Original article by: Jesse Walden, Partner, Variant; Jake Chervinsky, CLO, Variant
Original translation: Saoirse, Foresight News
introduction
Over the past decade, entrepreneurs in the crypto industry have generally adopted a value distribution model: that is, the value is attributed to two independent carriers: tokens and equity. Tokens provide a new way to expand the network at an unprecedented scale and speed, but the premise for this potential to be released is that tokens must represent the real needs of users. However, the continued increase in regulatory pressure from the U.S. Securities and Exchange Commission (SEC) has greatly hindered entrepreneurs from injecting value into tokens, forcing them to shift their focus to equity. Today, this situation needs to change urgently.
The core innovation of tokens is to achieve autonomous ownership of digital assets. With tokens, holders can independently own and control funds, data, identities, and the on-chain protocols and products used. To maximize this value, tokens should capture on-chain value, that is, transparent and auditable income and assets that are directly controlled only by token holders.
Off-chain value is different. Since token holders cannot directly own or control off-chain revenue or assets, such value should be attributed to equity. Although entrepreneurs may want to share off-chain value with token holders, this often involves compliance risks: companies that control off-chain value often have a fiduciary duty to preserve assets for shareholders first. If entrepreneurs want to direct value to token holders, then this value must exist on-chain from the beginning.
The basic principle that tokens correspond to on-chain value, and equity corresponds to off-chain value has been distorted by regulatory pressure since the birth of the crypto industry. The SECs broad interpretation of securities laws in the past has not only led to an imbalance in the incentive mechanism between companies and token holders, but also forced entrepreneurs to rely on inefficient decentralized governance systems to manage protocol development. Today, the industry has ushered in new opportunities, and entrepreneurs can rediscover the essence of tokens.
The old rules of the SEC have constrained entrepreneurs
In the ICO era, crypto projects often raised funds through public token sales, completely ignoring equity financing. They sold tokens with the promise that building protocols would boost the value of tokens after they went online, and token sales became the only way to raise funds, and tokens were the only value-bearing assets.
But ICOs failed to pass the review of the U.S. Securities and Exchange Commission (SEC). Since the 2017 DAO Report , the SEC has applied the Howey test to public token sales and determined that most tokens are securities. In 2018, Bill Hinman (former director of the SECs Division of Corporate Finance) identified full decentralization as the key to compliance. In 2019, the SEC further released a complex regulatory framework, increasing the probability that tokens will be identified as securities.
In response, companies are abandoning ICOs in favor of private equity financing. They support protocol development with venture capital and only distribute tokens to the market once the protocol is complete. To comply with SEC guidance, companies must avoid taking any actions that could drive up the value of the token after launch. The SECs regulations are so strict that companies are almost completely separated from the protocols they develop, and are even discouraged from holding tokens on their balance sheets to avoid being seen as having a financial motivation to drive up the value of the token.
Entrepreneurs then transfer the governance of the protocol to token holders and focus on building products on top of the protocol. The core idea is that token-based governance mechanisms can be used as a shortcut to achieve full decentralization, while entrepreneurs continue to contribute to the protocol as ecosystem participants. In addition, entrepreneurs can also create equity value through the business strategy of commoditization of complementary products, that is, providing open source software for free and then making profits through its upper or lower layer products.
But this model exposes three major problems: misaligned incentives, inefficient governance, and unresolved legal risks.
First, the incentive mechanism between enterprises and token holders is misaligned. Enterprises are forced to direct value to equity rather than tokens, both to reduce regulatory risks and to fulfill their fiduciary obligations to shareholders. Entrepreneurs no longer pursue market share competition, but instead develop business models centered on equity appreciation, and may even have to abandon the commercialization path.
Second, the model relies on decentralized autonomous organizations (DAOs) to manage protocol development, but DAOs are not competent for this role. Some DAOs rely on foundations to operate, but often fall into their own incentive misalignment, legal and economic constraints, operational inefficiencies, and centralized entry barriers. Other DAOs adopt collective decision-making, but most token holders lack interest in governance, and the token-based voting mechanism leads to slow decision-making, confusing standards, and poor results.
