Jesse Walden

Why Web3 projects should commoditize the complement (the product)

Co-Authored with Jonathan Glick

Nearly twenty years ago, Joel Spolsky coined a phrase that informed the decision-making of countless startups and tech giants: “commoditize the complement.” 

In general, a company’s strategic interest is going to be to get the price of their complements as low as possible. The lowest theoretically sustainable price would be the “commodity price” — the price that arises when you have a bunch of competitors offering indistinguishable goods. So: Smart companies try to commoditize their products’ complements. If you can do this, demand for your product will increase and you will be able to charge more and make more.

Companies selling cars, cereal, and printers benefit when prices decrease for gasoline, milk, and ink, because the total price of a product includes the product plus anything else you need to maximize its potential--the complement. When the cost of complements decreases, the core product becomes overall more affordable. As affordability improves, so do sales — and with increased sales, pricing power leverage over the complements increases — a virtuous cycle. The biggest fans of virtually free ink would be Canon and HP,  which would see their products become effectively cheaper to use without having to lower prices.

Web3 teams have an opportunity to learn from and improve on the strategy of commoditizing the complement. In this essay, we’ll discuss why building and commoditizing a product on top of a user-owned protocol offers maximum leverage to execute this strategy, with potential for stronger economic equilibriums that drive growth, and value, beyond that of earlier implementations executed by legacy tech companies. 

Let’s start with some historical examples.


Licensing, Co-opting, and Walled Gardens
 

In hardware, perhaps the most famous example of “commoditizing the complement” was Microsoft’s strategy of fostering competition among PC hardware manufacturers by licensing Windows, its popular operating system, to anybody who could pay. Doing so weakened the market position of hardware manufacturers by encouraging cut-throat competition within the PC industry. By reducing the total cost of buying a desktop computer, Microsoft eliminated IBM as a hegemonic threat, increased the addressable market for PCs, and in turn increased demand for Windows, which compounded their pricing power.

In software, corporate embrace of open source projects has inhibited startups’ ability to develop profitable and threatening businesses at that layer, while also encouraging the use of proprietary services that further extend the tech giants' advantage. Google licensing TensorFlow — its machine learning engine that cost millions of dollars to develop — killed would-be competitors building general machine-learning frameworks and increased the number of developers using and improving the TensorFlow software, driving demand for TensorFlow Enterprise on Google Cloud. 

In the Web2 era, platforms like Twitter and Facebook ran powerful but temporary versions of the “commoditize the complement” strategy early in their growth phase. By giving away their products and APIs for free, the platforms were able to attract invaluable social graphs and user data, which in turn helped attract an ecosystem of third-party developers that built products to reach those users and extend the platform’s functionality. But there was a catch: After commoditizing the API  as a way to drive growth, social networks shut off the valve and turned their platforms  into proprietary walled gardens to capture more of the value therein. This put them in zero-sum conflict with third-party developers and often, their users, by eroding their choice. 

Web3 protocols have an opportunity to do things differently, owing to the fact that they can distribute tokens to turn their users into owners, empowering them to govern the platform in alignment with their continued interests. 

Bootstrapping Through Commoditizing in Web3


The first and largest “user” of a Web3 platform — defined as a software service running on an open blockchain (and often called a “protocol” in Web3 parlance) — is usually the product team that built the underlying platform. Web3 teams building these platforms are wise to build the first product on top and give it away for “free,” as a commodity, in order to bootstrap users, data, and network effects.

An example is Uniswap: Uniswap Labs, the company, built app.uniswap.org, the first and primary interface to the Uniswap Protocol, which is open and runs on the Ethereum blockchain. Compound Labs, also a company, did the same for the Compound money-market protocol. Making these early DeFi protocols accessible via an intuitive, user-friendly front-end was critical to bootstrapping liquidity in each respective marketplace platform—and once liquidity poured in, so too did network effects wherein the pricing of the product got better for each additional user. A growing user base, coupled with solid developer documentation, greased the wheels for third-party devs to integrate the underlying protocols to new products and services. For example, Metamask includes token swaps directly in their Ethereum wallet, where the liquidity is sourced directly from Uniswap. Critically, Metamask  could do this without asking for permission, and without fear of the API getting yanked from underneath as was common in Web2, because the Uniswap protocol and all its data runs on a public blockchain, and is owned by users.

