Aligning stakeholders’ financial interests in the Digital Economy
Author: Thibauld Favre
Version: 1.2
Last update: Oct 17th 2019
Keywords: FAIR Securities, Continuous Securities Offering, Decentralized Autonomous Trust, Bonding Curve Smart-Contract, Multitude
A special acknowledgement to Joris Delanoue, my co-founder at Fairmint who relentlessly challenged the model since version 1.0 was published. Version 1.2 of this whitepaper really reflects the results of those sometimes heated but always fruitful discussions.
This research is financially supported by Fairmint.
Finally, many thanks to those persons who have kindly contributed to this research through their valuable feedbacks and insights: Pierre-Louis Guhur (Student - ENS Cachan) ● Marie Ekeland (Founder - Daphni) ● Tonje Bakang (Partner - The Family) ● Solomon Hykes (Founder - Docker) ● Andrea Luzzardi (Software Engineer - Docker) ● Samuel Alba (Senior Director of Engineering - Docker) ● Oussama Ammar (Founder - The Family) ● Alexandre Obadia (Research - Cambrial) ● David Fauchier (Founder - Cambrial) ● Minh Ha Duong (Principal - Cambrial) ● Florent Artaud (Founder - Ekwity) ● Willy Braun (Co-Founder - Daphni) ● Franck Le Ouay (Founder - Lifen) ● Duc Ha Duong (Founder - Officience) ● Dimitri De Jonghe (Founder - Ocean Protocol) ● Jérôme de Tychey (Blockchain tech Lead - Consensys) ● Kyle Hall (Writer - The Family) ● Billy Rennekamp ● Roxana Danila.
The digital economy has radically changed the nature of the relationship between customers and corporations. Today's individuals have switched from being passive consumers to being an essential force in creating value, either by their actual work (think Airbnb, Uber, Apple's App Store, Amazon Marketplace...) or through their data (Facebook, Google...). By leveraging their users' work, organizations in the digital economy have the ability to create products with personalized user experiences that can sustain increasing returns to scale, thus providing investors with large returns on investments.
Unfortunately, today's organizations have no simple and efficient way to strongly align the interests of their workforce of users with the financial success of their organization. This is mostly due to today's securities' laws that impose constraints and frictions when it comes to selling and distributing securities, especially to non-accredited investors.
To solve this issue, we propose a new paradigm: the Continuous Organization (CO), a new type of organization designed to align the stakeholders' interests significantly better than in traditional organizations. A Continuous Organization is any kind of organization that set up a Continuous Securities Offering (CSO) by funneling part or all of its realized revenues to a Decentralized Autonomous Trust (DAT). A DAT is a smart-contract with the ability to automatically issues, buy back and cancel fully digital securities called FAIR Securities (FAIRs) to meet market demand using predefined rules.
Continuous Organizations present very beneficial properties for all stakeholders:
- Founders get a simple and efficient mechanism to receive financing while strongly aligning their community with the financial success of their project, enhancing the organization's capacity to create strong network effects without affecting the organization's governance.
- Employees advantageously trade alienable illiquid stock options for inalienable liquid FAIR Securities (which can vest as well), truly aligning their interests with those of the organization.
- Early investors receive their fair share of the upside in the case whereby the organization is successful, without having to fear disproportionate dilution in later, bigger rounds.
- The community of users, customers, suppliers and partners of the organization get the ability to invest in the organization in a friction-less and permission-less manner, thus aligning their interests with those of the organization.
- Regulators can better protect citizens from risky ICOs due to the 'security' nature of FAIR Securities while also having the ability to tax revenues generated by Continuous Organizations.
- The environment benefits from the decoupling of governance and financial interests proposed by the Continuous Organization model, allowing founders and their organizations to be more focused on the long term.
It goes without saying that the "security" nature of FAIR Securities (FAIR Securities undeniably pass the Howey test) requires the issuer to comply with the securities laws of the juridisdiction it is operating in.
- Context
- Continuous Organizations
- Implementation
- Use cases
- Legal & Regulatory considerations
- Attack vectors
- Conclusion
- Annex
As the world transitions from the industrial age to the digital age, the legal structures that were invented and optimized to address the business needs of the industrial age are now showing their limits. Indeed, the digital economy has pushed organizations to adapt and transform their ways of doing business to such extent that their very nature has now completely changed:
|
Industrial Age think "General Motors" |
Digital Age think "Airbnb" |
|
| Capital intensity | High 💲💲💲 | Low 💲 |
| Returns to scale | Decreasing ↘ | Increasing ↗ |
| Main assets | Tangible 🏭 | Intangible 💻 |
| Size of workforce | Large 🙋🙋🙋 | Small 🙋 |
| Location of workforce | Concentrated 🌆 | Distributed 🌎 |
| Type of jobs | Manual 🔧 | Intellectual 🧠 |
| Main growth driver | Cost 💵 | User experience 👌 |
| Tax contribution | High 💲💲💲 | Low 💲 |
But despite this massive evolution of organizations, we still use the same type of legal entities to operate our businesses. These legal entities were designed within nation states to address the needs of organizations in the Industrial Age. They are ill-suited in the age of ubiquitous computing and networks, where organizations harness the power of the multitude to achieve increasing returns to scale, blurring the line between users and workers. To illustrate: an Uber driver is at the same time a user of Uber and a worker for Uber. Same goes for the renter of a flat on Airbnb. A Facebook user is also a (unpaid) Facebook worker etc...
Nicolas Colin, a colleague of mine at The Family, succintly described the situation in his book "Hedge":
"The key to understanding the digital economy is that it redistributes power from inside to the outside of organizations. A corollary to this law is that the businesses that succeed in the digital economy are the ones that realize how power has been redistributed outside of their organizations and learn to harness it anyway to fuel growth and profits."
To define the nature of this power, Nicolas Colin defined the concept of multitude in a previous book co-authored with Henri Verdier:
"The multitude is defined as the billions of individuals that are now equipped with increasingly powerful devices and connected with one another through wide networks."