Third, the compliance design fails to truly avoid legal risks. Although the model is designed to meet regulatory requirements, the SEC still investigates companies that adopt this model. Token-based governance also introduces new legal risks. For example, DAOs may be regarded as general partnerships, exposing token holders to unlimited joint and several liability.
Ultimately, the actual costs of this model far outweighed the expected benefits, undermining both the commercial viability of the protocol and the market appeal of the associated tokens.
Tokens carry on-chain value, while equity carries off-chain value
The new regulatory environment provides an opportunity for entrepreneurs 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 the realization of autonomous ownership of digital assets. It gives holders ownership and control over on-chain infrastructure, which has global real-time auditable transparency. To maximize this feature, entrepreneurs should design products so that value flows to the chain, allowing token holders to directly own and control it.
Typical cases of on-chain value capture include: Ethereum benefits token holders by burning fees through the EIP-1559 protocol, or diverting DeFi protocol revenue to the on-chain treasury through a fee conversion mechanism; token holders can also profit from intellectual property rights authorized for use by third parties, or earn revenue by routing all fees to the on-chain DeFi front-end interface. The core is: value must be traded on the chain to ensure that token holders can directly observe, own and control it without intermediaries.
In contrast, off-chain value should be attributed to equity. When income or assets exist in off-chain scenarios such as bank accounts, business cooperation or service contracts, token holders cannot directly control them and must rely on companies as intermediaries in the transfer of value. This relationship may be subject to securities laws. In addition, companies that control off-chain value have a fiduciary obligation to return profits to shareholders rather than token holders first.
This does not deny the rationality of the equity model. Even if the core product is open source software such as a public chain or smart contract protocol, crypto companies can still succeed with traditional business strategies. As long as the distinction between tokens corresponding to on-chain value and equity corresponding to off-chain value is clearly made, actual value can be created for both.
Minimize governance, maximize ownership
In the context of the new era, entrepreneurs need to abandon the idea of tokenized governance as a shortcut to regulatory compliance. Instead, governance mechanisms should only be enabled when necessary and should be kept minimal and orderly.
One of the core advantages of public blockchains is automation. In general, entrepreneurs should automate as many processes as possible and retain governance rights only for matters that cannot be automated. Some protocols may benefit from the intervention of humans at the edges, such as executing upgrades, allocating treasury funds, and monitoring dynamic parameters such as fees and risk models. However, the scope of governance should be strictly limited to functional scenarios exclusive to token holders. In short, the higher the degree of automation, the better the governance efficiency.
When full automation is not feasible, delegating specific governance rights to trusted teams or individuals can improve decision-making efficiency and quality. For example, token holders can authorize the protocol development company to adjust some parameters, eliminating the need for a full consensus vote for each 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 ensure decentralization and achieve efficient governance.
Entrepreneurs can also ensure that governance mechanisms operate effectively through customized legal structures and on-chain tools. It is recommended that entrepreneurs consider adopting new entity structures such as Wyoming DUNA (Decentralized Autonomous Nonprofit Association) to give token holders limited liability and legal personality, so that they have the ability to sign contracts, pay taxes and defend their rights in court; in addition, they should also consider adopting governance tools such as BORG (Blockchain Organization Registry Governance) to ensure that DAOs execute affairs within the framework of on-chain transparency, accountability and security.
In addition, the ownership of on-chain infrastructure by token holders needs to be maximized. Market data shows that users have very low recognition of the value of governance rights, and few are willing to pay for voting rights for protocol upgrades or parameter changes, but they are highly sensitive to the value of ownership attributes such as income control rights and on-chain asset control rights.