So to recap: Making the complement (the Uniswap trading app) accessible at zero cost is a way to maximize benefit to end-users, whose usage mobilizes the network effects of the underlying platform (Uniswap Protocol). These network effects bootstrapped by the commoditized product can help to attract third-party developers, who build more functionality, attracting more users and usage, compounding those network effects. Finally, a distribution of ownership of the underlying platform — in the form of tokens — can be distributed to those driving the value, typically users and developers. 

Web3 companies, in other words, can commoditize the complement — but not as a means of draining profits and position from a potential competitor, as in Web2, but as a practical means of furthering sustainable innovation.

This practice of progressive decentralization aligns all parties’ incentives around growing value in the underlying platform or protocol — and puts teams that earn tokens for their contribution in a position to commoditize the complement, their own product, in order to capture value in the underlying platform. 

Balancing the Needs of Protocol and Product


This Web3 model of commoditizing the complement — and the accompanying structural separation of protocol from product — creates the need for an economic equilibrium, in which protocols incentivize developers to commoditize their complementary products while reaching the widest possible user-base and aligning their success with the growth of the underlying platform.

With more teams jumping into Web3, it is worth highlighting best practices that enable this equilibrium. Two steps stand out as important: 

First, as a Web3 platform matures, there may be a benefit to structuring the core project development work between two teams: those focused on the underlying platform or protocol, and those building the initial product for the end-user (each might have its own distinct brand to avoid confusion).The product team learns what end-users need, and can help inform the protocol design. And as the protocol team learns what product devs require, they can consider adding features that will attract more of them.

Second, both the product and protocol team should be aligned around a singular goal: a KPI focused on protocol growth. Measuring against a protocol-level metric helps ensure the product is truly complementary, driving the intended value to the underlying protocol.  With dedicated product and protocol teams aligned around a shared metric — a protocol or platform level KPI—it should be possible to measure contributions to that KPI and meritocratically distribute value of the underlying platform to the developers and users who drove it.

The initial product team, which helps to bootstrap the network effects of the underlying protocol, should be rewarded for that outsized contribution to the ecosystem. But ultimately, protocol treasuries would be wise to optimize for multiple product teams building on top, as that’s likely a way to grow the platform bigger, faster. An economic equilibrium that can achieve that end has the potential to be a tide to raise all boats. 

In this equilibrium, a product that seeks to extract too much value from the protocol layer will face stiff competition from others that are commoditizing their product to capture value elsewhere. This excessive value capture would replicate, rather than reform,the Web2 model—third-party innovation would be suffocated, developers would be inclined to fork, and users would look for cheaper, more innovative alternatives. 

Some early examples of protocols working toward a proper equilibrium include grants programs from large DeFi protocols like Uniswap, Compound, AAVE, et al., which reward third-party developers for ecosystem-growing products and services in their native treasury token. Liquity Protocol rewards developers who build front-ends to their stablecoin protocol with LQTY rewards pro-rata to users who deposit funds to the protocol. These front-end operators can receive a portion of these rewards by tagging deposits facilitated by their interface and specifying a percentage of LQTY rewards to split with their users. UMA Protocol tried something similar with its Developer Mining program, which encourages distributed innovation using economic incentives to reward developers who directly contribute to sustainably increasing UMA’s Total Value Locked (TVL) KPI. If you’ve built or seen other good examples, I’d love to learn about them.

Commoditizing the complement is a concept with long roots in technology strategy. Web3's ownership economy provides us with new tools to employ it, not as a means of stifling innovation and community, but encouraging them.

To close, here's a summary pocket playbook:


Thanks to Jonathan Glick for being a great thought partner in crystallizing the piece, and to Li Jin, Spencer Noon, and many of the builders in Variant's portfolio and community for conversations that helped shape the ideas. 

