Airdrops, Emissions & Buybacks: A Guide to NOT Wrecking Your Token

A double-edged sword of crypto and blockchain projects is their token. On one hand, it allows us to "fairly" value a project or even speculate on its future value. However, this also has the effect of people only looking at the token value to form an impression or opinion of a project. A promising project can be portrayed negatively solely because its token is -80% down due to an unsuccessful airdrop or sketchy token distribution.

Having the price of the token constantly attached to a project and its technology can have a bad impact on the future prospects of a project. In other industries, there is less weight on the stock price for the consumers. Their decision to buy product A or B is rarely based on the stock price of their parent company but rather the marketing or the quality. In crypto, most of the consumers/users are also the investors who think they are board members in the given protocol. Just because their investment is underperforming, they often jump ship to another protocol.

Additionally, this applies to the workforce as well and can lead to a cyclical burnout or discouragement caused by the bear market. In a bull market, projects and companies have so much money to expand and hire that the demand outweighs the supply, causing them to hire less capable employees to hit their quotas. People start to show interest in the technology and begin to educate themselves when even their technologically illiterate cousin made money on Cardano. Then the bear market comes, and companies are forced to downsize; people previously excited about the technology lose interest when they see their precious crypto asset at -90% and focus on a different career. And the next time we experience a bull market, we restart the cycle.

Crypto arguably has the highest percentage of "tourists" – opportunists who join only when prices rise, extract value, then move onto the next trend. We can actually see this phenomenon right now with AI, where most of the "tourists" migrated. Forget Discord crypto signal groups; there are now paid groups for sharing prompts or even courses that promise to teach you how to write the perfect prompt. But back to the topic now, tokens may not always shed the best light on crypto, but they introduce a plethora of new incentives to participate in the decentralized economy. This, however, also includes incentives to game the distribution mechanism through various means to ultimately extract value.

In this article, we will analyze various token distribution strategies to determine which approach has a positive effect on the on-chain activity pre- and post-distribution, the token price and vice versa, and ultimately which approach defeats the purpose it was ultimately meant to achieve.

To start with, we need to differentiate the distribution mechanisms based on the time of distribution. Therefore, we will first look at "Pre-launch Distributions," which encompass how the token supply is allocated, to whom, when, and how these tokens unlock. Next, we examine "Post-launch Distributions," which include strategies on how to distribute tokens allocated for growth or the community participants via liquidity mining, various farming strategies, and quests.
We will also include the so-called "fair launches" that promise the highest degree of transparency. Finally, we will look at airdrops as a whole separately, as they can be employed both at launch and once the token is already out.

Pre-Launch Distributions

First, let's talk about token supply. Based on the token design, the supply can be fixed, inflationary, or deflationary, employing a hardcoded maximum supply, a token-emitting mechanism, or a burn/buyback mechanism, respectively. Fixed supply can also have dynamic issuance or burn. Additionally, based on the stage of the project, some of its tokens may be locked in for a vesting period, introducing another term, circulating supply, which describes the amount of tokens available on the open market, therefore not locked.

Depending on the scale of the project and the resources it may require to build, many projects opt for private means of funding. This includes allocating some percentage of the tokens to a small private group of investors with certain unlock restrictions as mentioned. Let's be honest, we need to look at these allocated tokens as a supply, which sooner or later will hit the market, creating inevitable sell pressure in the future.

Some projects may want to skip private deals and raise funds from the public. For this approach, the project might do a Pre-Sale on platforms like Coinlist or Fjord, where they offer some allocation to be purchased at a predetermined price or some curve to favor different tiers of buyers.
There are often some restrictions for individual buyers, such as upper limits to the amount of tokens available. Although not as popular as they used to be, IDOs (Initial DEX Offerings) reminiscent of the ICO (Initial Coin Offering) era are still around. These offerings represent the first opportunity to purchase tokens through a DEX (Decentralized Exchange) and may sometimes enforce a vesting or unlock schedule as well, but in contrast to private sales, they are less common.

During launch, or as we in crypto like to use acronyms, the TGE (Token Generation Event) usually distributes some percentage of the allocation. The allocation groups often include but are not limited to the Team, Early Investors, Later Stage Investors, Community (will get back to this), Growth Fund, Insurance Fund, and Liquidity Pools. Based on the project and token utility, the optimal allocation ratios may differ, but we can confidently point out some red flags:

• Short if not instant unlock/vesting for early investors.

