Written by: Jesse Walden, Variant Partner; Jake Chervinsky, Variant CLO
Translated by: Saoirse, Foresight News
Introduction
Over the past decade, crypto entrepreneurs have generally adopted a value distribution model that attributes value to tokens and equity as two separate carriers. Tokens provide a new way for networks to expand at an unprecedented scale and speed, but the premise of releasing this potential is that tokens must represent users' genuine needs. However, the continuous regulatory pressure from the SEC has greatly hindered entrepreneurs from injecting value into tokens, forcing them to shift their focus to equity. Now, this situation urgently needs to change.
The core innovation of tokens lies in achieving "self-ownership" of digital assets. Through tokens, holders can independently own and control funds, data, identity, and the on-chain protocols and products they use. To maximize this value, tokens should capture on-chain value, which is transparent, auditable, and directly controlled only by token holders.
Off-chain value is different. Since token holders cannot directly own or control off-chain income or assets, such value should belong to equity. Although entrepreneurs may wish to share off-chain value with token holders, this often carries compliance risks: companies controlling off-chain value typically have fiduciary obligations to prioritize assets for shareholders. If entrepreneurs want to direct value towards token holders, these values must exist on-chain from the beginning.
The basic principle that "tokens correspond to on-chain value, equity corresponds to off-chain value" has been distorted by regulatory pressure since the birth of the crypto industry. The SEC's broad interpretation of securities laws not only led to misaligned incentives between companies and token holders but also forced entrepreneurs to rely on inefficient decentralized governance systems to manage protocol development. Now, the industry has ushered in a new opportunity for entrepreneurs to re-explore the essence of tokens.
Old SEC Regulations Constrained Entrepreneurs
During the ICO era, crypto projects often raised funds through public token sales, completely ignoring equity financing. They promised that building the protocol would boost token value upon listing, with token sales being the sole fundraising method and tokens the only value-bearing asset.
However, ICOs failed to pass SEC scrutiny. Since the 2017 DAO Report, the SEC applied the Howey Test to public token sales, determining most tokens as securities. In 2018, Bill Hinman (former SEC Corporate Finance Director) defined "sufficient decentralization" as the key to compliance. In 2019, the SEC further released a complex regulatory framework that increased the probability of tokens being classified as securities.
In response, companies abandoned ICOs and turned to private equity financing. They supported protocol development through venture capital and only distributed tokens to the market after protocol completion. To comply with SEC guidelines, companies must avoid any actions that might increase token value after launch. The SEC's regulations were extremely strict, forcing companies to almost completely disconnect from the protocols they developed, and even discouraging them from holding tokens on their balance sheets to avoid being seen as having financial motivations to boost token value.
Entrepreneurs subsequently transferred protocol governance rights to token holders and focused on building products on top of the protocol. The core idea was that token-based governance mechanisms could serve as a shortcut to "sufficient decentralization," with entrepreneurs continuing to contribute to the protocol as ecosystem participants. Additionally, entrepreneurs could create equity value through a "complementary goods commoditization" business strategy, providing open-source software for free and then generating profits through upstream or downstream products.
However, this model exposed three major problems: misaligned incentives, low governance efficiency, and unresolved legal risks.
First, there was a misalignment of incentives between companies and token holders. Companies were forced to direct value towards equity rather than tokens, both to reduce regulatory risks and to fulfill fiduciary obligations to shareholders. Entrepreneurs stopped pursuing market share competition and instead developed business models focused on equity appreciation, even having to abandon commercialization paths.
Secondly, the model relied on Decentralized Autonomous Organizations (DAOs) to manage protocol development, but DAOs were not well-suited for this role. Some DAOs operated through foundations but often fell into their own incentive misalignments, legal and economic constraints, operational inefficiencies, and centralized access barriers. Other DAOs used collective decision-making, but most token holders lacked interest in governance, and token-based voting mechanisms led to slow decisions, mixed standards, and poor results.
Third, the compliance design failed to truly mitigate legal risks. Despite the model's aim to meet regulatory requirements, the SEC still investigated companies using this approach. Token-based governance also introduced new legal risks, such as DAOs potentially being viewed as general partnerships, exposing token holders to unlimited joint liability.
Ultimately, the actual cost of this model far exceeded expected benefits, weakening the protocol's commercial viability and damaging the market appeal of related tokens.
Tokens Carry On-Chain Value, Equity Carries Off-Chain Value
The new regulatory environment provides entrepreneurs with an opportunity to redefine the reasonable relationship between tokens and equity: tokens should capture on-chain value, while equity corresponds to off-chain value.
The unique value of tokens lies in enabling self-ownership of digital assets. They grant holders ownership and control of on-chain infrastructure with global, real-time, and auditable transparency. To maximize this characteristic, entrepreneurs should design products where value flows on-chain, allowing token holders to directly own and command.
Typical examples of on-chain value capture include: Ethereum benefiting token holders through EIP-1559 protocol fee burning, or redirecting DeFi protocol income to on-chain treasuries through fee conversion mechanisms; token holders can also profit from licensed third-party intellectual property or earn returns by routing all fees through on-chain DeFi front-end interfaces. The core principle is that value must be transacted on-chain, ensuring token holders can directly observe, own, and control without intermediaries.