Why Web3 teams ought to build & commoditize the complement (the product)

Product vs. Protocol: Finding a Balance in Web3

Li Jin

The passion economy is the what, the ownership economy is the how

Last summer, I left Andreessen Horowitz to start Atelier Ventures, an early-stage venture firm devoted to the passion economy: new platforms that enabled users to “monetize individuality.” In a world in which one-third of people’s lives are spent working, providing more freedom in how people make money is a direct way to improve their quality of life. The mission has been crystal clear since day one: to create paths for economic mobility at scale by allowing people to monetize their skills and creativity and lowering the barriers to entrepreneurship. In the midst of COVID lockdowns, that mission became even more urgent as large swaths of the population suffered job loss and turned to online platforms for income.

As I was starting Atelier, Jesse Walden was working on Variant Fund, a seed-stage venture firm focused on the ownership economy thesis, backing software that is built, operated and owned by users themselves. I first met Jesse Walden when we were both working at a16z: he was on the crypto team, and I was on the consumer team. In those days (2018), there was a wide gulf between consumer applications and crypto, and the deals that our respective teams evaluated hardly overlapped — yet in spite of that, we often mind-melded over internet creators and online platforms. 

Fast forward to today. Both of our funds are notably different in a sea of venture firms: they exist not just out of a desire for financial returns, but to support companies that catalyze greater social and economic equality. Our missions were, and are, two sides of the same coin: ownership is a cornerstone of financial freedom and enables greater enfranchisement of participants in the networks to which they contribute their time and energy.

The ownership economy has the opportunity to address one of the biggest and most morally troubling issues of our time: economic inequality. As the wealth gap continues to widen to levels not seen since just before the Great Depression, the best way to combat this is to enable everyone to become an owner of wealth-building assets. For too long, ownership has been restricted to a privileged set of individuals — whether on the basis of geography, network, expertise, access, or for regulatory reasons. This phenomenon is especially true in the online creator economy: despite platforms’ critical dependence on the contributions of creators and users, platforms’ value accrues to a cadre of founders, early employees, and investors, rather than to users themselves. Furthermore, to maintain defensibility, creator platforms own and lock in users’ data, content, identities, and interactions — leading to erosion of creator leverage and lack of control of their own businesses. As more of our time spent and work opportunities become mediated by online platforms, giving ownership of these platforms — in terms of value, content, and data — to their participants becomes a powerful vector for facilitating social and economic empowerment. Yet, broader distribution of ownership isn't just a more socially optimal outcome, it’s also the most optimal way to scale a network. Platforms that reward their users with ownership align incentives towards creating internet-scale armies of talent that will enable them to outcompete those who don't.

Crypto has showcased the power of ownership in rallying independent participants all over the world to help steward and grow internet-scale networks. The first to realize this opportunity were developers and technologists who were critical to the growth and operation of networks like Bitcoin and Ethereum; since they owned a piece of those networks in the form of their native tokens (BTC and ETH, respectively), they were eager to contribute to those protocols in deeper ways. Now, founders are pushing this more cooperative economic model towards mainstream consumer adoption, resulting in an avalanche of new platforms whose participants engage with the products and services they use in deeper ways because they’re aligned with their economic success. The future of consumer software is crypto, centered around the belief that what users create and the value they engender belongs to them.

User-owned and operated networks are nascent but already percolating in various verticals. For example, in gaming, Yield Guild Games is providing on-ramps to income-earning opportunities in the metaverse via a scholarship program that is community-owned and operated. In the creator economy, Mirror offers crowdfunding and publishing tools and plans to distribute governance tokens to its community; members can use these tokens to propose grants from Mirror’s treasury and influence how its product works. Uniswap, a crypto exchange, distributes its fees to the traders that provide liquidity and make the product useful. And this is just the beginning! 

Today marks a new chapter for both of our funds as I’m excited to announce that Atelier Ventures and Variant Fund are joining forces to invest in software that is owned and operated by its users. Together, we will lead investments in early-stage crypto companies out of our new $110 million fund. Enabled by crypto, the ownership economy is how we can truly deliver on the promise of the passion economy, and consumer technology more broadly. As someone who has worked and invested in Web2 companies for my entire career, this was not a decision I took lightly. But I arrived here in full confidence that the intersection of the passion economy and ownership economy is the future I want to work towards, and the area of technology that holds the most entrepreneurial and equitable potential for humanity. 