• Only a small percentage of tokens in circulation.

• KOL/Influencer allocations.

Post-Launch Distributions

Once the initial tranche of tokens is in circulation, projects may want to incentivize users to use their platform or dApp. This can be done through various strategies to increase activity, total value locked, transacted, or bridged volume. This aims to appeal towards new investors, show robustness, and, quite honestly, inflate metrics so the marketing department has content to post upon achieving a certain milestone. The tokens distributed post-launch are usually tokens from the Community, Growth, or Ecosystem allocation, but can also have a dedicated allocation such as Staking Rewards. Based on what the project wants to incentivize, it can employ these strategies.

Liquidity-mining

DeFi protocols compete among each other with various design choices, functionalities, or fee structures. However, at the end of the day, the depth of the liquidity is often the main reason they prefer one over the other. New protocols, therefore, seek to bootstrap and retain liquidity so their new and shiny product can compete with established protocols. The secondary goal is also that participants would get familiar with the protocol and will keep using it even after the incentive period is over.

To participate, protocols would pay out additional rewards in the distributed token for liquidity provisioning on top of trading fee rewards. By this approach, the new DeFi protocols could boast over 100% APRs (even 1000% for those who remember OlympusDAO) to attract new participants. It's important, though, to note that Liquidity-mining incentives will inevitably end someday, and the liquidity as well as  users, will either migrate to the next incentivized protocol or go back to the one that checks the most marks without incentives.

A great example is SushiSwap, that in 2020 launched their $SUSHI token and incentivized liquidity provision to bite into Uniswap's market share. It attracted a total of $800M worth of liquidity to their protocol. However, it was only until Uniswap launched their own $UNI token with no incentive prospect at the time to gain back around 10 times the liquidity of Sushiswap.

Liquidity-mining makes sense as a concept, rewarding those who enable the protocol to compete with others. But it comes short in clear communication and inflated expectations that could, and most probably will, drive many users away. The high initial APR will seem too good to be true, a no-brainer, let's say. But remember, if it seems too good to be true, it probably isn't. In this scenario, the more users participate, the more diluted the rewards. And as you are receiving the payout in the protocol's utility or governance token, its USD price also diminishes your rewards, so by the time you actually decide to liquidate those tokens, their price is already -60% if not -90%, and you start to question your choices. But hey, you contributed to the decentralized future of finance.

Farming

Farming is in essence very similar to liquidity mining, although it extends the notion to lending, borrowing, and staking as well. The goal is similarly to bootstrap and retain liquidity, to showcase the system's resilience and robustness with millions of dollars worth of assets.

Instead of providing liquidity for trading, users would deposit their assets to receive farming rewards on top of borrow fees or borrow assets from the protocol, pay the borrow fees but also receive rewards for borrowing. Based on the protocol's needs and targets, some assets may yield higher or lower rewards. For example, if Ether is being heavily borrowed (high utilization), depositing Ether is incentivized by more rewards, and borrowing is discouraged through higher borrow costs and less rewards. Conversely, if a lot of Ether is deposited and not being borrowed (low utilization), depositing is discouraged and borrowing is incentivized.

Staking is a concept with a wide area for interpretation, hence it can encompass consensus building (Proof-of-Stake), revenue share, yield multiplier, voting rights, token emissions, and lastly, circulating supply reduction. Therefore, not all staking mechanisms are deemed equal. In contrast to liquidity mining, lending, and borrowing, staking is quite flexible in what it should incentivize. However, as staking does not directly increase TVL or trading volume, it is even more difficult to design sustainably for the long run. Effectively, staking rewards token holders for locking their tokens from circulation (creating scarcity) by either giving you more tokens, letting you vote in governance, multiplying your other rewards, or, on the rarest of occasions, distributing some % of the protocol revenue. 

A concerning trend is when projects claim to share revenue because they 'have too much money'. When questioned about the source of these yields, they often pull the "Don't worry about it" card. This should trigger Luna and Anchor Protocol flashbacks for anyone who lived through that collapse.

