made it appear as if 82% of the supply (the same percentage of tokens staked) can&#8217;t become available for at least a year, when in fact, only 32.48% is subject to an official 1-year lock-up.&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;



<figure class="wp-block-image"><img decoding="async" src="https://lh3.googleusercontent.com/2845Ltk40l29VnMfRtQyjIwyx84dbS8-j5S4ZgmZH9WCBm4xVWG7VxN82mCxosBTGIJZb2Z-d7P_na-eliYz_R1dr_C77w0mge05gHvSrESbjlMMrB_Jqz_LG7t5OujehYQq5mSmzF3vEOnyJwJvI_4" alt=""/></figure>



The tokenomics post did state that the schedule is an estimate and included a disclaimer stating that it is subject to change without notice. But this has not prevented investors from <a href="https://youtu.be/6oywqy5AMsk?t=147" target="_blank" rel="noreferrer noopener">using the graph</a> to share a popular investing thesis predicated on the belief that close to 8.5 million (85%) of APT is locked for a year.&nbsp;



The limited liquidity on exchanges and the massive supply at the disposal of project insiders have led some to make accusations of price manipulation.



<figure class="wp-block-embed is-type-rich is-provider-twitter wp-block-embed-twitter"><div class="wp-block-embed__wrapper">
<blockquote class="twitter-tweet" data-width="550" data-dnt="true">Aptos dev team wallet has started feeding the Korean ducks, ~$20mm in spot sent to Binance in the last hour. $1b in inventory remains in the wallet. The tightly controlled supply has activated. <a href="https://t.co/Ll75mTX0TQ">pic.twitter.com/Ll75mTX0TQ</a>&mdash; light (@lightcrypto) <a href="https://twitter.com/lightcrypto/status/1619155047618850818?ref_src=twsrc%5Etfw">January 28, 2023</a></blockquote><script async src="https://platform.twitter.com/widgets.js" charset="utf-8"></script>
</div></figure>



<h3 class="wp-block-heading">Flag 2: Lack of utility</h3>



A token&#8217;s utility is a crucial aspect in determining its value. If it has no utility, its price is purely the result of speculation, leaving it vulnerable to manipulation by early investors and insiders.



Some see the <a href="https://blockworks.co/price/dydx">dYdX governance token</a> as an example of broken utility. While the platform uses it to incentivize trading activity and provide liquidity on the dYdX platform, there is very little reason for investors to hold the token once earned. There is no revenue-sharing model or meaningful governance incentives. The protocol removed all previous staking opportunities. And now the only motivation left is trading fee discounts.&nbsp;&nbsp;



Read more on the <a href="https://www.blockworksresearch.com/assets/dydx/tokenomics" target="_blank" rel="noreferrer noopener">Blockworks Research analysis of dYdX tokenomics</a>.



&#8220;To me [the governance feature] is just disingenuous,” Jeff Dorman, chief investment officer at Arca, said of dYdX. “You can&#8217;t ever actually participate in governance, because six holders own 90% of the token.&#8221;



This lack of utility makes it easier for project insiders to potentially generate speculative demand by delaying insider token unlocks, leading to, as Dorman states, &#8220;time-based selling pressure rather than merit-based buying.&#8221;



DYdX is one of the tokens that made the leaderboard for top-performing tokens in January. It increased by 210% from the start of the year. But this bull run coincided with an <a href="https://twitter.com/dydxfoundation/status/1618302395603161114?s=20&amp;t=i81l9j2-VcC-hq0q9Yn_iQ" target="_blank" rel="noreferrer noopener">announcement</a> to &#8220;postpone the initial release date applicable to investor $DYDX tokens to Dec 1, 2023.&#8221;&nbsp;



<figure class="wp-block-image"><img decoding="async" src="https://lh6.googleusercontent.com/eQCh0m2qy8FPfovaLiF42dsaG_Pv1kxoD0z_A99FV4XgzaFWMxFH3Y3fwi-orV-TYhicZiJ6aWry_IXhNRnZN8GYKpsrJPWx97oabVvK_6Xg1uIS1LgRrswfNd777ic7O-rnIlTKlbg30rFOI9LFG0Q" alt=""/></figure>



While this correlation is not direct proof that the announcement drove the price, it supports the narrative that tokens with weak utility are vulnerable to this type of manipulation.&nbsp;



<h3 class="wp-block-heading">Flag 3: Conflicts of interest</h3>



How a project makes money and shares it with its investors is crucial in determining the alignment of incentives. In the unregulated world of cryptocurrency, many projects choose not to share revenue with token holders due to their close resemblance to a security. And, in some cases, such as dYdX, all revenue is directed to an <a href="https://www.ar.ca/blog/dydxs-broken-tokenomics-and-pointless-vc-unlocks" target="_blank" rel="noreferrer noopener">LLC</a>.&nbsp;



