a16z Crypto has announced a groundbreaking approach aimed at transforming the economic models of application tokens, introducing cash flows for app tokens to create more permissive, flexible, and compliant fee structures. This new model is designed to enhance the value accruing to protocols while ensuring regulatory compliance across various jurisdictions, according to a16z Crypto.

Challenges for Token Models

While infrastructure tokens like those on Layer 1 networks have well-understood economic models based on supply and demand for block space, application tokens face a different set of challenges. These tokens, used in smart contract protocols on blockchains, cannot rely on gas fees and must develop their own economic models. Legal complexities also arise, as application tokens often facilitate regulated activities requiring governance by token holders.

Governance Challenges

Application tokens often come with governance rights, which can introduce risks if Decentralized Autonomous Organizations (DAOs) control protocol revenue or economic activities. To mitigate these risks, a16z suggests reducing DAO governance or adopting Wyoming’s Decentralized Unincorporated Nonprofit Association (DUNA) model, which offers a legal framework for DAOs in compliance with U.S. tax laws.

Value Distribution

Distributing value to token holders while complying with U.S. securities laws is another challenge. Direct mechanisms like pro rata distributions or token buy-and-burns resemble traditional financial practices, raising regulatory concerns. Instead, a16z recommends stakeholder capitalism, rewarding tokenholders for contributions that benefit the project, such as running a frontend or participating in a protocol.

Regulated Activity

Applications facilitating regulated activities must ensure their value accrual mechanisms comply with legal standards. Protocols should collect fees only from compliant frontends or APIs. This approach helps avoid regulatory pitfalls and ensures that tokenholders do not profit from illicit activities.

Fee Traceability

Fee traceability is crucial for ensuring compliance without introducing censorship risks. a16z proposes a two-step app-token staking system: identifying the frontend that generated the fees and routing these fees based on custom logic. This ensures that tokenholders receive fees only from compliant frontends, thereby avoiding legal jeopardy.

Mapping and Routing Fees

To achieve fee traceability, a protocol could map domains to public/private key pairs, ensuring that fees are correctly attributed to compliant frontends. Fees can then be routed to staking modules specific to each frontend, allowing tokenholders to choose compliant fee sources.

Implementation and Considerations

The implementation involves establishing a registry smart contract for frontends to register, validating transactions, and distributing fees through a FeeCollector contract. This system minimizes governance burdens and ensures compliance.

Additional considerations include specific fee models for Layer 1/Layer 2 applications, appchains, and application rollups. Each type of application may require different approaches to ensure that fees are collected and distributed in a compliant manner.

This innovative model by a16z Crypto aims to provide a robust economic foundation for application tokens, similar to those enjoyed by infrastructure tokens, while addressing the unique challenges faced by application protocols.

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