Many of the risks from liquidity mining apply here as well. But having multiple of these farming and liquidity mining strategies active at the same time could lead users to what we like to call looping. Deposit in one protocol, borrow against that, repeat a few times, provide liquidity on another protocol, borrow against the LP tokens, swap for some obscure token, and stake that. When identifying these multi-hop routes to maximize rewards and capital efficiency, creativity is the limit. But your risk management should be the limit; hence, as you increase the upside, you also increase the risk of liquidation on your borrowed assets at each step, creating additional knots in this loop. Quite a lot of risk to go through to farm a token that is very likely to drop another 80% once you untie those knots.

Quests

This concept is also very similar to the prior ones but is not limited to depositing, borrowing, staking, or LPing. Quests are, as the name implies, various tasks a user can fulfill in order to receive rewards. The tasks offer a wide range of customizability from social media engagement, on-chain actions, or holdings to testnet and various app usage. Distributing projects can use platforms like Galxe to handle the quest completion verification and reward distribution in the form of native tokens or NFTs.

As some quests may not require any upfront costs or assets, this raises the question of Sybil resistance. As we will also discuss in the next section, many of the even most prominent activity-based quests and airdrops were swarmed with bots. In a research paper titled "Quest Love" by Al-Chami and Clark, they analyze various quests, their completion likelihood, difficulty, costs, and how it affects the percentage of participating bots. They have found that quests that yield smaller rewards (rewards - costs) are often deemed unattractive for bots, while a genuine user is more likely to complete it even at a small loss. Additionally, bots can be distinguished through higher responsiveness; hence, bots can monitor the blockchain and once they find a profitable transaction, it can be then replicated or even front-ran by MEV bots.

Though quests can offer more versatility in customizability and types of actions, they still are subjected to the same issues that can arise as Liquidity Mining and farming. Quests do not always reward newly minted tokens; instead, many projects also reward commemorative NFTs that may be useful in the future.

Airdrops

As we mentioned at the beginning, airdrops can be done both at the TGE and later on. Many projects also adopted the idea of points, which essentially signals that some form of activity is being monitored and may be used to distribute future tokens. Among the first to employ the points tactic was BLUR, the NFT marketplace that made most NFT traders ditch OpenSea and their farm points. Let's not forget that since then MagicEden became the go-to marketplace (due to them launching a token) and now as OpenSea is launching a token, we might go full circle.

Sentiment around airdrops is usually divided on whether you received some tokens or not. If you qualified for an airdrop, it's the best token ever until you see it down -70% in 2 weeks. If you did not qualify you rant about how it was sybil farmed, allocated to insiders, etc.

Airdrops usually include but are not limited to the following eligibility criteria:

• Transact on our mainnet/testnet between block height X and Y,

• Have some amount of some tokens in your wallet before some block height Y.

• Have cumulative traded volume before block height Y over some amount.

• Have contributed to the project GitHub before some date.

• One-way deposit to our new blockchain that has no DEX or way to withdraw, it will be safe. Trust me bro.

• Be a part of some partnered community by owning their NFT.

Now someone would think that qualifying for the airdrop would not be hard if you knew beforehand. That's correct and usually the reason why projects announce these criteria after a snapshot has been taken. If the info gets out sooner, bots would be all over it just as fast as they will leave after the snapshot. StarkNet sends its regards.

When planning an airdrop, projects need to be careful with their desired goal and also what it can ultimately cause. Usually, you might want to reward early adopters, testers, Discord warriors, both development (coders) and capital (LPs) contributors. The idea is that they believe in the project and will proceed to help it grow. However, every user, as an individual, primarily needs to decide based on their own welfare.
Therefore, assuming some degree of rationality (rationality assumptions have been sort of a meme in academic papers when modeling DeFi), if the airdropped token does not provide any intrinsic value (revenue share, gas token, yield multiplier, stake/hold to participate) or it is outweighed by its momentary market value, it is very likely to get dumped in the first few weeks.

Major airdrops can also start small ecosystem rallies, i.e. Jupiter airdrop injected a considerable amount of new liquidity into Solana, which did, directly or indirectly, catalyze the Solana memecoin craze. If you check the JUP chart now, it is around the price it started. A similar, yet different example was the Hyperliquid airdrop.