In the digital economy, organizations rely on the multitude (i.e., "Uber drivers", "Airbnb hosts", "Apple App Store developers", "Facebook users"...) to thrive as a business yet the multitude has no vested financial interest in the wealth it contributes to creating at the organization level. Instead, the multitude enters the "gig economy", defined by part-time jobs paid upon successful completion of a service. These jobs, which used to be very rare during the Industrial Age, are now becoming increasingly common.
The radical transformation of organizations in the digital economy has created important challenges for all stakeholders that must be addressed:
"How can I incentivize my community to promote the long-term success of my organization?"
Money. As the multitude has become an essential part of the organization's workforce in the digital economy, founders need new mechanisms to attract, retain and empower a diverse and global community. Many marketing tactics already exist but none of them allow for a lasting, solid alignment of interests between the organization and its community. The real solution, which would be to sell and/or distribute securities to the multitude is so legally complex under current security laws that it is not a realistic option.
"Airbnb is a community-based company and we would be nothing without our hosts. We would like our most loyal hosts to be shareholders, but need these policies to change in order to make that happen."
The above quote is from Brian Chesky, CEO of Airbnb, in a statement about a comment letter Airbnb addressed to the SEC.
"How can I create a long lasting trust relationship with my community?"
Trust. To forge a lasting and solid alliance with the multitude, organizations need to earn the trust of the multitude. However, as more and more people understand how the VC financial model works, it is becoming harder and harder for VC-backed organizations to gain the trust of their community. Indeed, VCs' interests are only aligned with those of the organization until investors need liquidity. When investors demand liquidity, the alignment of interests suddenly focus on the very short term, wanting to sell their shares at the best price possible. In most cases, founders got heavily diluted and have lost control of the organization, and so there is not very much they can do to create a different outcome.
"I want a financial reward proportional to the risk I took and the value I created."
Fair value creation capture. Unlike investors whose investments are diversified across a portfolio of organizations, employees are not diversified and only derive revenues from the organization they work for. Many schemes exists to align employees' interests with the financial success of the organization, but most of them consist in providing illiquid and alienable conditioned securities or options on securities. The lack of liquidity in private organizations very often means that employees are forced to leave a lot of value (that they contributed to creating) on the table when they leave the organization.
"I wish I could be financially rewarded by this organization that I contribute to."
Long-term wealth-building & economic security. When a community (be they users, workers, partners, suppliers, customers...) fall in love with the product or service provided by an organization, they wish they could have the possibility of being financially rewarded for their active contributions to the product and building long-term wealth as they help the organization grow. One-off referrals, coupons and goodies can only do so much… people want money! This is especially true in today's context where well-paid jobs with pensions and 401ks are becoming the exception.
"I want the best return on investment for the risk I took."
Highest Return on Investment. Investors really want one thing: the ability to sell their stake at the highest valuation possible. The investors' need for governance only comes from the fact that their investments are illiquid and they need governance to protect it until a liquidity event comes. As long as they can sell their stake at the best price and at the time they see fit, they are happy. Without liquidity, venture capital investment is a game of home runs, which consists in finding the one investment that will make exceptional returns and over-compensate for the vast majority of other investments that did not perform well at all.
"I want to help innovators, protect investors and collect my fair share in taxes."
Regulators (usually) aim at providing innovators with a regulatory framework that helps them create new services and products. One key aspect of such a regulatory framework is to help innovators raise capital while giving investors reasonable legal protections against misconduct. Before the digital economy, this strategy would yield big returns through tax collection. Unfortunately for regulators, the digital economy has made tax collection much more difficult:
"The digital economy systematically disconnects the place of business from the place of consumption. Consequently, it is increasingly difficult to fix the location of the value created by this economy and to apply the rules of tax laws that are now outmoded." - Taxation of the Digital Economy - Pierre Collin & Nicolas Colin - 2013
"I want long-term thinking organizations."
Long-term, energy-efficient organizations. Creating incentive mechanisms that could lead to organizations optimizing for the long-term while keeping them accountable for their environmental impact would be highly beneficial for humanity as a whole. As of today, our inability to establish globally enforceable governance regarding environmental topics and the short-termism of today's financial markets, have made the Tragedy of the Commons all too real.
In recent years, the rise of cryptocurrencies has given birth to a new alternative to the traditional ways of financing organizations: the Initial Coin Offering.
Simply put (and grossly generalized), organizations doing an ICO have more or less the following generic pitch:
«We created a (sometimes fixed) supply of millions of tokens on a blockchain. These tokens are not securities as we don't give investors any financial or voting rights. However, you can expect these tokens to have future value because we designed a system in which they will have the following utility. We are putting a certain number of tokens up for sale to finance the development of the project. These tokens will be liquid very soon because we are going to be listed on exchange X. Buy our tokens.»
The good part of ICOs is that, on the surface, they seem to align the interests of the main stakeholders in the organization quite well:
- Founders raise a lot of money without giving any governance rights, allowing them to pursue their vision. Thanks to the tokens they generated, they can create many financial incentives that are beneficial to the organization, from recruiting talent to enabling network effects that have the potential exponentially grow their community. Some projects implemented on-chain governance or used a DAICOs to raise funds which gave token holders some governance rights, but they are more the exception than the rule.
- Investors are happy because they usually invest at a discounted valuation and their investment will likely become liquid quickly, when the token gets listed on one of the crypto-exchanges. This early liquidity allows them to drastically reduce their risk as they can decide to sell how and when they want, provided there is enough liquidity of course.
- Employees are happy because instead of stock options, they can get tokens that nobody can take away from them and that are liquid. If you were lucky enough to work for a crypto project in its early stage, you have a decent chance of becoming a millionaire not only on paper, but in cash.
The problem with this model is that it works only if the token does have value… unfortunately, that's rarely the case!