This arrangement can lead to a conflict of interest between token holders and inside investors. The lack of shareholder obligations makes project owners less incentivized to drive token demand.&nbsp;



Tokens that behave like commodities or currencies can fit this model. However, when there is no practical use or widespread adoption as a payment solution, the token acts more like an inflationary store of value. In dYdX&#8217;s case, the token saw an 82% decrease in value since its launch in September 2021.&nbsp;



<figure class="wp-block-image"><img decoding="async" src="https://lh4.googleusercontent.com/nq3rEw7tvEP43qvAfxjYVwff5OVMwZrferaHl5z8q1xQd9vqmVPNM7QaGvUyG4i9EJBpqhi29FYO-UiyAL1zZVX0uBqqxpd2asmXDxnCRwZHiWUXa5u9SWf1AvgS5X5i0AhL1IklgHimG1JXZeTfMVU" alt=""/></figure>



Dorman explained that there are many creative ways to drive demand for the dYdX token.&nbsp;



&#8220;One is to feed some of those revenues back through the token, either in the form of buybacks, or in the form of building up the DAO treasury. They could have partnerships with other platforms or protocols where the dYdX token has some value within someone else&#8217;s ecosystem. What you can&#8217;t do is just assign zero value and just say it&#8217;s a governance token, where you can&#8217;t ever actually participate in governance.&#8221;



Though, when a project like dYdX has scheduled token unlocks, there is a real temptation to pull the postponing lever instead of implementing the changes Dorman listed.&nbsp;



He added: &#8220;In my opinion, we&#8217;d be better off if there were no unlocks. It doesn&#8217;t incentivize any parties, the investors nor the issuing company to do anything before you get to unlock that value. And two, it restricts and floats and the tradable asset in a way that artificially creates gains.&#8221;



<h2 class="wp-block-heading">Understanding the wolf of crypto</h2>



The common occurrence of predatory tokenomics has led many skeptics to claim that the problem is inherent to crypto. But if you take a closer look, the pattern reveals that the wolf behind the wolf mask isn&#8217;t necessarily coming from within the industry.&nbsp;



&#8220;Most of these projects in their early days are very reliant on venture capital money,” Daniel McAvoy, blockchain and funds attorney at Polsinelli, said. “You know, there isn&#8217;t really a great way to get off the ground without going that route.”



“So in addition to equity and a slug of tokens, the VCs also want a hand in helping determine what the tokenomics are even going to be.&#8221;



He said that the one-year locking period is &#8220;almost universal&#8221; in the token purchase agreements and that a big reason for that is, &#8220;Under Securities Act Rule 144, there&#8217;s potentially an ability to resell something without requiring registration of that resale — so long as there&#8217;s been a one year holding period with respect to the token.&#8221;



If based in the US, venture capital fund managers must take reasonable steps to comply with SEC guidelines. But in addition to staying compliant with rules on the offer, sale and resale of securities, McAvoy said, &#8220;there&#8217;s also the fiduciary responsibilities that the venture capital manager has to their clients.&#8221;



He added: &#8220;The venture managers have a duty of care and loyalty. One of the things that they&#8217;re supposed to try and do is maximize returns for their investors. And to do so in a manner that is as close to compliant as possible. So there&#8217;s a bit of a push and pull. The duties that you have to your investors don&#8217;t necessarily match up with your desire for a particular protocol to succeed.&#8221;



So if a venture capital fund has a hand in influencing a project&#8217;s bad tokenomics, it may benefit from exiting a major position in a way that avoids potential fallout. Their playbook is to argue that their sale of an unregistered security qualifies for exemption and is in the interest of their investors. The SEC regularly enforces and takes into account the fiduciary responsibility of these fund managers to their investors, but they do not provide token holders the same degree of protection.&nbsp;&nbsp;



The reliance on venture capital funding and uneven enforcement of securities law fuel this predatory behavior. It creates an environment where token issuers are afraid to work in the interest of token holders and venture capital funds are encouraged to take profits at token holders expense.&nbsp;



This sad reality is an extension of the hyper-financialization problem seen across markets – where powerful institutions use the concentration of capital to drive speculative bubbles and extract wealth from new participants.&nbsp;



<h2 class="wp-block-heading">Final thoughts</h2>



Crypto has a complicated relationship with the &#8216;wolf of trading&#8217; archetype. News about venture capital investment in a particular project can carry credibility for some and incite suspicion in others. This division combined with the inherent competition between projects makes it difficult to navigate for an uninformed newcomer.&nbsp;



And while there are many innovative projects with fair launch distribution and real world utility embedded in their tokenomics, they often get lost in the socially engineered hype of well connected and venture capital-backed tokens.



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