Written by: Hack VC
Compiled by: TechFlow
This post covers a range of considerations for launching a successful web3 protocol token. These ideas are culled from practical experience at Hack VC assisting our portfolio companies with token launches over the past few years.
The information herein is provided for general informational purposes only and should not be relied upon for accounting, legal, tax, business, investment or other related advice.
1. Build relationships with liquidity providers
When a token project first launches, there is usually not a large supply of tokens on the market. This is because your investors and employees usually unlock or lock up their tokens in installments over a period of years. This leads to a lack of liquidity depth on exchanges, making token prices unreliable. Small buy and sell orders on exchanges can greatly affect the price of your token.
Is token price volatility a problem? Not necessarily, but it becomes very important if your token has some form of utility. Since users cannot acquire tokens in reasonable quantities or prices to utilize your network, your network may not function as expected, which may limit your network growth.
To solve this problem, you can work with one or more liquidity providers to help create liquidity for your tokens. Liquidity providers effectively lend tokens from your funds and create a market by providing their own stablecoins to pair with your tokens on the exchange. They usually have algorithmic trading bots that act as a "middleman" between buyers/sellers on the exchange, creating a liquid market.
A typical transaction with a liquidity provider involves them borrowing your tokens for 18 months, after which they have the right to buy those tokens at the then current price. So these transactions obviously have costs.
Examples of liquidity providers include Amber Group, Dexterity Capital, and Wintermute. Recently, a concept called on-chain liquidity providers has emerged, where a web3 protocol effectively acts as a liquidity provider. In this context, stablecoins are provided by dynamic LPs, who can even be members of your own DAO (this creates a strong alignment of interests, and a great way to reward your DAO members for their participation). Elixir.xyz is a pioneer in this concept.
Coinwatch is also an option you may want to consider, they are a “buy-side agent” for liquidity providers, helping the protocol negotiate these trades. Coinwatch helps startups negotiate cheaper, more efficient, and more consistent trades. They also track the activity of your liquidity providers so you can make sure you’re getting what you paid for.
2. If you are a DeFi protocol (or L1/L2 protocol), you should have a TVL plan for day-0 and beyond
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 yardstick for measuring the attractiveness of a DeFi protocol is the total value locked (TVL). If you start with zero TVL at day-0, it may create a chicken-and-egg dilemma for LPs, where no one is willing to take the risk of being the first LP to enter the pool.
Today’s LPs tend to behave conservatively (given some of the recent disasters that have occurred in web3). They usually worry about two things:
Are the benefits presented accurate compared to the benefits realized?
Am I at risk of losing my capital (from a hack or otherwise)?
You only have one chance to launch, so it makes sense to invest in making sure it goes well. Having TVL on day-0 can help kick-start the positive feedback of social validation and growth.
One way to address this is to effectively “pre-negotiate” the TVL prior to launch through other investors’ trust in the protocol. This could be venture capital firms, family offices, or high net worth individuals. A reasonable target for social acceptance might be 7-8 figures of TVL before others start to feel comfortable joining.
Ultimately, the best long-term solution for making LPs feel comfortable is to let your protocol run as intended for long enough without getting hacked. But it can be a helpful way to encourage early adoption to start building a track record.
There is an 80/20 rule between users and TVL (i.e. the top 20% of users may represent more than 80% of TVL), so the focus should be on attracting large deposits when increasing TVL.
You should also plan your liquidity mining issuance beyond the initial phase. Subsidizing it through token incentives is fine initially, but you will want to transition from that to sustainable fee-based returns in the long run.
An interesting technique to incentivize early TVL could be to create a “spillover” bucket for investors. Once you’ve hit your dilution limit for a round, you could consider only accepting investors who are willing to commit to TVL.