The problem is that it is very hard for the unsophisticated investor (and also for so-called 'sophisticated' ones!) to assess whether tokens will have any value at all. As a result, many retail investors, lured by the exceptional returns of a handful of well thought-out projects, burned themselves very badly.
Indeed, in most projects, the risk associated with investing in the project is an order of magnitude higher than the potential reward, and so the investment makes no financial sense. Here are a collection of the main risks associated with investing in an ICO:
- Is the team properly incentivized to create the product? In many projects, founders give themselves a large number of tokens with little or no vesting period. So if the ICO succeeds, the founders will immediately become rich and might very lose the motivation to actually create the product.
- Will the team be able to create the product at all? The project is usually at its earliest stage with no product to show, only good intentions described in a document.
- Can the product be created on the proposed timeline? Many projects massively underestimate the significant technical constraints posed by integrating a blockchain with a token in their system.
- Can the product achieve a good user experience? Most projects completely underestimate the UX constraints posed by integrating a token in their system.
- If the product is delivered, will it be used at all? It is hard to know whether the team will achieve product/market fit.
- If users like the product, will the token capture any value? The project could be wildly successful and yet the token may have no value as it's not a security.
- If the token has value, will it be a good investment? Most projects sell their tokens at what is already a very high valuation.
Given the above, it is expected that most projects will fail and are bad investments. Even worse, a project can be very successful yet the token has no value. This creates two important problems:
- Retail investors get scammed due the way the Shitcoin Waterfall works in ICOs
- Regulators don't know how to handle ICOs. On the one hand, they welcome innovations that attract talent and investors; but on the other hand, they don't like it when retail investors get scammed.
At the time of writing this paper (September 2018), it has been now established that, unless an ICO takes place within the context of a reputable platform (i.e. CoinList, which is very selective or, to a lesser degree, TokenFoundry...), odds are that the ICO is a scam and you should be very cautious before investing. Indeed, due to the legal uncertainty around ICOs, the most promising projects now raise money privately and only use ICOs (or pure Airdrops) as a way to boost their community-building efforts.
It is sad to see that many of the ICOs on the market are scams. In the best case scenario, they are promoted by well-intentioned founders who mistook an ICO for a Series A fundraising round. In the worst-case scenario, these ICOs are simply engineered by scammers trying to abuse unsophisticated investors to get rich quick. Needless to say that, in this context, it is hard not to see the ICO market for utility tokens dying off.
More recently, crypto exchanges started doing "IEOs" (Initial Exchange Offerings) which are just ICOs performed directly by the exchange. Unsurprisingly, the results are the same.
A Continuous Organization refers to any organization that set up a Continuous Securities Offering (CSO) to give to every stakeholder the ability to invest in the organization at any single time.
A Continuous Securities Offering (CSO) is a novel way for organizations to receive financing without releasing any equity or any governance rights. A CSO uses an organization's realized revenues (i.e. revenues for which a payment has been made) as a collateral to back fully digital securities (called FAIR Securities or FAIRs) that anyone can buy or sell to speculate on the organization's future revenues.
To create a Continuous Securities Offering, an organization would agree to build a collateral of value using a fixed percentage of its realized revenues during a pre-defined minimum period of time. This is done concretely by funneling the said fixed percentage of revenues into a Decentralized Autonomous Trust (DAT). A DAT is a smart-contract that automatically issues and buy back FAIRs to meet market demand from investors using a token bonding curve contract with sponsored burning.
Important note about the currency used to interact with a DAT
In the following examples, we are using ETH (the currency of the Ethereum blockchain) as the currency to interact with the DAT. ETH is the native currency for an Ethereum-based DAT. It does not mean that end users (individuals and organizations) will necessarily have to manipulate ETH to interact with DATs. First, ETH can be replaced by a stablecoin (like DAI or USDC) to remove the volatility associated with ETH.
Many individuals have explored the bonding curve model since Simon De La Rouvière first came up with the idea in 2017.
A bonding curve contract is a specific type of smart-contract that issues its own tokens through Buy and Sell functions. To buy tokens, the buyer sends ETH to the Buy function which calculates the average price of the token in ETH and issues you the correct amount. The Sell function works in reverse: The contract will calculate the current average selling price and will send you the correct amount of ETH (excerpt taken from Token Bonding Curves Explained).
In the case of Continuous Organizations, the Buy and Sell functions are distinct:
A token bonding curve model has interesting properties, including:
- Limitless supply. There is no limit to the number of tokens that can be minted.
- Deterministic price calculation. The buy and sell prices of tokens increase and decrease with the number of tokens minted.
- Guaranteed and immediate liquidity. The bonding curve contract is the counterparty of the transaction and always holds enough ETH in reserve to buy tokens back. So tokens can be bought or sold instantaneously at any time, the bonding curve acting as an automated market maker.
- Continuous price. The price of token n being inferior to the token n+1 and superior to the token n-1, calculating the number of tokens minted for a given amount of ETH (or the number of ETH sent back for a given amount tokens) requires some integral calculus.
It is important to note that in a bonding curve model, the x-axis represents the number of tokens issued. To give a simple example, let's say B(x)=x and S(x)=0. The cost C to buy the first 10 tokens is given by the surface between the buy curve and the sell curve that can be expressed as the following integral:
.
So, in our example: C=10*10/2=50.
In the case of Continuous Organizations, we introduce the revenue-based bonding curve: a bonding curve that uses 2 different functions, one for the buy curve and another for the sell curve: B (for buy) and S (for sell) with .
The bonding curve contract of a Decentralized Autonomous Trust issues FAIR Securities (FAIRs). These FAIRs represent a claim on the DAT's cash reserve. It is important to note that, unlike a stock, a FAIR does not represent a claim on the organization's ownership, it only carries a financial right to the cash reserve managed by the DAT. And the DAT's cash reserve is a function of the organization's revenues. So, by buying FAIRs, an investor gets a financial exposure on the organization's future revenues.