Avoiding securities 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 speaking, securities represent a set of rights tied to a legal entity, including the right to economic benefits, voting rights, information rights, or legal enforcement rights. For example, in the case of stocks, holders obtain specific ownership rights linked to the company, but these rights are completely attached to the company. If the company goes bankrupt, the relevant rights will become invalid.
Tokens, on the other hand, grant control over on-chain infrastructure. These powers exist independently of any legal entity (including the creator of the infrastructure), and will continue to exist even if the company exits operations. Unlike security holders, token holders generally do not enjoy fiduciary duty protection or legal rights. The assets they own are defined by code and are economically independent of their creators.
In some cases, the fact that on-chain value may be partially dependent on the off-chain operations of a business does not necessarily in itself fall under the ambit of securities law. While the definition of securities is broadly applicable, the law is not intended to regulate all relationships where one party is dependent on another to create value.
In reality, many transactions involve a revenue dependency relationship but are not regulated by securities laws: consumers who purchase luxury watches, limited edition sneakers or high-end handbags may expect brand premiums to drive asset appreciation, but such transactions are clearly not regulated by the SEC.
Similar logic applies to a large number of commercial contract scenarios: for example, landlords rely on property managers to maintain assets and attract tenants to realize profits, but this partnership does not make landlords securities investors. Landlords always retain full control of assets and can veto management decisions, change operating entities, or take over the business at any time. Their control over the property is independent of the manager and is completely separated from the performance of the manager.
Tokens designed to capture on-chain value are closer to the above-mentioned physical assets than traditional securities. When holders acquire such tokens, they clearly know the assets and rights they own and control. They may expect the continued operation of the enterprise to drive asset appreciation, but there is no legal right connection between them and the enterprise, and the ownership and control of digital assets are completely independent of the enterprise entity.
Ownership and control over digital assets should not constitute a securities regulatory relationship. The core application logic of securities law is not one party benefits from the efforts of another party, but investors rely on entrepreneurs in an asymmetric relationship of information and power. If there is no such dependency, token transactions centered on property rights should not be characterized as securities issuance.
Of course, even if securities laws should not apply to such tokens, it does not rule out the SEC or private plaintiffs claiming that they apply, and the court’s interpretation of the legal provisions will determine the final determination. However, the latest policy trends in the United States have sent positive signals: Congress and the SEC are exploring a new regulatory framework, shifting their focus to “control of on-chain infrastructure.”
Under the control-oriented regulatory logic, as long as the protocol remains independent and the token holder retains ultimate control, entrepreneurs can legally create token value without violating securities regulations. Although the policy evolution path is not yet fully clear, the trend is clear: the legal system is gradually recognizing that not all value-added behaviors need to be included in the scope of securities regulation.
Single asset model: full tokenization, no equity structure?
While some entrepreneurs prefer to create value through both tokens and equity, others prefer the single asset model, anchoring all value on the chain and attributing it to tokens.
The single asset model has two core advantages: one is the incentive mechanism that aligns enterprises and token holders, and the other is that it allows entrepreneurs to focus on improving the competitiveness of the protocol. With minimalist design logic, leading projects such as Morpho have taken the lead in practicing this model.
Consistent with traditional analysis, the determination of securities attributes is still centered on ownership and control, which is particularly critical for the single asset model because it clearly focuses value creation on tokens. In order to avoid securities-like relationships, tokens need to grant direct ownership and control of digital assets. Although this model may be gradually institutionalized at the legislative level, the current challenge still lies in the uncertainty of regulatory policies.
Under a single asset structure, the company should be set up as a non-profit entity with no equity, serving only the self-developed protocol. When the protocol goes online, control needs to be transferred to the token holders, and the ideal form is to be organized through a blockchain governance-specific legal entity such as Wyoming DUNA (Decentralized Autonomous Nonprofit Association).
After going online, enterprises can continue to participate in the construction of the agreement, but the relationship with token holders must be strictly separated from the entrepreneur-investor paradigm. Viable paths include: token holders authorizing enterprises to exercise specific powers as agents, or agreeing on the scope of cooperation through service contracts. Both roles belong to the conventional settings of the decentralized governance ecosystem and should not touch the scope of application of securities laws.
