Part 2 - Tokenomics series

In mythology, the Labyrinth was created to imprison the Minotaur, a bloodthirsty creature with a man’s body and a bull’s head. King Minos, fearing the creature, enlisted the genius Daedalus to craft a maze so intricate, no one could escape. But, when Athens’ prince, Theseus, killed the Minotaur with Daedalus’ help, Minos was furious. He retaliated by imprisoning both Daedalus and his son, Icarus, in the very Labyrinth he had built.

While Icarus’ arrogance led to his downfall, Daedalus is the real architect of their fate—without him, Icarus would never have been imprisoned. This myth mirrors the hidden backdoor token deals that have become common in this crypto cycle. In this article, I’ll shed light on these deals—Labyrinth-like structures crafted by insiders (Daedalus) that doom projects (Icarus) to fail.

What Are Backdoor Token Deals?

High FDV coins have become a hot topic, sparking endless debates about their sustainability and impact. Yet, a shadowy corner of this discussion often goes unnoticed: backdoor token deals. These deals are secured by a minority of market participants through off-chain contracts and side letters, often obscured and nearly impossible to identify on-chain. If you’re not an insider, you’ll likely remain unaware of these deals.

In his latest article,@cobie""> @cobie introduced the concept of phantom pricing to highlight how real price discovery now occurs in private markets. Building on that, I want to introduce the idea of phantom tokenomics to illustrate how on-chain tokenomics can present a distorted and inaccurate view of the actual off-chain tokenomics. What you see on-chain may appear to represent the true ‘cap table’ of a token, but it’s misleading; the phantom off-chain version is the accurate representation.

While many types of token deals exist, I’ve identified a few recurring categories:

1. Advisory Allocation: Investors receive extra tokens for advisory services, typically categorized under team or advisor allocations. This frequently serves as a means for investors to lower their cost basis, with little to no additional advice provided. I’ve seen advisory allocations reach as high as 5x the investor’s initial investment, effectively reducing their real cost basis by 80% compared to the official round valuation.

2. Market Making Allocation: A portion of the supply is reserved for market-making on CEXs, which is beneficial as it boosts liquidity. However, conflicts of interest arise when market makers are also investors in the projects. This enables them to hedge their locked tokens using the tokens allocated for market-making.

3. CEX Listings: Marketing and listing fees are paid to be listed on top CEXs, like Binance or ByBit. Investors sometimes receive extra performance fees (up to 3% of the total supply) if they assist in securing these listings. @CryptoHayes recently published a detailed article on this topic, showing that these fees can reach as high as 16% of the total token supply.

4. TVL renting: Large whales or institutions providing liquidity often secure exclusive, higher yields. While regular users might be satisfied with a 20% APY, some whales quietly earn 30% for the same contribution through private deals with the foundation. This practice can be positive and necessary for securing early liquidity. However, it’s crucial to disclose these deals in the tokenomics to the community.

5. OTC Rounds: While common and not inherently bad, OTC rounds create opacity since the terms are often unknown. The biggest culprits are the so-called KOL rounds, which act as nitro for token prices. Certain Tier 1 L1s (names withheld) have recently adopted this practice. Large Twitter KOLs receive enticing token deals with steep discounts (~50%) and short vesting periods (linear over six months), incentivizing them to promote the token as the next [insert L1] killer. When in doubt, here’s a handy KOL translation guide to cut through the noise: https://x.com/0xLouisT/status/1823030042567348423

6. Selling Unlocked Staking Rewards: Since 2017, many PoS networks allow investors to stake vested tokens while collecting unvested rewards. If those rewards are unlocked, it becomes a way for early investors to take profits sooner. @gtx360ti and @0xSisyphus have called out examples like Celestia and Eigen recently.

All these token deals create phantom tokenomics. As a community member, you might glance at the tokenomics chart below and feel reassured by its apparent balance and transparency (chart and numbers are illustrative).

But if we peel back the layers to reveal the hidden phantom deals, the real tokenomics would look like this pie chart. It doesn’t leave much for the community.

Much like Daedalus, the architect of his own prison, these arrangements seal the fate of many tokens. Insiders trap their projects in a Labyrinth of opaque deals, causing tokens to bleed value from all sides.

How did we end up here?

Like most market inefficiencies, this issue stems from a significant supply-demand imbalance.

There’s an oversupply of projects coming to market, largely a byproduct of the 2021/2022 VC boom. Many of these projects have waited 3+ years to launch their tokens, but now they’re all entering a crowded space, fighting for TVL and attention in a much colder market. It’s not 2021 anymore.