Our merger represents a belief that the future of the passion economy, and of consumer software, is crypto. Together, our partnership — Jesse Walden, Spencer Noon, and I — will back founders at the earliest stages. Jesse was an early believer in crypto’s consumer potential and gained hard-won insights from a number of vantages: as a founder of Mediachain, an early protocol that pioneered ideas since popularized by NFTs; a research lead at Spotify, which acquired his startup; and as an investor, where he has written the playbooks on emerging best practices for founders building in the crypto space. Spencer was an early expert in DeFi; a one of the first crypto investors to leverage on-chain analytics to value the fundamentals of new financial marketplaces at DTC Capital; and was also a crypto entrepreneur, starting Bitcoin on-ramp company BTCity in 2014. Together with my expertise in consumer marketplaces and platforms, we provide a diverse and unique perspective that will help founders execute on strategy decisions unique to crypto projects, but also bridge the gap in go-to-market for crypto’s next leg up towards mass-market adoption.

If you’re a founder aligned with our vision for a more meritocratic internet, we’d love to chat.

A first-check venture fund investing in the Ownership Economy

Atelier Ventures and Variant Fund are joining forces - Variant

Atelier Ventures and Variant Fund are joining forces

Variant Team

Silicon Valley has known for years that ownership is a keystone of building great products. In order to build the best products, startups need to attract the best talent, and to attract the best talent, offering equity in the form of stock options is a best practice to align employees with the company’s success. But today, only a small group of insiders — founders, investors, and employees — get to reap the rewards of ownership, while the broader community who are also instrumental to a company’s success are locked out of this opportunity for life-changing wealth creation. Just imagine: if every early Uber driver had received $5,000 of Uber stock when it was a seed-stage company, that equity would be worth $25 million by the time the company went public. 

Given the overhead of legal contracts and legacy financial infrastructure, it has historically been infeasible to distribute ownership at the scale required to reward every user who participates in the value creation of today's largest platforms. Crypto tokens are an innovation that enables the movement of value with the speed of information, akin to data packets. Tokens can unlock the vision of more meritocratic distribution of ownership and align incentives toward building networks that grow bigger, faster. We call this the ownership economy — products and services that are built, operated, and owned by their users — and it is unfolding even faster than we initially imagined when we started Variant. 

We believe that ownership will be a keystone of all next-generation products and platforms. The first to realize this were the developers and technologists who contributed to the movement by building and operating the first multi-billion dollar internet scale networks: Bitcoin and Ethereum. Now, a new generation of entrepreneurs are rebuilding the internet with this more meritocratic and competitive model in mind. From developer-facing infrastructure to financial marketplaces, social media, gaming, digital art and collectibles, ownership has unlocked a new design space for scaling products faster than predecessors because users are aligned with their success. Some examples from our portfolio: Uniswap is a financial exchange, similar to Coinbase, where users who make the exchange liquid are rewarded with fees and given tokens conferring governance rights. Mirror is a publishing platform and toolkit for Web3 creators, where users — rather than the core team — decide how to grow the platform. Blitmap is one of the healthiest communities in Web3, whose users are anchored around ownership of NFTs created by artists and remixed by community members. And the list goes on.

The insight that next-generation networks would be built, operated and owned by their users is the reason why Variant was founded: to support and push forward the ownership economy. Beyond driving positive social outcomes in terms of how wealth is built and distributed, we believe that moving and distributing ownership at the speed of information is also the most optimal way to scale software services and communities. This is proven out by quantitative data: in April 2021, $122 billion in transactions took place on decentralized exchanges, up from less than $1 billion a year earlier. Ethereum settled more than $6 trillion in transactions in the past year despite being only 6 years old. Art Blocks, a curated digital art marketplace has seen billions of dollars in transaction volume grow alongside a fanatical community of collectors, including us.