One of last year's biggest airdrops, which also used points to measure the degree of user activity to distribute their native token HYPE. In a similar manner, following the airdrop, all tokens deployed natively on Hyperliquid went vertical. In contrast to JUP, HYPE is not just a governance token but also entitles the holder to stake it and receive a share of revenue. Additionally, it functions as a gas token for the HyperEVM (which went live just a few weeks ago). Because of this, even in the current turbulent environment, HYPE is "only" down -50% from the top but still is at 5x from the airdrop, while JUP is down about -75% from the top and below the airdrop price, just touching its all-time low.

Just from these examples, we can draw some conclusions:

• Airdrops inject new capital into the ecosystem that will, to some degree, be redistributed to other tokens within the ecosystem.

• If the token is disconnected from the economic activity of the protocol/network/dapp, a rational user will eventually dump the token.

• If the eligibility for an airdrop is known a priori or is automatable without any anti-sybil measures, it attracts extractive actors who will dilute the "honest" recipients.

Takeaway

Announcing an airdrop evidently boosts social sentiment and on-chain activity. However, based on the eligibility criteria, distribution strategy, and token purpose, a rational actor will sell their token if the value of the token does not outweigh the momentary market price. Therefore, if the ecosystem needs attention, users, liquidity, and is airdropping tokens, the more realistic goal it will achieve is a short-lived marketing effort that ultimately hurts the overall sentiment and track record. If the airdrop is instead a means of distributing a token crucial to the economic mechanism within the protocol, it is less likely to be dumped and does stabilize the value at some imaginary "fair value" price.

To put simply, it is simpler to attribute value to a claim on protocol revenue or transaction inclusion than to the right to vote in a governance proposal. Most of the airdrop recipients won't think about their potential voting power, won't write up a governance proposal, or quantify the potential value of the token with the probability of their proposal passing. But even the less sophisticated participants can do the maths of their share of the revenue, extrapolate that, and justify holding the token instead of dumping.

Fair-Launch Distributions

The protocols that employ fair-launches often disregard goals other than network effect. The notion of a fair-launch is that tokens are added to circulation by a function of time, or rather, blocks. Meaning no private or public deals, no airdrop, no quests or farming incentives. New tokens are only issued by the protocol per block or epoch and can include some proportional distribution. For example, Morpheus, which we already mentioned a few times in our articles, also employed a fair-launch strategy.

However, they wanted to incentivize different groups of actors: Coders (who contribute to the Morpheus codebase), Builders (who build on top of Morpheus), Compute Providers (who contribute compute power to the network), and Capital providers (who deposit yield-bearing assets into the network). In addition to a 4% cut to a protection fund, each of the 4 roles is entitled to a 24% cut of the protocol emissions that decrease daily until they reach 0 in year 2040.
This approach, even though adjusted for the needs of a multi-role network, is to a degree reminiscent of Bitcoin rewarding miners. This approach is, however, not oriented on raising funds or injecting capital; instead, it clearly incentivizes usage and growth. However, as the actors here are also rational and have real-life expenses, this creates inevitable sell-pressure as they liquidate tokens to cover costs. The hope is that future network effect will eventually outweigh this continuous selling pressure.

As we already mentioned something similar to Bitcoin, discussion recently led to employing Proof-of-Work to ensure fair-distribution. That does not necessarily mean PoW for building consensus, but rather solely to distribute tokens based on contributed hashrate. One of the projects using this strategy is ORE on Solana.
Heavily advocated for by Anatoly (Solana founder), ORE aims to be the gold of Solana. The work solved here has nothing to do with ledger history or voting power; instead, the work is specifically designed to be ASIC and GPU resistant as it uses a CPU-friendly DrillX algorithm. Ultimately aiming to fairly distribute ORE amongst users who should not be able to gain a considerable advantage over others.

Tokens are distributed, what now?

Once the tokens are in circulation, their value is now decided by the market, not by the founders or their VCs. As we already mentioned, the token price has a great effect on the perception of not only the token but also its protocol or network. 

The crypto community copes with price volatility through characteristic self-deprecating humor:

• "Just bought the fifth dip this month!"

• "This flash crash is just a Black Friday sale!"

• "ETH is ultrasound money and the future of finance... but only when it's above $4K."

If the project is not happy with the current social sentiment and wants to influence the price and thus its public opinion, they do so by buying back tokens with their revenue, distributing revenue to token holders/stakers, adjusting the emission rate, or, as the potential last resort, transitioning to a new token.