The function B defines the price at which FAIRs can be bought from the DAT. B is a linear function and has a positive slope b such that B(x)=b*x where and
b>0. The slope b can be chosen arbitrarily. The higher b is, the more value unit tokens will have, and vice-versa, as the lower b is, the less value unit tokens will have.
If you want your investors to have a lot of tokens, pick a very small value for b (like 1x10^(-9)). It has no financial impact, simply allowing more granularity for fractional rights.
The function S defines the price at which FAIRs are bought back by the DAT. S is a linear function as well and has a slope s such that S(x)=s*x where and
s>0. However, in a Continuous Organization, the value of s changes over time. To explain how the value of s changes over time, it is important to understand how a DAT receives and processes the cash it receives.
The first (in "time", not in "proportion") source of cash-flows for a DAT_ are investors who want to invest in the Continuous Organization. They do that by calling the buy() function of the DAT. Whenever an "external" investor (as opposed to the organization itself) sends funds to the DAT, a fraction of the funds sent is being held in the cash reserve by the DAT and the rest of the funds are being transferred to the organization's wallet. We'll call I (for invest) the percentage of the funds being held in the cash reserve. I is a constant.
Value flow when an investment occurs
Impact on the Bonding Curve Contract of the DAT when an investment occurs
The investors buying FAIRs are doing so to invest money in the underlying organization. Investors don't want their money to be held in reserve by the DAT, they want their money to be put to good use by the organization. Consequently, the value of s must be an order of magnitude lower than b, which means that I should ideally be low. I could also be 0 if the organization's characteristics (revenues, growth...) can justify it.
Example: Let's say that an investor sends 10 ETH to the DAT, if I=10% then the DAT will transfer 9 ETH to the organization's wallet and will keep 1 ETH in its cash reserve.
The rules described above do not apply if the investor is the beneficiary organization, that is, if the organization is technically investing in itself. In that case, I is always equal to 100%. It means that whenever an organization is investing in its DAT, 100% of the amount invested by the organization to buy FAIRs goes to the buy-back reserve. For more information, see the FAIRs purchase by the beneficiary organization section below.
When an investor buys FAIRs for a cost c, he receives x FAIRs, with x being equal to:
(see proof in Annex)
with c the amount used to buy FAIRs, b the sell slope and a the number of FAIRs already in circulation before the transaction.
At any time, the beneficiary organization can decide to buy FAIRs. To do that, the beneficiary organization calls the buy() function like any other investor, however, unlike external investors, the funds sent by the beneficiary organization to purchase FAIRs are 100% funneled to the buyback reserve (i.e the contribution ratio I is equal to 100% when funds come from the beneficiary organization).
This guarantees a total alignment of interests between all investors. Indeed, if the beneficiary organization was able to buy FAIRs with the same investment ratio I than external investors, it would concretely mean that the beneficiary organization is able to buy FAIRs for a fraction of the price compared to external investors (because the organization receives by definition (1-I)% of the amount invested). This difference could easily be abused by dishonest organizations and managers.
Purchasing FAIRs is also how the organization can reward FAIRs holders. Indeed, when the beneficiary organization buys FAIRs, not only does it increase the buy-back reserve, it also increases the slope of the selling curve (see detailed explanation below).
As a consequence, in the case of an organization with off-chain revenues, buying FAIRs is how the organization actually funnels its revenues to the DAT. That means that, the more revenues the organization generates, the more FAIRs it accrues over time and can use to further incentivize its key stakeholders. Of course, the organization can also simply decide to burn() its FAIRs if it wants to maximize the reward to FAIR holders.
Value flow when the beneficiary organization purchases FAIRs
Impact on the Bonding Curve when the beneficiary organization purchases FAIRs
The difference between an investment by an external investor and a FAIRs purchase by the beneficiary organization is their respective contribution ratio to the DAT's reserve:
- investment by external investor: an amount M contributes
I*Mto the DAT's reserve while minting the value equivalent of M, thus a contribution ratio of(I*M)/M=Iand by construction I<<100% - FAIRs purchase by beneficiary organization: an amount M contributes
Mto the DAT's reserve while minting the value equivalent ofM, thus a contribution ratio ofM/M=100%
After each transaction, s can be recalculated from the amount in reserve Rt:
so
(see proof in Annex)
Example: Say I=10%,s0=0.1 and b=1. Assume an investor buys the first 10 tokens for 50 ETH, so the DAT now has 50x10%=5 ETH in reserve. Then, the beneficiary organization buys FAIRs for 1 ETH of value. This 1 ETH is used to mint 0.0995 tokens (we'll leave this as an exercise for the reader. Hint: the equation to solve is ), which gives s1=0.1176. So, the operation increased value for FAIRs holders as s1>s0, that is, they can now sell their FAIRs at a higher value than before.
A FAIRs holder can at anytime take the decision to burn its FAIRs by calling the burn() function.
Burning FAIRs does not technically destroys them (the total supply of FAIRs, including burnt FAIRs remains the same) but it makes sure that no one will ever be able to use them so that their marginal value can be redistributed equally to other FAIR holders.
It makes little sense for an investor to do so with its FAIRs, but it does make sense for the beneficiary organization to be able to burn its FAIRs (1) if it has no use of them or (2) if it wants to increase the value of all other FAIRs.
Indeed, when a FAIR is burnt, its lowest possible value is equally redistributed to all FAIRs holders so that, when an investor sells its FAIRs, he receives a fraction of the cash reserve + a pro-rata of the value locked in burnt FAIRs. See sell() section below for the exact calculus.
The direct consequence of this is that there is never value locked forever in the cash reserve: selling 100% of the non-burnt FAIRs will deplete the cash reserve from 100% of its value.