Success for Variant is a world in which everyone becomes an owner of the products and services that they use. For this future to become reality, we need to continue to pull it forward. We believe it will take the support of a new kind of investor — one that is crypto-native but also has deep empathy and intuition for mainstream consumers. That is why we are thrilled to announce that Li Jin — our friend and a former colleague at Andreessen Horowitz — is merging her esteemed Atelier Ventures with Variant. The New York Times called Li the “It girl of venture capital,” but those that have worked with her know that she is an incredibly smart, thoughtful, and mission-driven investor. Li deeply believes in the values of the ownership economy, and her expertise in consumer and creator products is unparalleled in the crypto space.

As Li beautifully outlined in her blog today, crypto and the ownership economy are how we fully realize the vision of the passion economy that she laid out in 2019 with her seminal essay. The future of consumer technology is in crypto, and for it to fully blossom, we need investors who can help navigate the next wave of adoption from the early majority of internet users.

With that, we are pleased to announce a new $110 million first-check fund to continue investing in the ownership economy — from consumer platforms to gaming to infrastructure to DeFi. By design, we are sized for early-stage investing, where our expertise in startup building, protocol design, and consumer-focused go-to-market strategy can really move the needle for companies, networks, and DAOs.  

Given our vision of user ownership, we also felt that it was imperative for Variant to embody and live our own thesis as a firm — to be owned by our users, the founders that we back. Therefore, we purposefully expanded Variant’s investor base to include over 100 of the brightest minds and builders in web3, crypto, and technology, including builders from Uniswap, Compound, Foundation, Zora, Yield Guild Games, Mirror, and more. This enables us to take a decentralized approach to scaling our operations. The Variant Community will take an active role in shaping the fund's success and supporting projects in our portfolio. We aim to build a firm that adds value by turning our network into a product that founders can use and own.

If you believe in a more equitable internet and are building a crypto project in the ownership economy, we’d love to hear from you.

Variant Fund II: $110 million fund built for the ownership economy - Variant

Variant Fund II: $110 million fund built for the ownership economy

Scott Kominers

Lila Shroff

A Labor Movement for the Platform Economy

The Creator Economy is in Crisis. Now Let’s Fix It.

Leah Callon-Butler

Gabby Dizon

Richerd Chan

Jason Li

The Leaping Corgi Scholarship sponsors players to start earning in the metaverse

Jon Itzler

I’m thrilled to announce I’ve joined Variant, where I’ll be helping entrepreneurs build the future of finance & culture alongside Jesse Walden, Spencer Noon, our advisors Stani Kulechov, Jake Chervinsky, Cooper Turley and our partners.

Since my time working on request-for-quote orders via 0x in 2017, I’ve been convinced that all of finance will ultimately become permissionless and transparent. 

I grew up with DeFi as it evolved and fell in love with leveraging these core tenants – through avid participation in the protocols themselves, obsessing over cryptoeconomic incentives & mechanism design, and in the ability to query any piece of present or historical on-chain data. 

I’ve always been particularly fascinated by protocol tokens and their role in bootstrapping networks. I like diving into their fundamental makeup as productive assets and analyzing optimality of mechanics. On-chain data allows you to go deeper on things like quantifying the effectiveness of distribution models & subsidies, painting a picture of the full protocol with dashboards (how I met Spencer), or creating tools like a whitelisted set of historical governance participants for a guarded launch. 

I’ve believed for a long time that tokens are strictly better than equity as a form of programmatic ownership. When I met Jesse for the first time last year, I quickly saw the alignment we shared in what he eloquently coined as The Ownership Economy.

The thesis is effectively this – community ownership is a cheat code. Giving users a financial stake in the success of a project can accelerate its growth curve, allowing networks to scale far beyond the scope of traditional companies.

Variant takes an expansive view on the power of community ownership and the impact it can have towards building a more meritocratic and equitable society on-chain. Today, we’re just starting to see the thesis play out beyond pure financial primitives. While we’ll continue to invest in the former, we’re excited to help push the edge of what will come to represent the next defining era of crypto: NFT’s, NFT infrastructure, emerging creator economies, on-chain social graphs, and ideas we haven’t conceived of yet but ingenious founders will. The metaverse will be owned & operated by users. 

I’m grateful for the opportunity to work alongside the founders and builders in the Variant portfolio and broader community to help execute on the vision.