Buybacks

There has been some critique regarding buybacks, especially as it does not create intrinsic value for the token. Buybacks create the sense of buy-pressure, but the holder ultimately attributes its value to the prospect of someone buying the token from them, which they already do so without the buyback. It does increase scarcity, but not the value directly.

Revenue distribution

As mentioned in the airdrop section, sharing the protocol revenue with holders creates real value tied to its success. Simply comparable to dividends, which create a simpler and more deterministic way to value the token. The infamous "Fee Switch," which usually refers to a phase in development when the protocol is robust enough to start distributing revenue to holders, is expected or already being implemented by DeFi bluechips like Aave, Uniswap, or Sky (ex-MakerDAO). Rewarding liquidity providers, depositors, and stakers based on the revenue they generated rather than stashed away or newly minted tokens. Another approach is to distribute revenue to developers who create apps based on their revenue.

This is being employed by Sonic (ex-Fantom), which rebates 90% of the gas fees generated by smart contracts. We will see how it goes for Sonic and the others after the Fee Switch is active for some time, but it highlights one important notion: Distribute revenue to those who enable it.

On the blockchain level, fees are generated if users use smart contracts, so pay developers. In DeFI, fees are generated if users prefer one dapp over another, if users prefer deeper liquidity, pay LPs. In DePIN, fees are generated when users have access. To increase availability, we need more participants/nodes so pay node runners. One crucial aspect here is to distribute value. Meaning that revenue should be distributed in revenue form (stables or ETH), not emitting new tokens or buying back their own token and distributing that, hence, the sell-pressure is inevitable.

Emissions&Burn

We already touched on the fixed or dynamic supply of tokens. Trying to affect the token price through emitting fewer tokens or burning them, ultimately only creates some sense of scarcity. Less profound than with buybacks, but switching from an inflating supply to a fixed or even deflating one can have an effect on the price. But once again it has way less effect than buybacks, hence those require protocol revenue to be used, and even less than revenue distribution.

New Token/Rebrand

Sometimes it may even occur that the current token design, total supply, or value accrual mechanism is not suitable anymore for the given protocol or application due to additional functionality or a complete architecture overhaul. First, let's start with Aave, which rebranded from ETHLend in early 2020 to accommodate its technological upgrade. The previous token LEND was redeemable for AAVE at a 1:100 ratio.

More recently, MakerDAO also rebranded to Sky with a conversion ratio of 1:24,000 and DAI being upgradable to USDS at a 1:1 ratio to align with a so-called "Endgame" which should enable sustainable and decentralized growth trajectory. Finally, yet another major rebrand has been the Fantom transitioning to Sonic at a 1:1 conversion ratio to accommodate the new tokenomics and differentiate the technology, as Sonic introduces a new DAG-based consensus, fast-finality, high throughput, and revenue share mentioned in the above section while still supporting EVM execution.

Conclusion

Designing and implementing tokenomics is not as simple as it may seem. According to Nick Szabo, a computer scientist applying common sense can design a better cryptocurrency than an economist guessing about computer science and cryptography. 

Additionally, common sense might not be enough, and domain-specific knowledge of both computer science and economics may be needed. Thereby, we cannot simply apply economic principles in blockchain networks and expect it to work like it does in traditional markets. Instead, we need to focus on the intersection of these fields and the nuances stemming from the nature of blockchains.

It's crucial to understand that no tokenomics model is perfect or universally applicable. What works for a DeFi protocol might be entirely unsuitable for a layer-1 blockchain or a decentralized social network. Each project must tailor its tokenomics to its specific use case, token utility, target audience, and desired network effects.

The timing also matters significantly. Early-stage projects might need to sacrifice some degree of decentralization to secure funding and development resources, while established protocols can afford to focus more on sustainable value accrual mechanisms. In either case, the tokenomics should align with the project's development roadmap, technical capabilities, and community expectations.

The art of effective tokenomics lies in finding the right balance between immediate token value, long-term sustainability, appropriate incentives, and fair distribution – all while remaining adaptable to changing market conditions and evolving project needs.

We hope this article provided some insight into how tokens are distributed and that you can make more informed decisions regarding your holdings and whether to finally dump that governance token you got airdropped last year or keep holding it.