Representation of the impact of burning FAIRs on the Bonding Curve
Investors can at any time decide to sell their FAIRs to get ETH back. They do that by calling the sell() function of the DAT. When the DAT receives FAIRs, it burns the received FAIRs and sends ETH back to the selling investor according to a function S (for sell). S has a slope s that increases discretely over time, every time the DAT receives a payment. The ETH sent back to the investor is taken from the DAT "buyback" cash reserve and does not affect the organization's treasury.
Value flow when a FAIR sale occurs
Impact on the Bonding Curve Contract of the DAT when an investor sells its tokens
When an investor sells x FAIRs, assuming no FAIRs were previously burnt, he receives an amount c, with c being equal to:
(see proof in Annex)
with s the sell slope and a the number of FAIRs in circulation before the transaction.
In the case FAIRs were burnt (see previous section), the calculus becomes:
where x' is the number of burnt FAIRs.
A Continuous Organization has the option to perceive its customer's payments directly through the DAT by calling its pay() function.
Whenever the DAT receives a payment P, a fraction of the payment received is being funneled into the cash reserve. We'll call D (for Distribution) the percentage of the revenues being funneled into the cash reserve and d the corresponding fraction of the revenues (d=P*D). The entire amount d is saved in the DAT's cash reserve, thus increasing the value of FAIRs.
It is important to note that calling pay() will also trigger the issuance of new FAIRs. The number of FAIRs issued is equivalent to the number of FAIRs that would be created if buy(d) was called. By default, these newly minted FAIRs are sent to the organization like showed on the following graph:
Value flow when the CO relies on the DAT to receive its payments
Optionally, the customer can specify a parameter of the pay() function to sent the newly minted FAIRs to an address of his choice (most likely the address of his wallet) in which case the value flow would look like this:
Value flow when the customer specifies his wallet address to pay()
Example: Suppose D=5%, if the Continuous Organization receives a payment of 100 ETH, 5 ETH will be funneled to the "buyback" cash reserve, increasing the collective value of FAIRs.
Note: For some Continuous Organizations (COs with no underlying legal entity, for example), it can make sense to receive their customers' payments (i.e. the CO's revenues) directly through the DAT. It is important to note that it is not mandatory for the organization's revenues to funnel through the DAT as the organization can also decide to only reward FAIRs holders through FAIRs purchase.
For organizations that already have a running business, they will very likely prefer to first receive a payment from their customer in fiat (as they usually do, without changing their selling process) and will then purchase FAIRs to transfer a fraction of their perceived revenues to the DAT to increase the FAIRs value, as illustrated here:
This way, the DAT is made completely invisible for the customer (no change in UX) and the organization does not have to modify any of its highly optimized selling processes.
When the DAT is being created (and only then because once created the DAT becomes immutable), the organization can decide to "pre-mint" for itself and for free a number PM of FAIRs. That means that, instead of having the supply of FAIRs of the DAT start from zero, it would start from PM.
Pre-minting FAIRs can often make a lot of sense to the organization, be it to reward its founders, to pay its early employees, to reward its early users or to secure a liquidity pool for the secondary market.
However, it is very important to realize that pre-creating FAIRs comes with a potentially high cost, as these "free" pre-minted FAIRs represent a selling pressure on the DAT as they are FAIRs that got allocated "for free", without any contribution to the DAT "buyback" cash reserve.
Technically speaking, it means that the greater the number of FAIR tokens that are pre-minted, the lower the sell curve will be (i.e., the s slope defined previously). So concretely, if an organization decides to pre-mint a large number of FAIRs when setting up the DAT, it may want to be very careful not to pre-mint too many of them because it could have a significant negative impact on the risk and financial reward of investors.
Impact of pre-minted tokens, everything else being equal
So, as an organization, you might have good reasons to pre-mint some FAIRs but beware because pre-minting too much will make your FAIRs become less attractive for investors. A good rule here is to only pre-mint the FAIRs needed before generating revenues. Once revenues starts rolling in, the organization will accrue FAIRs naturally, through the funneling of its revenues to the DAT.
A Continuous Organization is an organization that issues FAIR securities through a Continuous Securities Offering by funneling part or all of its realized revenues to a specific type of smart-contract called Decentralized Autonomous Trust (DAT). These FAIR securities represent a claim on the DAT's present and future cash reserve and allow investors to speculate on the revenue growth of the organization. The organization, its investors and, potentially, its customers interact with the DAT by sending ETH or FAIRs to it:
| Source of cash-flow | What happens at the DAT? |
Investment (buy) |
▪ The DAT receives ETH from the buying investor ▪ The DAT mints new FAIRs and send them to the buying investor. ▪ The sum invested is in part distributed to the beneficiary organization and in part saved in the DAT cash reserve according to a pre-defined immutable function I (for investment). |
FAIR purchase (buy) |
▪ the DAT receives ETH **from the beneficiary organization** ▪ the DAT uses the funds to mint new FAIRs and sends them back to the beneficiary organization. ▪ The funds used to mint the FAIRs are entirely funneled in the DAT cash reserve. |
FAIR burn (burn) |
▪ The DAT receives FAIRs ▪ The DAT destroys the received FAIRs ▪ The lowest value of the burnt FAIRs is being reaffected equally to all FAIRs holders via the `sell()` function. |
Investment (sell) |
▪ The DAT receives FAIR securities from the selling investor ▪ The DAT burns the received FAIRs and sends ETH back to the selling investor according to a function S (for sell). S has a slope s that increases discretely over time, every time the DAT receives a payment. ▪ The ETH sent back to the investor is taken from the DAT cash reserve and does not affect the organization's treasury. |
Revenues (pay) |
▪ The DAT receives a payment from a customer. ▪ The DAT transfers the revenues to the organization but retains a fraction D (for distribution) of the revenues that are funneled to the cash reserve, issuing new FAIRs. ▪ The organization (or optionally the customer) receives the newly minted FAIRs. |
Finally, a DAT can be created with pre-minted FAIRs for the organization that can then distribute them freely to stakeholders. However, it is important to note that these pre-minted FAIRs come at a cost as they are directly diluting future investors.