My DM’s are open to all or reach me at jon@variant.fund.

Custom-weighted baskets of commodity indexes for hedging your personal CPI

Great social UX for tracking activity on chain

I’m thrilled to announce I’ve joined Variant, where I’ll be helping entrepreneurs build the future of finance & culture alongside Jesse Walden, Spencer

Joining Variant

Podcast: Bankless: The Creator Economy | Jesse Walden, Li Jin, Cooper Turley

Fred Ehrsam

Blake Robbins

Podcast: Fred Ehrsam: Creators, Communities, and Crypto Part II

Nathan Baschez

Yash Bagal

Apple is Holding Back the Creator Economy

Chris Dixon

Kevin Chou

Podcast: a16z Podcast: The Creator Economy: NFTs and Beyond

Podcast: Indie Hackers: Indie Hacking in the Passion Economy with Li Jin of Atelier

We studied 50+ startups on TikTok and here’s what we found

tl;dr While many crypto startups have successfully made their users into owners by following the  While many crypto startups have successfully made their users into owners by following the Progressive Decentralization playbook, a number of founding teams feel compelled to step back from their projects at the time of token launch to reduce the risk that their tokens will be deemed securities. An alternative path may allow founders to stay involved confidently by building their platforms to mirror the democratic structure of member-owned cooperatives. This approach may allow teams to improve stakeholder equity, community decisions making, and product quality, all without sacrificing founder leadership. 

I. The problem: founders step back from leadership, hindering innovation 

Founding crypto teams often feel compelled to step back from their projects at the time of token launch, in part, due to fear that their continued involvement in such projects will increase the risk that their projects’ tokens will be deemed securities.

Why is a founding team’s continued involvement potentially a problem? Because their token is more likely to be deemed a security if a tokenholder expects profits derived from the managerial or entrepreneurial efforts of others. Thus, in order to reduce the risk that a regulator might find that tokenholders purchased tokens expecting to profit from the efforts of the founding team, the team distances itself from specific parts of the project—for example, refraining from discussing the token publicly, hosting UIs, or participating in protocol governance. 

Founders stepping back from a project offer an opportunity to decentralize leadership and provide an open source tool to the community, which is an applaudable objective given that decentralized control and ownership are key principles of crypto networks and The Ownership Economy. That said, when a founding team steps away, users risk the loss of their institutional knowledge and leadership. We believe policymakers would likely prefer that founders stay involved to help steward the overarching policy goals of consumer protection, yet the guidance remains unclear and pushes many teams to reduce their involvement. 

Where a network is sufficiently similar to a cooperative (aka co-op), however, we believe the team could launch a token and decentralize ownership, while continuing to lead their project without fear of violating securities regulations. 

This model will not be for everyone! It won’t even work for most! But many networks already unknowingly share key similarities with cooperatives that might allow for them to make the argument that, like cooperatives, the control/ownership rights that they convey to users are not securities. And where a network is not sufficiently similar, the founders should consider whether certain trade-offs might make their network sufficiently similar, and thereby allow them to continue playing leadership roles at, or make meaningful contributions to, their project after token launch. 

For this to work, a founding team must be dedicated to integrating the values and processes of a cooperative into its structure (though they do not necessarily need to legally incorporate as a cooperative). Courts place an emphasis on economic reality and disregard form when assessing securities, so they will look through attempts to set up cooperatives that lack substance. In mirroring the structure of a cooperative, projects will also benefit from an organizational structure that has been designed over generations to prioritize stakeholder equity and collective participation. 

In this post we’ll focus on U.S. law and cooperatives but founding teams should also consider the benefits of similar organizational structures in different jurisdictions. For example, Nexus Mutual has organized its decentralized insurance alternative as a discretionary mutual, a type of cooperative in the U.K. and Australia which does not have a direct equivalent in the U.S. 

This post does not provide a comprehensive legal analysis. We are flagging this argument for further consideration and these alternative structures in the hopes that founding crypto teams consider them with counsel. If you think this structure might work for you, discuss it with counsel who has a strong understanding of blockchain law and relevant organizational structures.

