Vircon Legal Consultancy

What Is a Dual-token Economy?


The dual-token economy, also known as the two-token economic model, is a term for crypto projects that combine two different types of tokens in their ecosystem. This model is known for its methods of avoiding compliance issues, avoiding volatility, and splitting the project's ecosystem into two tokens for effective use. Three formats of dual-token projects that fulfill the above purposes are as follows:

1- Bundled ICO-Based Dual Token Model

Under the bundled format of the dual-token model, a blockchain project issues one token to secure funding from the public and a second token to be used on the network to perform certain tasks or activities that primarily serve utility purposes (e.g., to fuel transactions on a platform) within the platform. One advantage of the dual economic model is that it avoids the uncertainty of whether a token offering is a security offering under U.S. federal securities laws. As token sales occur over a period of years, one of the most important questions is whether token offerings are securities offerings within the meaning of the U.S. federal securities laws.

The definition of "security" stipulated under Section 2(a)(1) of the Securities Act of 1933 and Section 3(a)(10) of the Securities Exchange Act of 1934 includes "investment contracts" in addition to familiar financial instruments such as stocks and bonds. The definition of "security" is so broad that the U.S. Securities and Exchange Commission (the "SEC") has the authority to regulate a wide variety of instruments as securities. Although the definition of securities is broad, it generally does not explicitly include tokens and digital assets. The SEC, in its Framework for Investment Contract Analysis of Digital Assets, has defined "digital asset" as "an asset issued and transferred using distributed ledger or blockchain technology, including but not limited to virtual currencies, coins, and tokens." A fundamental aspect of federal securities regulation is found in Section 5 of the Securities Act of 1933, which requires that any offer or sale of securities be registered with the SEC or exempt from such registration pursuant to applicable statutory exemptions. An "offer" is defined broadly in the Securities Act of 1933 as "any attempt or offer to sell, or solicitation of an offer to buy, any security or any interest in a security for consideration."

The SEC takes the position that this essentially means that tokens offered in ICOs must offer a clearly defined ownership stake in the platform, including the right to receive future dividends and interest from the profits of the project, in order to be treated as securities under U.S. federal securities laws. In the absence of a clear rule on what digital assets are considered securities and whether all token offerings are considered securities offerings, blockchain projects are beginning to separate utility tokens from security tokens, adopting the two-token economy model to avoid the uncertainty and risk of being exposed to potential securities law violations, including unregistered offerings.

Indeed, treating transaction utility tokens as securities could lead to legal compliance requirements that would be too inflexible for the overall operation of the platform. To avoid these complications, many blockchain projects rely on dual token models for ICOs. This involves issuing a token, the security token, at the ICO stage to attract investors to the project. To comply with securities law, this token gives its holder the right to participate in the project, as well as potential rights to future dividends and profits. The second token, the utility token, can be issued at any stage - before, during, or after the ICO. The Utility Token is usually used as a perk to increase interest in the security token. For example, a certain number of utility tokens can be offered to each person who buys a security token. All in all, blockchain projects under the bundled ICO-based dual token model aim to fulfill the requirements of SEC by raising funds through the offering of security tokens and offering utility tokens that can be used to fulfill another task, depending on the design of the platform.

2- Detached ICO-Based Dual Token Model

In the detached ICO-based dual-token model, the utility token is not issued at the same time as the security token, so the utility token is not used as an incentive to purchase the security token. Both tokens are treated separately, with no promotional mechanism in place to encourage potential investors with utility token offerings. This model is usually preferred when security tokens are issued first to raise funds and then utility tokens are issued when the project is ready for use.

3- Non-ICO Dual Token Model

Another use case for introducing a dual token economy is to create a healthy, non-volatile trading environment by creating a relationship between two tokens in an ecosystem. Most often, the relationship begins with an initial token that can be traded on coin exchanges. The secondary token, on the other hand, can only be acquired by exchanging the initial token into the secondary token. Thus, the value of the secondary token will most likely increase steadily as it operates on the deflationary principle of supply and demand. However, the model is not limited to ICO-funded projects. The best-known example of a dual token model to create a non-volatile trading environment that has never conducted an ICO is MakerDAO's use of MKR and DAI.

The DAI token is used to provide loans to users of the platform. The loans are backed by ETH, which users deposit into a "vault" on the system. The MKR token is used as a governance token and price stability mechanism for the DAI, which is a stablecoin that maintains a 1:1 peg to the USD. The model in MakerDAO shows that if the DAI stays at 1 USD, the MKR tokens will be destroyed. If DAI deviates too far from the 1 USD level, MKR tokens are created. For Maker, DAI can be described as a utility token that enables the main function of the platform, which is lending. Thus, the use of a second transactional token to absorb the volatility of the platform is the main aspect of non-ICO dual token model. While the stablecoin is pegged to a fiat currency, the second transactional coin fluctuates in line with the overall activity of the platform.

Another advantage of adopting the dual-token economic model is that it offers token holders and potential investors more incentives than other projects in the industry. With two tokens, a crypto project can offer end users a better incentive structure, features, upgrades, and functionalities. In addition to the many benefits that can be cited for the various dual token models, there are also potential drawbacks that need to be considered. First, tokenomics could be confusing for investors. Holders of different tokens on the blockchain platform could face potential conflicts of interest.

An obvious example of this shortcoming is that at Maker DAO, after DAI holders lost about $2,500,000 from their vaults on the system, platform users decided not to compensate them in a governance vote. Since MKR, not DAI, is the governance token, only MKR holders had a say in how the lost funds should be handled. Both dual token models and stablecoin projects that rely on this model are likely to increase due to the increasing attention of SEC to blockchain projects. In the case of ICO-driven projects, the dual token model can serve as both a compliance mechanism and a means to increase investor interest. In the case of non-ICO projects, the dual-token model can serve as an efficient way to separate a volatile transactional token from a pegged stablecoin. As both ICOs and stablecoin projects are expected to increase, it is very likely that the number of dual-token projects will continue to grow.

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