Entrepreneurs need to pay special attention to distinguishing between single asset tokens and company-backed tokens such as FTT, the latter of which are actually closer to securities. Unlike native tokens that grant control and ownership of digital assets, tokens such as FTT represent the right to claim the companys off-chain income, and their value is completely dependent on the issuing entity: if the company operates poorly, the holder has no way to remedy; if the entity goes bankrupt, the token will return to zero.
Company-backed tokens create the very imbalance of power that securities laws are designed to address: holders cannot audit off-chain revenue, veto corporate decisions, or change service providers. The core contradiction lies in the asymmetry of power. Such holders are completely controlled by the company, forming a typical securities-like relationship that should be included in the scope of regulation. Entrepreneurs who adopt a single-asset model must avoid such structural designs.
Even if the single asset model is adopted, the company may still need off-chain revenue to maintain operations, but the relevant funds can only be used for cost expenditures and cannot be used for value delivery to token holders such as dividends, repurchases, etc. If necessary, funds can be obtained through treasury appropriations, token inflation, etc. approved by the holder, and control must always be in the hands of the token holder.
Entrepreneurs may raise several defenses, such as no capital investment if no coins are sold to the public and no common enterprise if no asset pool, but these claims, including non-securities-like relationship, cannot ensure that the risks of current legal application can be avoided.
Open Questions and Alternative Solutions
The new era of crypto presents exciting opportunities for entrepreneurs, but the space is still in its early stages and many questions remain unanswered.
One of the core questions is: Can you completely abandon the governance mechanism while circumventing securities law regulation? In theory, token holders can just hold digital assets without exercising any control. But if the holder is completely passive, this relationship may evolve into the scope of securities law, especially when the company still retains some control. Future legislation or regulatory rules may recognize the single asset model without governance, but entrepreneurs still need to follow the current legal framework.
Another question is how entrepreneurs handle initial financing and protocol development in a single asset model. Although mature structures are relatively clear, the optimal path from startup to scale is still unclear: if there is no equity to sell, how can entrepreneurs raise funds to build infrastructure? How should tokens be distributed when the protocol goes online? What type of legal entity should be adopted, and does it need to be adjusted with the development stage? These details and more questions are still to be explored by the industry.
In addition, some tokens may be more appropriately defined as on-chain securities. However, the current securities regulatory system has almost killed the survival space of such tokens in a decentralized environment, which could have released value with the help of public chain infrastructure. Ideally, Congress or the SEC should promote the modernization of securities laws so that traditional securities such as stocks, bonds, bills, and investment contracts can run on the chain and achieve seamless coordination with other digital assets. But before that, regulatory certainty for on-chain securities is still out of reach.
The way forward
For entrepreneurs, there is no universal standard answer to the design of token and equity architecture, only a comprehensive balance of costs, benefits, risks and opportunities. Many open questions can only be answered gradually through market practice. After all, only continuous exploration can verify which model is more viable.
The original intention of writing this article is to clarify the current choices faced by entrepreneurs and sort out the solutions that may emerge as crypto policies evolve. Since the birth of smart contract platforms, vague legal boundaries and strict regulatory environments have always restricted entrepreneurs from unleashing the potential of blockchain tokens. The current regulatory environment has opened up a new space for exploration for the industry.
We have constructed a navigation map above to help entrepreneurs explore new areas and proposed several development paths that we believe have great potential. However, it should be clear that the map is not the real territory itself, and there are still many unknowns waiting for the industry to explore. We firmly believe that the next generation of entrepreneurs will redefine the application boundaries of tokens.
Acknowledgements
Special thanks to Amanda Tuminelli (DeFi Education Fund), John McCarthy (Morpho Labs), Marvin Ammori (Uniswap Labs), and Miles Jennings (a16z crypto) for their insights and suggestions for this article.
