Written by: Will Awang

Web3 is a value network built on the blockchain. All values ​​on it can be tokenized. Tokens are the digital form of value and can be freely and efficiently combined, circulated and distributed in the value network of Web 3. The "three-token model" proposed by Dr. Xiao Feng of HashKey Group clearly explains the various dimensions of value, namely, utility tokens, security tokens and non-fungible tokens (NFTs), which represent the right to use, ownership and digital certificates respectively.

SAFT (Simple Agreements for Future Tokens) is the most common agreement in Web3 investment and financing, which captures the value of Web3 projects in the form of tokens. This article will combine the HashKey Group white paper "Web3 New Economy and Tokenization" and the US Cooley Law Firm's SAFT white paper to understand SAFT, Web3 token investment and financing, and the value capture method of token investment and financing from the perspective of the three-token model.

(from: How to Invest in Web3: The Next Phase of the Internet)

Summary

  • Web3’s new economy is a stakeholder economy, with the core being the use rights system;

  • The functional token, equity token, and NFT in the three-token model represent usage rights, ownership rights, and digital tokens respectively;

  • The right to use cannot be decentralised, but it can be tokenised, i.e., a functional token, which is a representation of the value of the right to use and captures the value of network benefits.

  • SAFT itself is an investment agreement. SAFT is only applicable to functional tokens. Through a two-step agreement mechanism, the transformation of tokens from security tokens to functional tokens is realized, thereby circumventing the securities supervision of the US SEC to a certain extent.

  • The purpose of Web3 project investment and financing is to capture the value of the project. The difference between equity and token investment lies in determining where the value is realized and how to capture it.

Web3 New Economy’s Three-Token Model

(from: Analyzing tokenization and leading the new economy! The white paper "Web3 New Economy and Tokenization" was released at the 2023 Hong Kong Web3 Carnival)

A deep understanding of the essence of the three-token model is very helpful for different forms of value capture in Web3 investment and financing.

Whether in the economic model of Web1 or Web2 (surveillance capitalism), the platform enjoys the ownership of the final information data. The platform generates huge commercial value through monetization, giving birth to platform-level business giants such as Facebook and Googel, but this has nothing to do with ordinary user participants. Web3, based on the blockchain network, is based on an economic model of a value network (stakeholder capitalism), emphasizing data credibility, data sovereignty and value interconnection. Under the premise that all values ​​can be tokenized, value not only includes ownership, but more importantly, the right to use.

Ownership is exclusive and difficult to divide. The organizational form under the ownership system (generally a company) aims to maximize shareholder interests and is the embodiment of shareholder capitalism. The right to use is non-exclusive and has multiple sharing characteristics. It can be authorized and licensed multiple times, and can even be open source and CC0 infinitely cycled. The core of the right to use system is stakeholder capitalism. The original organizational form may not be suitable. The decentralized autonomous organization (DAO) based on open source organizations and non-profit organizations is naturally suitable for stakeholder capitalism and has become the main organizational form of the new economic model of Web3.

Under the right to use system, all participants in the organization collaborate on a large scale as stakeholders, make their own contributions, and share the value of the organization. In this context, the shareholder ownership represented by the project shareholders is no longer meaningful, and what is truly valuable is the right to use the project. The right to use cannot be stockized, but it can be tokenized. Combined with blockchain distributed ledger technology, the right to use can be standardized and shared in the form of Tokens, which is related to the interests of every participant in the project network, namely the Utility Token.

(from: Web3 New Economy and Tokenization)

Based on the Web3 economic model, the right to use system, and stakeholder capitalism, the three-token model built around the project - utility tokens, security tokens, and non-fungible tokens (NFTs) - will share value with all participating stakeholders based on their own value forms. For example, stakeholders only have the right to use the blockchain network, system, or application if they own the token; or tokens can be certificates of voting rights, and can participate in community voting, voting, and governance, etc., which are all manifestations of the right to use.

  • Utility Tokens capture the network scale effect of the Web3 network, system or application. The larger the volume of ecological applications and users, the higher the market demand for the token, and the price of the token depends on the market's value discovery.

  • Security tokens capture the value of future cash flows of equity assets such as equity and debt.

  • NFT is a digital asset form of the underlying assets of things, which can be called a "digital token". NFT is related to the value of the underlying assets it anchors, and its value comes from various sources.

Legal attributes of SAFT

SAFT (Simple Agreements for Future Tokens) is an investment agreement specifically for Web3 projects built on the blockchain network. SAFT stipulates that the project party will use the subscription rights of tokens after the future network is launched as consideration in exchange for the current funds of investors for the current development and construction of the project network.

Since security tokens are the focus of supervision in various jurisdictions, SAFT establishes a set of protocol mechanisms to ultimately achieve the effect of launching a utility token network, thereby circumventing the supervision of the U.S. Securities and Exchange Commission and related laws on the investment and financing of Web3 project tokens.

(from: https://saft-project.org/)

The SAFT white paper (The SAFT Project: Toward a Compliant Token Sale Framework), which was mainly handled by the US Cooly law firm, was released on October 2, 2017. It first proposed the SAFT transaction model, aiming to provide a compliant token issuance path for Web3 projects based on the US securities law system. It is mainly divided into two steps:

(1) Project development stage: For Web3 projects that are still in the development stage, after investors invest money, their expected profits depend on the management and development of the network by the project development team. Since the tokens have no actual utility, the nature of the tokens at this stage is more like a value representation of equity, and the value captured is the future cash flow capacity of the Web3 project.

This type of investment behavior may meet the standards of the Howey Test and be considered an "investment contract," which is subject to strict securities supervision by the U.S. Securities and Exchange Commission. However, an exemption can be applied for under Regulation D Rule 506 of the U.S. Securities Act, without the need for securities registration, and investors are limited to accredited investors.