3. Follow best security practices
The security of your protocol is of utmost importance. If your protocol is hacked, then it will be a stain on your record forever and may deter users from participating. Follow some key steps:
Consider choosing technologies that can reduce the risk of smart contract attacks in advance. For example:
Programming in the formally verified and type-safe Move language is often safer than Solidity (e.g. via MovementLabs.xyz).
Another approach is to introduce a delay in the finalization of transactions to allow time to catch smart contract attacks (e.g., via UseFirewall.com).
Another approach is to use formal verification of zero-knowledge code (e.g., in the case of a bridge), through technology such as AlignedLayer.com.
Perform audits on multiple smart contracts before your protocol goes live to convey confidence to your users and team that your code is reliable. Note that this does not guarantee that you won’t be exploited, but it is a good step to take. Examples include Trail of Bits and Quantstamp .
Establish a code change process so that if you make additional changes to your smart contract over time, you can re-examine each code increment with a lightweight audit. This is a step that is often overlooked by teams and can be critical to catching bugs in hastily committed commits.
Consider using formal verification or fuzz testing. Formal verification is the exhaustive mathematical verification of your code system. It provides comprehensive coverage analysis that can increase your confidence in attacks. Fuzz testing is making slight changes to the inputs to the system to find possible vulnerabilities. An example of a vendor that provides formal verification and fuzz testing is Veridise .
Consider investing in a bug bounty program. This can incentivize white hat hackers to find vulnerabilities because they will be rewarded. In web3, the current market leader is ImmuneFi .
4. Measuring product-market fit before mainnet
Web3 projects are notorious for listing tokens before confirming that their project solves a real pain point for customers. If you take this approach, you are setting yourself up for a dramatic drop in the price of your token because your KPIs will be questionable at best.
But how do you measure product-market fit before launching? Some teams try to confirm this through testnets, but the challenge with testnets is that customer behavior may be different compared to the mainnet. When it comes to financial matters (e.g., DeFi protocols on testnets), because users are using "game coins", they may not act as seriously as real assets and may simply be airdrops rather than serious users.
To solve this problem, I recommend launching a "private mainnet" (different from a testnet) where your service goes live with real money and real users to confirm product-market fit. Users are invite-only (e.g., your investors, friends, and team) so that you don't miss out on your marketing launch because of a small group of private users.
5. Make sure your launch timing 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 tokens until their protocol has created substantial real value. This is similar to how web2 startups don’t rush to go public until they have built a solid business.
Releasing tokens during a specific market window is risky. If retail users buy your tokens at the bottom of a bear market, and if there is a bull market in the future, the token price of these users may be more likely to appreciate, which may bring strong loyalty and evangelism to your project. If you compare this approach to releasing tokens in a bull market and experiencing a sharp drop in a future bear market, these users will naturally be much fewer.
One way to mitigate this risk is to create a more attractive entry price for investors through an Initial Exchange Offering. 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, your users typically don’t provide anything substantial for the tokens — the airdrop is free for them. This allows for the widest possible distribution, but does not necessarily result in users “caring” about your protocol, since they are not investing/taking any risk. That is, they are not participating.
How to create user engagement? You may want to avoid selling tokens to retail users (for legal/regulatory reasons). One potential solution is an Initial Exchange Offering (IEO). It works by allocating a portion of your token supply to an exchange, which then sells it to users at a low price (providing added value to retail investors). This is also a good way to build trust with the exchange.
The Sui blockchain is a good example of this approach. Sui is an L1 based on the Move programming language, created by former Meta employees. They conducted an IEO, which was very successful.
6. Pay attention to the lock-up period when designing the token unlocking schedule
Most web3 projects will have their employees and investors unlock their tokens over multiple years. In cases where you are migrating from web2, you will often see this unlocking have a “cliff”. This means there is a minimum unlock period before the tokens unlock (e.g. there is a one year cliff, no unlocks for the first 12 months, then at the end of the 12th month you unlock a full year of tokens all at once).