In contrast, off-chain value should belong to equity. When income or assets exist in off-chain scenarios like bank accounts, business collaborations, or service contracts, token holders cannot directly command them and must rely on companies as value transfer intermediaries, a relationship potentially subject to securities laws. Moreover, companies controlling off-chain value have fiduciary obligations to prioritize returning earnings to shareholders rather than token holders.
This does not negate the rationality of the equity model. Even for core products like public chains or smart contract protocols that are open-source software, crypto companies can still succeed through traditional business strategies. By clearly distinguishing that "tokens correspond to on-chain value, equity corresponds to off-chain value," actual value can be created for both.
Minimize Governance, Maximize Ownership
In this new era, entrepreneurs need to abandon the mindset of using tokenized governance as a regulatory compliance shortcut. Instead, governance mechanisms should only be enabled when necessary and maintained at a minimal and orderly level.
One of the core advantages of public blockchains is automation. Generally, entrepreneurs should automate as many processes as possible, reserving governance rights only for matters that cannot be automated. Some protocols might benefit from "humans at the edges" intervention, such as executing upgrades, allocating treasury funds, and overseeing dynamic parameters like fees and risk models. However, the governance scope should be strictly limited to scenarios exclusive to token holders' functions. In simple terms, the higher the degree of automation, the more efficient the governance.
When full automation is not feasible, delegating specific governance rights to a trusted team or individual can enhance decision-making efficiency and quality. For example, token holders can authorize protocol development companies to adjust certain parameters, eliminating the need for consensus voting on every operation. As long as token holders retain ultimate control (including the ability to monitor, veto, or revoke authorization at any time), the delegation mechanism can both safeguard decentralization principles and achieve efficient governance.
Entrepreneurs can also use customized legal frameworks and on-chain tools to ensure effective governance mechanisms. It is recommended that entrepreneurs consider adopting new entity structures like Wyoming's DUNA (Decentralized Autonomous Nonprofit Association), which grants token holders limited liability and legal personality, enabling them to sign contracts, pay taxes, and seek legal protection. Additionally, they should consider using governance tools like BORG (Blockchain Organization Registration Governance) to ensure DAOs operate within a framework of on-chain transparency, accountability, and security.
Moreover, it is crucial to maximize token holders' ownership of on-chain infrastructure. Market data indicates that users have extremely low recognition of the value of governance rights, with few willing to pay for voting rights on protocol upgrades or parameter changes. However, they are highly sensitive to ownership attributes such as income distribution rights and on-chain asset control rights.
Avoiding Securities-like Relationships
[The rest of the translation follows the same professional and accurate approach, maintaining the original meaning and technical nuance.]One of the core issues is: Can securities law regulation be avoided while completely abandoning governance mechanisms? Theoretically, token holders can merely hold digital assets without exercising any control rights. However, if holders remain entirely passive, this relationship might evolve into the scope of securities law application, especially when the enterprise still retains partial control rights. Future legislation or regulatory rules might recognize the "single asset" model without governance, but entrepreneurs currently still need to follow the existing legal framework.
Another issue concerns how entrepreneurs handle initial financing and protocol development in the single asset model. Although mature architectures are relatively clear, the optimal path from startup to scale remains unclear: How can entrepreneurs raise funds to build infrastructure without sellable equity? How should tokens be distributed when the protocol goes online? What legal entity type should be adopted, and does it need to be adjusted with development stages? These details and more questions are yet to be explored by the industry.
Moreover, some tokens might be more suitable for being defined as on-chain securities. However, the current securities regulatory system almost stifles the survival space of such tokens in a decentralized environment, which could have released value through public chain infrastructure. Ideally, Congress or SEC should promote modernization of securities laws, enabling traditional securities like stocks, bonds, notes, and investment contracts to operate on-chain and achieve seamless collaboration with other digital assets. But before that, regulatory certainty for on-chain securities remains far from reach.
Path Forward
For entrepreneurs, there is no universal standard answer for token and equity architectural design, only a comprehensive weighing of costs, benefits, risks, and opportunities. Many open-ended questions can only be gradually answered through market practices, after all, only continuous exploration can verify which model is more viable.
Our intention in writing this article is to clarify the current choices facing entrepreneurs and sort out potential solutions that might emerge with the evolution of crypto policies. Since the birth of smart contract platforms, ambiguous legal boundaries and strict regulatory environments have always constrained entrepreneurs' potential to release blockchain tokens. The current regulatory environment has opened up a completely new exploration space for the industry.
We have constructed a navigation map to help entrepreneurs explore directions in this new domain and proposed several development paths we believe have potential. But it must be clear that the map is not the real territory itself, with many unknowns waiting for the industry to pioneer. We firmly believe that the next generation of entrepreneurs will redefine the application boundaries of tokens.
Acknowledgments
Special thanks to Amanda Tuminelli (DeFi Education Fund), John McCarthy (Morpho Labs), Marvin Ammori (Uniswap Labs), and Miles Jennings (a16z crypto) for their profound insights and valuable suggestions for this article.
