Intercoin Inc. is finishing its work developing smart contracts on the Ethereum platform to allow any project to raise money to build their network, issue their own utility tokens, give them to their backers, peg them to fiat, and get unlimited and fair liquidity for them. No one would have to pay a lot to get onto a centralized exchange, because the whole thing could be launched on the permissionless Ethereum blockchain just as one can launch a website on the Web. Merchants on the platform would be able to accept the tokens, and cash them out, selling them to the next customers. Token holders everywhere will push others to buy and accept the tokens, growing the network effect of the project.
This can finally realize the original dream of permissionless, trustless networks that are owned by the participants, rather than centralized platforms extracting rents forever on behalf of the original investors and developers. It will transition our society’s innovation engine from competition to collaboration, like we see with open source, wikipedia, and science. People will be compensated fairly. Open source software and journalism can be monetized. And all this can potentially be done without fear of regulators coming after the issuers of the tokens. This is not a fantasy! This is the environment our new DeFi product, the Utility Token Contract, will bring about.
The Landscape Today
Decentralized Finance, or DeFi, is all the rage in 2020, with investors funding many projects to create financial applications that don’t require trusting any centralized party. This reflects a general trend, that Fred Wilson from Union Square Ventures has pointed out, that new applications beget new infrastructure (web3.js) which lets the industry build better apps.
It’s especially great the industry is thinking in terms of composability of components. DeFi has been called “money LEGOs” which warms our heart – we have been building social media LEGOs since 2011 under a company whose logo is building blocks.
Ethereum has emerged as the dominant platform for building DeFi applications today. The number of active addresses on Ethereum has doubled just since the start of 2020, while Bitcoin’s has only grown by 50%.
“The level of development on ethereum is crazy: initial coin offerings, stablecoins, non-fungible tokens, decentralized exchanges and other decentralized finance applications, Web 3 use cases,” - Messari chief executive Ryan Selkis
Current DeFi solutions have centered largely around stablecoins and lending, with all the use cases that go with it. Stablecoins like USDT and DAI have outstripped most trading pairs in trading volume, as people want to hold crypto assets pegged to their favorite fiat currency. Lending platforms like Celsius recently raised a $30MM equity round with Tether as a lead investor.
Filling a Crucial Need: Utility Tokens
With all the excitement surrounding DeFi, people seem to have given up on the initial dream that started it all: utility tokens that powerful countries would not regulate as securities. Let’s recall some of the benefits everyone was pointing out a mere 4 years ago:
- The network would be owned by the participants rather than those who launched it
- We could finally monetize open source projects and properly value contributions
- We could rescue journalism and monetize other online content without ads
The idea went that utility tokens would be obtained in order to be used, not held for speculative purposes of resale in the future. FileCoin would be used to pay for storing and serving files. Ethereum would be used to pay for transactions on a world computer. The initial development would be financed by pre-selling securities (remember the SAFT?) that promised the holder a certain number of tokens once the network was up and running. Many analysts were very bullish on this idea. Even notable crypto curmudgeon Preston Byrne admitted it could be a workable model.
Regulators Strike Back, Return of the Utility Token
Then the regulators created an atmosphere of uncertainty, thorough their messaging and enforcement, and the industry gave up on its dream of crypto-currency transforming the way we fund new projects. We were there, we saw it happen. But since 2018, there have been significant new developments:
June 14, 2018: SEC’s Director William Hinman gave a speech where he explicitly compared utility tokens to oranges in SEC vs Howey, expressing hope that one day we can have true utility tokens go mainstream.
April 3, 2019: The SEC issues its first No-Action Letter allowing TurnKey Jet, Inc. to issue bona fide utility tokens.
May 19, 2019: SEC’s Commissioner Hester Pierce expressed clear interest in allowing forbearance and sandboxes to allow new innovation and opportunities in crypto to develop.
July 25, 2019: SEC issues a second No-Action Letter, this time to Pocketful of Quarters, Inc. that goes further than TurnKey Jet, and allows approved and KYC-ed service providers to exchange the tokens for ETH at predetermined exchange rates.