This sounds good because it encourages loyalty and discourages a sell-off of tokens. However, in practice, if you have a large number of employees or investors selling 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 linear unlocking (i.e. tokens accumulate smoothly over time). This way, there is a slow inflow of tokens into the market, avoiding sudden drops.
7. Set aside a budget for exchange listing
Many exchanges will charge fees for listing your token, so you’ll need to plan ahead and set aside a budget for this if you want to get listed on some of the more popular exchanges. Some of the most well-known exchanges have been shown to charge around $1 million to list a token, so the listing process can be very expensive.
One exception is if you are a top-notch project backed by a well-known fund, sometimes exchanges will list you for free as it will attract users to their exchange. This is an advantage of working with a well-respected VC firm from your funding round (as it buys you social proof on the exchange side).
8. Raise capital before going public
We have come across many token projects that attempt to raise funds after launching their tokens. This can be a bit more difficult than a startup anticipates.
Most private investors arbitrage between public and private markets. The market for funds doing private rounds is much larger than the market for public token rounds, limiting the potential pool of investors. For example, you would exclude most early stage funds.
It is also difficult to raise funds after the token launch because the negotiations themselves can be challenging. A 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 can one determine a price and come to agreement with private investors?
These problems go away if you raise money before the token goes public, when the token price is unknown and you can include a much larger group of private equity funds that will invest in this asset class.
9. Invest in high-quality legal counsel for TGE
Over the years, we have come across many teams who have been woefully underserved by their legal counsel. In web3, founders take on far greater risk than in web2, so getting strong crypto-native legal advice is critical. I encourage founders to ensure their attorney has crypto-specific practice experience when preparing for a TGE.
By the way, the regulatory landscape in web3 is still evolving. Often, decisions are subjective rather than objective. Remember, most lawyers are not business people and often optimize advice based on hypothetical legal arguments rather than actual decision making in the real world. In other words, when it comes to regulation, don’t follow your lawyers, you need to use your own judgment and assess your own risk appetite, especially given that the law changes frequently.
10. Determine the right time to monetize via a fee switch
Many protocols (especially DeFi) postpone their fee switches to a future date, implemented via fee switches. The purpose is to subsidize maximal short-term growth and postpone monetization until later. This is similar to how in web2, Facebook and other social networks postponed advertising/monetization until they had the critical mass of a social network. If your optimization goal is to attract new users, then delaying monetization makes perfect sense.
The danger of delaying monetization is that it could interfere with product-market fit. Generally speaking, if users are willing to pay for your service, then that is the strongest indicator that you have “serious” users who will remain loyal. However, if your fees have a significant impact on the economics of your user base, then by delaying monetization you may be hiding core issues in your protocol. However, if your fee rates are modest, this may be a lower risk.
“Toggling” that fee switch is actually the process of transitioning from a pure governance or placeholder token structure to accruing value to token holders via platform fees. Typically this is done at the outset (e.g. GMX), but certainly not always (UNI and many other projects).
Here are some project characteristics that might warrant consideration for a fee switch:
Sufficient number of users
Strong liquidity of tokens
Broad holder base
Takers (traders) pay healthy fees to liquidity providers (creators)
Maybe consider giving LP tokens at the same time as the fee switch via an airdrop or similar distribution method, so that even if they no longer receive 100% of the fees, they still feel like they are getting some return through the tokens
Consider the minimum expected return target APY yield for token holders relative to other opportunities/markets and construct fee parameters that make sense and are fair in that context
For example, for staking rewards, 5% is considered standard, while 10% is considered high (LIDO can reach 10%)
For trading venues, 2.5-5.0bps is standard, 10-25+bps is high; better venues can charge higher fees
For lending, a reasonable net interest margin (NIM) between borrowers and lenders is typically 1-2%, which is expected to compress over time.
in conclusion
Hopefully, you’ll find these ideas useful to consider for your token launch. Please note that best practices for token launches are continually evolving and the ideas in this article are just a starting point.