(2) Project development is completed and launched: For projects that have been developed and launched, the tokens (Already-functional Utility Token) issued have many functions (usage, consumption, governance, etc.) that allow users to access the Web3 project ecosystem network. The nature of the token at this stage is a value representation of the right to use, and is defined as a utility token.

Since the token already has practical properties, generally speaking, the main purpose of investors purchasing the token is to obtain the practical value of the project network, not for pure profit. Moreover, for a decentralized token economic system or governance system, the price of the token in the secondary market is completely affected by the supply and demand relationship in the market, and is not dominated by the contribution of the project development team. This is very different from (1) the role of tokens in the project development stage. Therefore, the SAFT white paper believes that such a utility token does not have the attributes of a "security" and is generally not subject to strict supervision by the U.S. Securities and Exchange Commission. However, the purpose of SAFT is to comply with the regulations of the U.S. SEC. Strictly speaking, it is only applicable to professional investors (Accredited Investment) and is not suitable for most small and medium-sized investors.

（from: Kraken’s Legal Chief Has No Time to Educate Firms About Crypto）

Although we have seen the SEC raise many challenges to SAFT in the recent Kik and Telegram cases, it always feels that there are flaws in the design and issuance rhythm of utility tokens. As one of the drafters of the SAFT white paper, one of the lawyers who understands Crypto and US securities law best, Marco Santori, currently the general counsel of Karken, was overturned by the SEC in February 2023 due to Karken's Staking as a Service business, not to mention the SAFT agreements of projects with different networks, different token function designs, different token economic designs, and different investors.

There are many legal ways to invest and finance Web3, such as SPA (Share Purchase Agreement) and SAFE (Simple Agreement for Future Equity) involving equity, TPA (Token Purchase Agreement) and SAFT (Simple Agreement for Future Tokens) involving tokens, or a combination of the two, SAFE + Token Warrant/Side Letter. The specific form to be adopted needs to be based on the nature of Web3 investment and financing.

The Essence of Web3 Investment and Financing

The most important thing for Web3 project investment and financing is to determine where the value is realized. When valuing equity projects, more attention is paid to the company's future cash flow capabilities, because shareholders have the legal right to distribute the company's profits. When valuing token projects, the traditional cash flow valuation model is not applicable. More attention is paid to the project network scale effect, the demand between the network and the token, and the function of the token. Therefore, compared with token financing projects, token economics is very important.

(from: Connecting Web3 Wallet to Twitter Account)

(1) Twitter’s Web3 Hypothesis

Twitter, the current Web2 internet giant in the creator ecosystem, operates through the organizational form of a company. Its goal is to maximize shareholder interests, reflecting shareholder capitalism. The value of investment lies in the company's ability to obtain future cash flows, and stock prices reflect the value of future cash flows. Imagine a Twitter based on the Web3 new economic model, which uses its tokens to incentivize all participants in the network ecosystem (content creators, developers, validators, other market participants, etc.) to jointly maintain the Twitter ecosystem network and promote governance. The token's effectiveness is not only a medium of exchange, but also provides users with access to the Twitter ecosystem network, consumption of products/services on the Twitter ecosystem network, and governance of decisions on the Twitter ecosystem network.

This new Web3 economic model releases economic benefits and governance power from centralized entities to the entire decentralized ecological network. All stakeholders involved can share the value they create, reflecting stakeholder capitalism. In this model, Twitter's equity may not be meaningful. Twitter's tokens will replace equity to capture greater value on the Twitter ecological network, and the token price reflects the supply and demand relationship of the ecological network for tokens.

(from: https://dune.com/hildobby/NFTs)

(2) Opensea and Blur

Opensea, once the world's largest NFT trading platform, received $300 million in financing from Paradigm and Coatue in January 2022, with a valuation of $13.3 billion. Opensea's cash flow is mainly supported by its transaction fees. Such projects of Opensea can be understood as typical equity investment and financing projects in Web3. They can be applied to traditional business models in many ways. Investors capture the value of the company's future cash flow, and equity investment is more desirable.

At the same time, in March 2022, Blur received $11 million in financing from Paradigm. Facing the huge mountain of Opensea, Blur directly activated the community a year later (in the form of airdropping tokens to community participants), opened up the liquidity feast of the NFT market, and achieved a curve overtaking of the Opensea network effect. This type of project of Blur can be understood as a typical token investment and financing project in Web3. Investors capture the scale effect of the Blur network ecosystem. The larger the scale of ecological applications and users, the higher the market demand for the functional token, and the price of the token depends on the market's value discovery.

However, considering the sluggish performance of Blur tokens after their listing and the limitations of token functions, it can be seen that how to design the functions of tokens and the token economic model is the top priority for the long-term operation of the project.

(from: https://docs.blur.foundation/tokenomics)

Therefore, it can be seen that the purpose of Web3 project investment and financing is to capture the value of the project. The difference lies in determining where the value is realized and how to capture it.

Final Thoughts

The significant increase in the liquidity of Web3 project value has put higher demands on project parties. They need to be able to describe the future model of the project and the arrangement of the token economy relatively clearly during the white paper financing stage. Otherwise, it will be difficult to connect with the subsequent SAFT and development plan.

Therefore, in the early stage of the project when the model has not yet been finalized, it is also possible to adopt the setting of equity financing + token terms (SAFE + Token Warrant/Side Letter). On the one hand, it can also solve the purpose of SAFT to circumvent US securities supervision, and on the other hand, it can provide the project with a way of equity financing while retaining the possibility of token financing.

There can be many ways, but Web3 projects must generate value, otherwise it will be foggy.