The initialization phase of a CSO is specific in that it does not use the bonding curve. Indeed, to kickoff a CSO, the beneficiary organization needs to set an minimal funding goal (MFG). This MFG is the amount of investment required for the bonding curve to start. All investors investing before the MFG is reached (using the buy() function) receive FAIRs at the same average price.
Initialization phase of a Continuous Securities Offering
Until the MFG is reached, all funds are escrowed and investors can decide to withdraw their investment at any time (by calling the sell() function) and will receive 100% of their investment back. Once the MFG is reached, the bonding curve starts, a fraction I of the MFG is funneled to the cash reserve and the complement (MFG*(1-I)) is being transfered to the beneficiary organization.
Also, before the MFG is reached, the beneficiary organization can unilateraly decide to cancel the CSO in which case investors can then withdraw 100% of the funds they individually invested.
It's important to note that once the MFG is reached, then the organization cannot cancel the CSO anymore and it will now continue to be live for a minimum period of time (defined in the smart-contract by the organization). Equally, after MFG is reached, investors cannot withdraw their funds anymore as the bonding curve started. They can now only call the sell() function will operates as described in the previous section.
The MFG protects both investors and the organization. It protects the investors because if there is low appeal from investors, the MFG won't be reached and investors can withdraw their money. Plus, the fact that all early investors get averaged priced FAIRs means that no early investors will get unreasonably low price FAIRs. But the MFG also protects the organization as the organization can use it to gauge the market appetance for its CSO and can decide to cancel it if investors interest is below its expectations.
The organization should not set the MFG too high though, otherwise it would have the effect of transforming the CSO into a simple crowdfunding campaign and defeat the purpose of the CSO. In other words, the CSO must reflect the minimum amount the organization expects to validate its CSO. It should definitely not be set to the entire value an organization expects to raise.
A CSO can continue indefinitely but it doesn't have to: the beneficiary organization can decide to close it at anytime after the minimum period of time expired.
In order to give some necessary visibility to investors, the beneficiary organization has to commit to keep its CSO running for a minimum period of time (3 years, 5 years, 10 years...). After this minimum period of time has passed, the organization does not have to close its CSO but it can. Also, at any single time, the organization can increase the minimum period of time it commits to keep its CSO running to give increased visibility to investors.
Closing a CSO is not free. To close its CSO, the beneficiary organization will have to pay an exit fee. The price of this exit fee is equal to the current issuance (buy) price of FAIR multiplied by the number of FAIRs outstanding. Once the exit fee is paid, the organization can close its CSO which allows every single investor to then sell their FAIRs at the same price: the current buy price (and hopefully the highest).
Visualization of the exit fee required to close a Continuous Securities Offering
By doing this, it means that the last investor will make a white operation (bought at buy price and sold at the same price moments after) while early investors will hopefully turn a profit (it is obviously not guaranteed as the last issuance price is not necessarily the highest price).
The spread that exists between the buy price and the sell price of FAIRs creates an incentive for investors to buy and hold FAIRs until the Continuous Organization starts generating revenues:
- Pre-revenue. The price appreciation of FAIRs is due to investors' speculation as they anticipate future revenues.
- Post-revenues. Once revenues begin to flow, the price appreciation of FAIRs starts being driven by the revenues generated by the organization, as a fraction of the revenues is funneled to the buyback reserve of the DAT.
There is a clear incentive for investors to hold their FAIRs and act as long-term investors.
The spread between the Buy and Sell curves also leaves space for a secondary market of FAIRs. If the current price of a newly minted FAIR is 10, an investor would rather buy an already-minted FAIR from another investor willing to sell at a better price than the buyback price offered by the DAT.
Obviously, this secondary market is bounded in a dynamic price range imposed by the DAT: it would not make sense for a buyer to bid a price higher than the current price proposed by the DAT. Likewise, it would not make sense for a seller to ask for a price lower than the price proposed by the DAT.
Said otherwise, an investor will always be better off buying or selling their FAIRs in the secondary market, as the price will likely be better than the price proposed by the DAT.
Interestingly, the recent rise of automated market mechanisms for secondary markets (like Uniswap or Kyber network) means that one could completely blend the primary market (the DAT) and the secondary market together from a UX perspective: a user would enter the value of FAIRs he wants to buy and his trade could be automatically optimized between the primary and secondary market. This is a feature Fairmint provides, which is important to reduce price volatility and maximize investors' returns.
One of the most valuable properties of a Continuous Organization is that the liquidity of FAIRs is immediate and guaranteed. If an investor does not find a buyer or a seller in the secondary market, they can always buy or sell tokens to the DAT. By construction, the DAT always has the funds to buyback FAIRs at a price defined by the S function. The DAT really acts as the organization's central bank, minting new tokens when demand exceeds available supply and contracting the token supply when sellers outnumber buyers.
In the proposed bonding curve model the buyback price (defined by the S function) for a given supply is very low compared to the buy price (the B function). So one could argue that, even if there is guaranteed liquidity, this liquidity has limited utility because investors would likely take a loss by selling to the DAT. This is true only if an investor buys FAIRs and sells them back to the DAT short thereafter.
However, if the investors have more patience and if the organization develops well:
- more investors will buy FAIRs, thus increasing both the buy and the sell price to where the investor will turn a profit by selling their FAIRs back to the DAT.
- the organization will start generating revenues, thus automatically increasing the buyback reserve and increasing the value of FAIRs (using the mechanism described previously).
- the organization can also start distributing FAIRs directly if it is doing well and sees an interest in doing so. Distributing FAIRs has a double effect:
- significantly increasing sell price because these FAIRs are bought from the DAT and the funds are 100% saved in the buyback reserve, thus increasing the value of s and with it the minimum sell price.
- increasing the investor's return on investment (ROI) as the investors can decide to immediately sell back the FAIRs they received to cash them out.
