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 allocation model that separates tokens and equity into two distinct carriers. Tokens provide a new way for networks to expand at an unprecedented scale and speed, but this potential can only be realized if tokens truly represent user 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 - transparent and auditable income and assets directly controlled 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 crypto industry's inception. 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 arrived at a new opportunity for entrepreneurs to re-explore the essence of tokens.
SEC's Old 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 drive token value post-launch, 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 had to avoid any actions that might increase token value after launch. The SEC's regulations were so strict that companies almost had to completely separate from the protocols they developed, and were even discouraged from holding tokens on their balance sheets to avoid being seen as having financial motives 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 could be 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 by providing open-source software for free and generating profits through products above or below the protocol.
However, this model exposed three major problems: misaligned incentives, low governance efficiency, and unresolved legal risks.
First, incentives between companies and token holders became misaligned. Companies were forced to direct value towards equity rather than tokens, both to reduce regulatory risks and fulfill fiduciary obligations to shareholders. Entrepreneurs stopped pursuing market share competition and instead developed business models focused on equity appreciation, even abandoning 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, resulting in slow decisions, mixed standards, and poor outcomes.
Third, compliance design failed to truly mitigate legal risks. Despite the model's intent to meet regulatory requirements, the SEC still investigated companies using this approach. Token-based governance 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 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, auditable transparency. To maximize this characteristic, entrepreneurs should design products where value flows on-chain, allowing token holders to directly own and command.
Typical on-chain value capture examples 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 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 partnerships, or service contracts, token holders cannot directly command them and must rely on companies as value transfer intermediaries, a relationship potentially constrained by 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 must 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 much 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 - simply put, the higher the degree of automation, the more efficient the governance.
When full automation is not feasible, delegating specific governance rights to trusted teams or individuals 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 execute transactions 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 the value of ownership attributes such as income distribution rights and on-chain asset control rights.
Avoiding Securities-like Relationships
To address regulatory risks, tokens must be clearly distinguished from securities.
The core difference between securities and tokens lies in the rights and powers they confer. Generally, securities represent a series of rights tied to a legal entity, including economic benefits, voting decision-making, information rights, or legal enforcement rights. Taking stocks as an example, holders obtain specific ownership linked to a company, but these rights are entirely dependent on the company's entity. If the company goes bankrupt, these rights become invalid.
In contrast, tokens grant control over on-chain infrastructure. These powers exist independently of any legal entity (including the infrastructure's creators). Even if a company exits operations, the powers conferred by the token will persist. Unlike security holders, token holders typically do not enjoy trustee protection or have legal rights. Their assets are defined by code and are economically independent of their creators.
[The translation continues in the same manner for the entire text, maintaining the original structure and meaning while translating to English.]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 retains partial control rights. Future legislation or regulatory rules might recognize the "single asset" model without governance, but entrepreneurs currently need to comply with existing legal frameworks.
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 might it need adjustment across development stages? These details and more await industry exploration.
Additionally, some tokens might be more suitable for being defined as on-chain securities. However, the current securities regulatory system almost stifles the survival of such tokens in decentralized environments, which could have released value through public chain infrastructure. Ideally, Congress or the SEC should promote securities law modernization, 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 distant.
Path Forward
For entrepreneurs, there is no universal standard for token and equity architectural design, only comprehensive trade-offs between costs, benefits, risks, and opportunities. Many open-ended questions can only be gradually answered through market practices, as continuous exploration is the only way to validate which models are more viable.
Our intention in writing this article is to clarify current choices for entrepreneurs and outline potential solutions that might emerge with evolving crypto policies. Since smart contract platforms' inception, ambiguous legal boundaries and strict regulatory environments have constrained entrepreneurs' potential to unleash blockchain tokens. The current regulatory environment has opened up entirely new exploration spaces for the industry.
We have constructed a navigation map to help entrepreneurs explore directions in new territories and proposed several development paths we believe have potential. However, it must be clear that the map is not the actual territory, with numerous unknowns awaiting industry pioneers. We firmly believe that the next generation of entrepreneurs will redefine the application boundaries of tokens.
