Hack VC: Top 10 Tips for Project TGE
Original article by Ed Roman, Managing Partner at Hack VC
Original translation: 1912212.eth, Foresight News
Connect with liquidity providers
When a token is first launched, a large supply of tokens is usually not available in the market. This is because the tokens of investors and employees are usually vested/locked for several years, resulting in a lack of liquidity depth on exchanges, making the price of tokens too volatile. Small buy and sell orders on exchanges can greatly affect the price of project tokens.
Is token price volatility a problem? Not necessarily, but it becomes very important if your token has some form of utility. Your network may not function as intended because users cannot acquire tokens in reasonable quantities or prices to use the network, which may inhibit network growth.
To solve this problem, you can hire one or more liquidity providers to help create liquidity for your token. Liquidity providers can borrow tokens from your vault and create markets by providing their own stablecoins to pair with your tokens on exchanges. They usually have algorithmic robots that act as "middlemen" between buyers/sellers on exchanges, thereby creating liquid markets.
A typical transaction with a liquidity provider involves them borrowing your tokens for 18 months, after which they have the option to buy them back at the then current price. So these activities obviously come at a cost.
Examples of liquidity providers include Amber Group, Dexterity Capital, and Wintermute. More recently, the concept of on-chain liquidity providers has emerged, where Web3 protocols effectively act as liquidity providers. Stablecoins are provided by dynamic LPs, who can even be members of your own DAO (this creates a strong alignment of interests and is a great way to reward participating DAO members).
DeFi protocols (or L1/L2 protocols) need to develop TVL plans from the beginning
We see many technical founders launching DeFi protocols hoping that the motto of “if we build it, they will come” will apply. However, this is often not the case — you need a strong go-to-market strategy to attract capital. The measure of attractiveness of a DeFi protocol is TVL. If you start with 0 TVL, then it may create a chicken-and-egg dilemma for LPs, with no one willing to take the risk and be the first LP to enter the pool.
Today’s LPs tend to be more conservative (considering some of the recent crashes in Web3). They usually worry about two things:
Are the rates of return shown accurate relative to actual rates of return?
Am I at risk of losing my capital (due to hacking or other reasons)?
One way to solve this is to have strong social proof of other investors who trust the protocol from the start. You can effectively "pre-negotiate" the TVL with a private group before launching. This could be a VC, family office, or high net worth individual. A reasonable target for public consensus is 7-8 figures of TVL before others start to feel comfortable joining.
Ultimately, the best long-term solution for LPs to feel comfortable is to have your protocol function as intended for long enough without being hacked. This can be a useful way to encourage early adoption to start building a track record.
Users and TVL tend to follow the 80/20 rule (i.e. the top 20% of users can account for more than 80% of TVL), so acquiring large deposits should be the focus when growing TVL.
Beyond the initial phase, you should also plan a release schedule for liquidity mining. Initially, subsidizing through token incentives is fine, but in the long run, it is recommended to transition to sustainable fee-driven returns.
An interesting trick to increase early TVL is to create an “overflow” bucket for investors. Once you hit the dilution limit for the round, you can only consider investors if they also commit to TVL.
Follow best security practices
The security of your protocol is of utmost importance. If your protocol is hacked, then it will be a permanent stain on your record and may deter users from participating. There are a few key steps to follow:
Consider choosing technologies in advance that can help reduce the risk of smart contract hacks. For example: Programming in the Move language, which is formally verified and type-safe and generally safer than Solidity (e.g., through MovementLabs.xyz). Another approach is to introduce delays in transaction completion to provide a window to intercept smart contract hacks (e.g., through UseFirewall.com). Using zero-knowledge formal verification of code (e.g., in the case of a bridge) through technologies such as AlignedLayer.com.
Perform multiple smart contract audits before launching your protocol to communicate to users and the team that your code is solid. Note that this does not guarantee that you will not be exploited, but it is a step in the right direction. Examples include Trail of Bits and Quantstamp.
Establish a code change process so that if you make additional changes to the smart contract over time, you can re-examine each code increment with a lightweight audit. This is a step that teams often overlook and is critical to catching vulnerabilities that arise from hasty code submissions.
Consider using formal verification or fuzz testing. Formal verification is the exhaustive mathematical verification of a code system. It provides comprehensive coverage analysis that can increase your confidence in your ability to defend against attacks. Fuzz testing is the process of slightly changing the inputs to a system to discover edge cases that could be exploited. Veridise is an example of a vendor that offers both formal verification and fuzz testing.
Consider investing in a bug bounty program. This can incentivize white hat hackers to find vulnerabilities by giving them rewards. The current market leader in Web3 bug bounties is ImmuneFi.
Measuring product-market fit before mainnet launch
Web3 projects have a bad reputation for launching tokens before they solve real customer pain points. If you take this approach, your token price will drop dramatically because your KPIs are questionable at best.
But how do you measure product-market fit before launching a product? Some teams try to confirm this through testnets, but the challenge with testnets is that customer behavior may be different compared to the mainnet. This is especially true when it comes to finance (e.g., DeFi protocols on testnets), because users are using "test coins" and may not take their actions seriously, and may just be airdropping and mining, and may not be serious users.
To solve this problem, I recommend launching a "private mainnet" (different from a testnet) where your service is used with real users with real capital to confirm product-market fit. These users are invitation-only (e.g., your investors, friends, and team) so that you don't screw up your marketing campaign with a small group of private users.
Make sure the launch schedule is correct
When is the right time to launch a token? Most of the time, I would advise startups to hold off on launching their token until they have created significant real value with the protocol. This is similar to how pre-IPO Web2 startups tend not to rush to IPO until they have built a solid business.