Finally, it is good to keep in mind that the DAT is only the buyer-of-last-resort. It is very likely that an investor could sell their FAIRs on the secondary market at a higher price than the "buy-back price" offered by the cash reserve of the DAT for a given supply.
By construct, a Continuous Organization is continuously fundraising as investors can permission-lessly buy and sell the organization's FAIRs at any time:
- Any increase in FAIR supply (i.e., a FAIR that is being minted by the DAT, not bought on the secondary market) directly translates into funding for the organization.
- Any decrease in FAIR supply (i.e., a FAIR that is being sold to the DAT, not sold on the secondary market) is being paid by the buyback reserve of the DAT and does not affect the organization's treasury.
Whereas in the traditional VC financing model, fundraising defocuses the entrepreneur in a time-consuming and uncertain process that creates dangerous valuation thresholds, COs help the entrepreneur stay focused on execution and make the organization more resilient to the business ups and downs.
To illustrate this, let's take the example of a Continuous Organization whose FAIR price over time as measured by the buy function of the DAT follows the following very volatile curve:
The zones in blue correspond to upward trends of the FAIR price, which translates into the Continuous Organization raising funds. Alternatively, the white zones are downward trends which translates into the DAT (not the organization) buying back the FAIRs that are being sent to it using its buyback reserve.
Continuous Organizations provide many benefits over traditional organizations for all stakeholders, most notably:
| Stakeholder | Benefits |
|
🏃🏽 Founders |
▪ Build solid incentives to grow and strengthen your community ▪ Recruit talents more easily, anywhere in the world ▪ Keep long-term control of your organization ▪ Make your organization more resilient against business ups and downs ▪ Be less distracted (legal, fundraising) and focus more on execution. ▪ Get personal liquidity (once vested). |
|
👩💻 Employees |
▪ Align your personal financial interest with that of the organization ▪ Sell your FAIRs when it makes sense for you |
|
🙋🏻 The multitude |
▪ Get a share of the value created if the organization is successful ▪ Enjoy the same long-term financial benefits as employees |
|
👩🏿💼 Investors |
▪ Reduce your investment risk using the FAIRs liquidity ▪ Sell your FAIRs at public market price ▪ Sell your FAIRs at the pace you want ▪ Invest anywhere in the world |
|
👨⚖️ Regulators |
▪ Favor innovation in your jurisdiction to create new products and services ▪ Protect your citizens from scams with FAIR ▪ Collect taxes easily at the DAT level |
|
🌎 The planet |
▪ Founders can keep long-term control of their organization ▪ Investors are incentivized over the long-term ▪ Continuous Organizations are more inclusive than traditional organizations |
The Continuous Organization model is blockchain agnostic but requires a turing-complete smart-contract language to be implemented. The availability of stablecoins are not necessarily a requirement but they definitely improve the UX of Continuous Organizations.
A reference implementation for the Ethereum blockchain has been specified and implemented (in Vyper language) by Fairmint. The contracts are currently being audited by Consensys Diligence and the results of the audit will be made public as soon as it is finalized.
Ultimately, once the concept matures, we believe that COs have the potential to become the de-facto standard form of organization for founders looking to start a new venture, be it non-profit or for-profit. Until then, we think there are some use cases that already make a lot of sense, most notably:
- Long-term employee incentivization. Incentivizing employees is a key topic in any successful organization. Unfortunately, today's mechanisms are far from being perfect, especially for private organizations whose shares are not publicly listed. Instead of directly giving employees equity or offering stock options, an organization could use a DAT to provide their employees with inalienable, liquid FAIRs aligned with the success of the organization.
- Organizations with large contributive communities. As of now, it is very legally and technically difficult to financially incentivize communities. If you have a platform business at a late stage (Airbnb, Uber, Yelp-like...) and wish to further engage your community in your platform, you start a CO by setting up a DAT. Obviously, you would not funnel 100% of your revenues to the CO immediately but would instead perhaps commit to buying a certain amount of FAIRs of the DAT every month. This way, you can very simply financially align your community with the success of your business. Plus, you can use the FAIRs to distribute them in the way you prefer to your community, employees etc...
- Early startups bootstrapping their network effect. Startup founders who develop marketplaces or any kind of 2-sided network always face a chicken-and-egg problem. By setting up a CO and using FAIRs, they can solidly incentivize early adopters to join and contribute by aligning them with the long-term success of the project. Unlike today, FAIRs give early adopters the opportunity to get a fair part of the platform's upside value that they create by joining and contributing early.
- Real estate tokenization. Given that investors in Continuous Organizations are buying FAIRs in anticipation of future cash-flows, it would make a great deal of sense to use COs to buy and tokenize real estate. Indeed, real estate is a well-known provider of steady and predictable cash-flows, and so such a project could create a CO to finance the acquisition of real estate and provide its investors with predictable returns.
- Organization-less online communities. You don't need a pre-existing organization to create a CO, nor do you need to incorporate one. Let's say you have a business idea and want to start a CO out of a purely online community. The beneficiary of the DAT could simply be a multisig wallet with the project leaders, the DAT would pre-mint FAIRs to distribute/incentivize the community and the D parameter of the DAT would be set rather high to trigger significant rewards to the community when revenues are generated.
DISCLAIMER: What is written in this section as it only reflects the author's opinion and does not constitute a legal opinion. Please consult a lawyer specialized in Securities law in your jurisdiction for a legal opinion.
A Continuous Organization requires the setup of a Continuous Securities Offering (CSO). Apart from the continuous aspect of the offering, which is novel, a CSO is simply another type of Securities Offering. As such, a Continuous Organization will very likely need to comply with the securities law in its jurisdiction.
In the USA for example, it is likely that a CSO can be conducted using the Reg D 4(a)(2) Rule 506(c) exemption. Using this exemption means the CSO is issuing restricted securities which, in most cases, require a 1 year lockup before being transferable. Ask your securities lawyer for legal advice before proceeding.