Safe Harbor for Utility Tokens
These no-action letters have created a safe harbor for issuers of utility tokens, that can fit within the requirements spelled out in the letters. They are as follows:
- PoQ will not use any funds from Quarters sales to build the Quarters Platform, which has been fully developed and will be fully functional and operational immediately upon its launch and before any of the Quarters are sold;
- the Quarters will be immediately usable for their intended purpose (gaming) at the time they are sold;
- PoQ will implement technological and contractual provisions governing the Quarters and the Quarters Platform that restrict the transfer of Quarters to PoQ or to wallets on the Quarters Platform;
- gamers will only be able to transfer Quarters from their Quarters Hot Wallets for gameplay to addresses of Developers with Approved Accounts or to PoQ in connection with participation in e-sports tournaments;
- only Developers and Influencers with Approved Accounts will be capable of exchanging Quarters for ETH at pre-determined exchange rates by transferring their Quarters to the Quarters Smart Contract;
- to create an Approved Account, Developers and Influencers will be subject to KYC / AML checks at account initiation as well as on an ongoing basis;
- Quarters will be made continuously available to gamers in unlimited quantities at a fixed price;
- there will be a correlation between the purchase price of Quarters and the market price of accessing and interacting with Participating Games; and
- PoQ will market and sell Quarters to gamers solely for consumptive use as a means of accessing and interacting with Participating Games.
Level 1: The Utility Token Contract
We set out to build a smart contract which neatly fits all the above criteria, about which Hester Pierce said the transactions are “so clearly not an offer of securities that I worry the staff’s issuance of a digital token no-action letter… may in fact have the effect of broadening the perceived reach of our securities laws. If these tokens were securities, it would be hard to distinguish them from any medium of stored value.”
Suppose you are building a new network of buyers and sellers, and you want to launch a new token X for your ecosystem. The Utility Token Contract is designed to issue an unlimited amount of X and make it available to buy at a fixed price with a stablecoin (such as 1 USDT or 1 DAI). Anyone can buy X simply by sending USDT to the contract, and receiving the corresponding amount of X in return. They can also sell each X to the contract in exchange for a discount, say 0.9 USDT.
As long as the smart contract always sells each minted X for 1 USDT, it will always have enough USDT to buy back the tokens. Moreover, no rational buyer would spend more than $1 for X when they can buy it in unlimited quantities from the contract. Similarly, no rational seller would accept less than 90 cents for each X since they can sell it back to the contract.
However, “market makers” could appear, who trade within the narrow range, buying for 98 cents and selling for 92 cents, for example. This creates an opportunity for more entities to buy and sell the token, without making the token itself a security.
There is no need to pay a centralized exchange to get the token listed, if the contract is always standing ready to buy or sell. But because merchants and others who accept X will only get 90 cents instead of $1 if they send it to the contract, everyone holding X will be asking their employees and suppliers to start accepting some payments in X as well, increasing its network effect and overall market cap. Have you ever asked people to consider taking payment in Bitcoin or Ethereum? That’s what it looks like.
Level 2: Pre-Selling the Token
Although our Utility Token Contract, as described above, would already benefit any existing project, we can go further. Because the project deploying the smart contract becomes its owner, they will be able to tell the contract to mint some X and send it to specific addresses for free.
The project can use this ability to pre-sell some of the tokens using a SAFT (which is a security transaction), and once people begin buying X from the contract to use for utility purposes, the contract owner can start to tell the contract to give out X tokens, which have real value because the network is up and running, with at least one merchant (the project itself) willing to provide services.
However, giving out too many tokens can create an imbalance in the issuing contract, where the contract does not have enough USDT to buy back all the X outstanding. This is a situation similar to fractional reserve banking: since not everyone is going to demand all the X at once, the contract can in fact hold smaller reserves of USDT to X. It starts out with a 10% surplus, and may go down to an 80% deficit (20% reserves.)
Since buyers of X would naturally be concerned about this situation, each Utility Token Contract can be deployed with customizable limits on how many tokens can be minted and sent in this way:
Time-based limits: Every time a new Ethereum block is mined, increment the total number X the token can mint and send out at the owner’s behest
Volume-based limits: The amount is limited to be a fraction of how much USDT has currently been deposited with the contract.
We are working on submitting an Ethereum Improvement Proposal for a new token standard, such as ERC5377, to codify the above as a standard, that can be easily configured with the right parameters, and verified on services like Etherscan.
We are also building tools that will allow anyone to quickly check the parameters of a given Utility Token Contract, including the limits, to verify that its economics are sound, before buying the token. The actual buying and selling are trivial, since they involve simply sending USDT or X to the contract, respectively.
Some of the ideas for this contract design are based on descriptions of Bonding Curves which are used in projects such as Bancor to allow trading tokens whose price could go up indefinitely.
What to do next?
If you are inspired by these ideas, comment below and join the discussion. If you want to have Intercoin work with you to help you raise money for your project, contact us. Finally, if you’re an investor who is interested in what we’re doing, definitely fill out the form on https://intercoin.org or email us and we will reach out to you directly.