There are dangers in launching tokens during a specific market window. If retail investors buy your tokens during a deep bear market, there is a higher probability of price appreciation if there is a bull market in the future, which can create strong loyalty and virality for your project. If you switch this approach to launching tokens during a bull market, and there is a sharp drop in a bear market in the future, then the enthusiasm of these users will naturally be much lower.
One way to mitigate this risk is to create a more attractive entry price for investors through an IEO. To understand this concept, consider that most Web3 projects plan to airdrop a large portion of their token supply to users. When you do this, users typically don't provide any information in exchange for tokens, and the airdrop is free for them. This provides the widest possible distribution of tokens, but does not necessarily lead to users caring about your protocol because they are not investing/risking anything. In other words, they have no participation in it.
You may want to avoid selling tokens to retail investors (for legal/regulatory reasons). One potential solution is an IEO. It works by allocating a portion of the token supply to an exchange, which then sells it to users at a low price (creating easy wins for retail investors who see appreciation). It’s also a great way to build trust with the exchange.
Sui is a good example. Sui is based on L1 of the Move programming language and was created by former Meta employees. They conducted an IEO and it was very successful.
Keep cliff unlocking in mind when designing token vesting schedules
Most Web3 projects have employee and investor tokens vested over multiple years, which sets a cliff at the beginning. In practice, if you have a large number of employees or investors who all sell their tokens on similar dates, a sudden large sell-off in the market can lead to negative price action. To avoid this, we recently started recommending continuous vesting (a steady accumulation of tokens on a smooth curve). In this way, tokens flow slowly into the market, thus avoiding sudden drops.
Set aside a budget for listing on an exchange
Many exchanges will charge a fee to list your token, so if you want to list your token on some of the more popular exchanges, you will need to plan ahead and budget for this. Some of the most well-known exchanges have been known to charge up to $1 million to list a token, so the listing process can get expensive quickly.
An exception is if you are a Tier 1 project backed by a well-known fund, in which case sometimes exchanges will list you for free as it attracts users to their exchange. This is one of the advantages of working with a large VC in a funding round (as it can buy your social proof through the exchange).
Pre-Token Fundraising
We have come across many projects that have tried to raise funds after launching a token. This can be more challenging than the startup expected.
Most private equity investors arbitrage between public and private markets. The market for funds raising private equity is much larger than for public equity, limiting the number of potential suitors. For example, you will be excluded from most early-stage funds.
It’s also difficult to raise money after the token launch because the negotiations themselves can be challenging. The typical structure is a discount to the public token price. But during the fundraising process, the token price can fluctuate wildly. If the token price is a moving target, how do you determine a price benchmark and agree on that price with private placement investors?
These problems go away if you raise funds before you launch the token. The token price is unknown at this point and you can include more private funds that will invest in the asset class.
Providing high-quality consulting services to TGE
Over the years, we have encountered a large number of teams that are severely underserved by legal counsel. Web3 founders inherently take on more risk than Web2, so obtaining strong crypto-native legal advice is critical. I encourage founders to ensure their advisors have experience in cryptocurrency-specific practice areas when preparing for a TGE.
By the way, the regulatory landscape for Web3 is still evolving. Often, decisions are subjective rather than objective. Remember that most lawyers are not businesspeople, and they often optimize advice based on hypothetical legal arguments rather than actual decisions in the real world. In other words, don’t follow your lawyers when it comes to regulation — you need to use your own judgment and assess your risk appetite, especially given that the law itself is constantly changing.
Choose the right time to monetize with a fee switch
Many protocols (especially DeFi) defer "fee revenue" to a future date via fee conversions. The idea is to subsidize maximum short-term growth and defer monetization until later. This is similar to how Web2, Facebook, and other social networks defer advertising/monetization until they have a critical mass of social graphs. If you are optimizing to attract new users, then deferring monetization makes perfect sense.
The danger of delaying monetization is that it can interfere with product-market fit. Generally speaking, if users are willing to pay for your service, then this is the strongest indicator that you have "real" users and that they are sticky. However, if your fees have a significant impact on your user base economics, then delaying monetization may hide core problems in your protocol. However, if your adoption rate is moderate, the risk may be low.
The fee transition is really a shift from pure governance, to accumulating value by distributing platform fees to token holders. Usually, this is easier after it’s done (e.g. GMX), but of course this isn’t always the case (UNI and many others).
Here are some characteristics of projects that might require fee conversion:
The number of users reaches a critical point;
The token has high liquidity;
Broad holder base;
Takers (traders) pay a reasonable fee to liquidity providers.
Perhaps consider giving LPs tokens at the same time as fee conversions via an airdrop or similar distribution, so even if they no longer get 100% of the fees, they still feel like they are getting some return through tokens.
Consider the lowest hurdle rate target APY yield for token holders relative to other opportunities/markets and construct fee parameters that make sense and are fair in this context.
For example, for staking rewards, 5% is considered standard, while 10% is considered high (LIDO can set 10%).
For trading venues, 2.5-5.0 bps is standard and 10-25+bps is high; better venues can charge higher fees.
For loans, a reasonable net interest margin (NIM) between borrowers and lenders is typically 1-2% and is expected to compress over time.
Perhaps consider giving LPs tokens at the same time as fee conversions via an airdrop or similar distribution, so even if they no longer get 100% of the fees, they still feel like they are getting some return through tokens.
Consider the lowest hurdle rate target APY yield for token holders relative to other opportunities/markets and construct fee parameters that make sense and are fair in this context.