In some jurisdictions, like France for example, we think the legal framework might be significantly more favorable with FAIRs very likely falling under the new "jeton" category of the recently enacted "Loi Pacte" (which means that a FAIR might not be treated as a security ("instrument financier") in France). Again, ask your preferred securities lawyer before proceeding to any offering.
Front-running attacks. As perfectly stated in Relevant's blog:
"Bonding curves are susceptible to front-running attacks. This is when an adversary watches for a big buy order coming in and sends her own buy order with more gas to cut ahead of the original order. Once the original order is executed, the attacker sells her tokens at a guaranteed profit."
One simple solution to these attacks is to set an upper limit on the amount of gas buyers and sellers can use in their transaction. Another, more robust (but also more complex to implement) solution, would be to implement a regular price fixing: Instead of the orders being executed immediately, they are instead batched into a pool of orders and every hours the contract executes the trades taking into account the orders registered in the order book. It means that the trades are not executed immediately but it has the immense advantage of preventing front-running attacks. This is how the Gnosis DutchX Decentralized exchange works:
"Hence, with batched orders entering the block at the time the auction clears with the same price for all bidders and sellers, neither miners nor the exchange itself, or other participants will be able to game the system."
Such a system would not penalize liquidity much if the price fixing is regular enough (every 6 hours in the case of DutchX) and has the huge advantage of preventing front-running.
It is also important to note that, most likely, investors in FAIRs will have to be KYCed so it will be easy to trace back potential front-running attacks to the individual responsible for them.
Any type of organization, for-profit and non-profit, can become a Continuous Organization by setting up a Continuous Securities Offering.
A Continuous Securities Offering (CSO) is a novel way for organizations to receive financing without releasing any equity or any governance rights. A CSO uses an organization's realized revenues as a collateral to back fully digital securities called FAIRs that anyone can buy or sell to speculate on the organization's future revenues.
To create a Continuous Securities Offering, an organization agrees to build a collateral of value using a fixed percentage of its realized revenues during a pre-defined minimum period of time. This is done concretely by funneling the said fixed percentage of revenues into a Decentralized Autonomous Trust (DAT), a smart-contract that automatically issues and buy back FAIRs to meet market demand from investors.
Continuous Organizations are a new type of internet-native organisation that are more efficient, stable and inclusive than traditional organizations. Thanks to their fully digital liquid FAIR securities, Continuous Organizations are able to align stakeholders' interests better than traditional organizations. On top, they are easy to incorporate and their properties make them ideal to incentivize employees, grow and strengthen communities, and create virtual online organizations.
To continue the conversation and contribute, you are more than welcome to join our online forum. You can also interact with us on Twitter or on our dedicated Telegram channel.
When buying FAIRs, you need to perform a calculus to know how much FAIRs you will get for the amount you are willing to invest.
Let's calculate the number of FAIRs x received when d is invested when a FAIRs have already been minted. We have the following:
So the number of tokens minted for an investment d is:
When selling FAIRs, you need a calculus to know how much you will get back for the amount of FAIRs you are willing to sell.
Let's calculate the number value M received when x FAIRs are sold when a FAIRs have already been minted. We have the following:
Which gives:
As s is easy to calculate:
We ultimately get:
Now the sell calculus show above is right only when no FAIRs are burnt. If FAIRs are burnt, the burnt value is redistributed proportionally at each sell(). Here is how it works in a scenario where we have x' burnt tokens and x tokens in circulation. We have a theoretical burnt value of R' as shown in the following graph:
We have:
Now, we do not want this value R' locked forever. We want to redistribute it to current FAIRs holder so let's "spread" R' accross all current FAIRs holders:
We have:
Which means we can now express the complete sell() function, including the burn factor:
[1]: the definition of Returns to Scale on Wikipedia
[2]: FAIR: Frictionless Agreement for Investments and Returns
[3]: FAIR Securities undeniably pass the Howey test
[4]: To illustrate: an Uber driver is at the same time a user of Uber and a worker for Uber. Same goes for the renter of a flat on Airbnb. A Facebook user is also a Facebook (non-paid) worker.
[5]: Nicolas Colin is a regular contributor to the Financial Times and Forbes
[6]: The Family is a european organization educating, protecting, and financing ambitious Entrepreneurs
[7]: Hedge, A Greater Safety Net for the Entrepreneurial Age
[8]: L'age de la multitude - Entreprendre et gouverner après la révolution numérique (not translated in english)
[9]: Airbnb asks SEC to let it give hosts equity
[10]: In the 'best case scenario' liquidity event which is the IPO, "the average founder ownership at IPO was 17% and the average VC ownership at IPO was 56%"
[11]: The End of Employees
[12]: See Multicoin Capital "Venture Capital Economics with Public Market Liquidity"
[13]: Quote from Taxation of the Digital Economy - Pierre Collin & Nicolas Colin - 2013
[14]: See Tragedy of The Commons definition on wikipedia
[15]: Some projects have on-chain governance or used a DAICOs to raise funds which gave token holders some governance rights, but there are more the exception than the rule
[16]: ...and also for the so-called sophisticated investors!
[17]: ICOs raised a record $8.3B in Q2 2018 but most of them were abject failures
[18]: Public - ICO Returns 2014-2018
[19]: Meltem Demirors explains the ShitCoin Waterfall on Laura Shin's podcast
[20]: Multibillion dollar ICO market down to a few hundred million
[21]: Token Bonding Curves Explained
[22]: Sponsored Burning for TCRs
[23]: equilibrium bonding market, dynamic bonding curve, fomo3d etc...
[24]: Simon De La Rouvrière
[25]: Tokens 2.0 - Curved Token Bonding in Curation Markets
[26]: Excerpt adapted from the article Token Bonding Curves Explained
[27]: See the definition of Irrevocable Trust on investopedia