Demand doesn’t match that supply. There aren’t enough buyers to absorb the influx of new listings. Similarly, not all protocols can attract funds to park TVL. This has turned TVL into a scarce, highly sought-after resource. Instead of finding organic PMF, many projects fall into the trap of overpaying with token incentives to artificially boost KPIs, compensating for a lack of sustainable traction.

Private markets are where the action is now. With retail investors gone, most VCs and funds struggle to generate meaningful returns. Their profits have shrunk, forcing them to generate alpha through token deals instead of asset selection.

One of the biggest issues remains token distribution. Regulatory hurdles have made it nearly impossible to distribute tokens to retail investors, leaving teams with limited options—primarily airdrops or liquidity incentives. If you’re a team trying to solve the token distribution problem, whether through ICOs or alternative methods, let’s talk.

Takeaways

Using tokens to incentivize stakeholders and accelerate project growth isn’t inherently problematic; it can be a powerful tool. The real issue is the complete lack of on-chain transparency in tokenomics.

Here are a few key takeaways for crypto founders to enhance transparency:

1.Don’t Give Advisory Allocations to VCs: Investors should provide full value to your company without needing additional advisory allocations. If an investor requires extra tokens to invest, they likely lack genuine conviction in your project. Do you really want someone like that on your cap table?

2.Market Making Is Commoditized: Market-making services are commoditized and should be competitively priced. There’s no need to overpay. To help founders navigate this space, I’ve created a guide: https://x.com/0xLouisT/status/1808489954869133497

3.Don’t Mix Fundraising with Unrelated Operational Matters: During fundraising, focus on finding funds and investors that can add value to your company. Avoid discussing market makers or airdrops at this stage—don’t sign anything related to those topics until later.

4.Maximize On-Chain Transparency: On-chain tokenomics should accurately reflect the reality of the token distribution. At genesis, distribute tokens transparently across different wallets, mirroring your tokenomics diagram. For example, with the following pie chart, ensure you have six main wallets representing allocations for the team, advisors, investors, etc. Proactively reach out to the teams at:

• @etherscan, @ArkhamIntel, and @nansen_ai to label all relevant wallets.

• @Tokenomist_ai for vesting schedules.

• @coingeckoand @CoinMarketCap to ensure accurate circulating supply and FDV.

• If you’re an L1/L2/appchain, ensure that your native block explorer is intuitive and easy to navigate for all users.

1. Use On-Chain Vesting Contracts: For teams, investors, OTC, or any type of vesting, ensure it’s transparently and programmatically implemented on-chain via a smart contract.

2. Lock Insiders’ Staking Rewards: If you’re going to allow locked tokens to be staked, at the very least, make sure that staking rewards are also locked. You can check out my take on this practice here: https://x.com/0xLouisT/status/1840039173815681038

3. Focus on your product, forget about CEX listings: Stop obsessing over getting a Binance listing; it won’t solve your problems or improve your fundamentals. Take @pendle_fi as an example: it traded on DEXs for years, reached PMF, and then easily secured a Binance listing. Focus on building your product and growing your community. Once your fundamentals are solid, CEXs will be begging to list you at much more favorable prices.

4. Don’t Use Token Incentives Unless Necessary: If you’re giving out tokens too easily, something’s wrong with your strategy or business model. Tokens are valuable and should be used carefully for specific goals. They can be growth-hacking tools, but they aren’t a long-term solution. When planning token incentives, ask yourself:

• What quantifiable goals am I trying to achieve with these tokens?

• What happens to that metric once the incentives stop?

If you think the results will drop by 50% or more when the incentives stop, your token incentive program is likely flawed.

If there’s just one key takeaway from this article, it’s this: prioritize transparency.

I’m not here to blame anyone. My goal is to spark a real debate that promotes transparency and reduces phantom token deals. I genuinely believe this will strengthen the space over time.

Stay tuned for the next part of my Tokenomics series, where I’ll dive into a comprehensive guide and rating framework for tokenomics.

Let’s make tokenomics transparent again and break free from the Daedalus Labyrinth.

Disclaimer：

1. This article is reprinted from [0xLouisT]. All copyrights belong to the original author [0xLouisT]. If there are objections to this reprint, please contact the Gate Learn team, and they will handle it promptly.
2. Liability Disclaimer: The views and opinions expressed in this article are solely those of the author and do not constitute any investment advice.
3. Translations of the article into other languages are done by the Gate Learn team. Unless mentioned, copying, distributing, or plagiarizing the translated articles is prohibited.