II. Potential solution: code rules that make the network analogous to a cooperative 

A cooperative is an autonomous association of persons (“members”) united voluntarily to meet their common economic, social, and cultural needs and aspirations through a jointly-owned and democratically-controlled enterprise. (source) 

Unlike with typical stock ownership, distributions of the benefits to a cooperative’s members are not proportional to those members’ initial investments, but are instead determined by their labor, efforts and success in using the cooperative, also known as “patronage.” The more a member patronizes a cooperative, the more services that member receives and/or the more of the cooperative’s earnings are allocated to that member.

Cooperatives can resemble traditional corporations in that they have similar functions and follow similar practices: including electing a board of directors to set policy and hiring a manager to run the operations. Cooperatives can be incorporated under state law or operated as unincorporated associations. Some states have established themselves as leaders in cooperative governance, and places like Wyoming and Minnesota are considered to be the “Delaware of cooperatives.”

Two common forms of cooperatives are consumer cooperatives, which are owned by consumers who buy goods or services from their cooperative (e.g., REI, Navy Federal Credit Union, Pedernales Electrical Coop) and producer/marketing cooperatives which are owned by the producers of commodities or crafts who have joined forces to process and market their products (e.g., Sunkist, Dairy Farmers of America).

Despite the similarities, cooperatives are fundamentally different from typical corporations in their ownership/control and distribution of benefits. For our purposes, some of the key distinctions include (source):

Cooperatives are owned and controlled by members, not shareholders — The leaders of a cooperative are generally elected by its members, who are the users of its products or services. Unlike in a corporation, each member usually has only one vote in selecting directors, rather than having voting power based on the amount of shares they hold.

Earnings are allocated to members based on the amount they use the cooperative —  By contrast, in a corporation, earnings are allocated to shareholders based on the amount of equity they hold. Use of a cooperative includes activities like buying or selling to, or marketing goods through, a cooperative.

Members form a cooperative to receive a service, not a financial return from a liquidation event — Unlike shareholders in a corporation, members of a cooperative want to obtain a service, like a market for products or the performance of a specialized function. However, members can also be motivated to join, in part, for a financial return. For instance, members may join so as to participate in the financial upside of buying at a discount by leveraging the greater purchasing power of a cooperative. See below for a further explanation of the financial upside in cooperatives.

Capital is generally contributed by members and debtholders, rather than by equity investors — Cooperatives generally raise capital by direct contributions through membership fees, by agreement with members to withhold a portion of net income based on patronage, or through retention of a portion of sales proceeds for each unit of product marketed. More recently, cooperatives have started employing a variety of financing mechanisms, including the sale of preferred shares, which function as a mix of debt and equity. Preferred shares are considered to be debt because they often come with an interest rate and are eventually redeemable for their par value, and equity because they provide the holder with certain other rights (e.g., pro-rata rights, rights of first refusal, etc.). (source)

(b) Why do cooperatives provide a useful framework for crypto token securities analysis? 

Co-op rights to ownership are not securities

Based on the rulings in United Housing Foundation, Inc. v. Forman, and B. Rosenberg and Sons, Inc. v. St. James Sugar Cooperative, Inc., we believe tokens representing ownership rights similar to membership or stock in a cooperative are not securities under U.S. law. In both decisions, the courts held that “stocks” representing membership and ownership in cooperatives, were not securities.

In reviewing United Housing and B. Rosenberg, one legal commentator provided that: “Securities law views the cooperative member as unique. Relationships established by cooperative principles are the very reason for the investment instrument’s identity as something other than a security despite similarities in name and form.” (source) 

In United Housing, the U.S. Supreme Court found that “shares of stock” which entitled the buyer the right to occupy an apartment in a housing cooperative were not securities. The decision was made, in part, because the stocks did not possess the characteristics traditionally associated with stock, namely that they could not be transferred to a non-tenant, they conferred no voting rights in proportion to the number of shares owned, and they could not appreciate in value. Further, the co-op did not seek to attract investors; on the contrary, they emphasized the “non-profit” nature of the cooperative.

In B. Rosenberg, the court found that “stock” in a co-op marketing agency was not a security, in part, because the stock could not be transferred, bore no dividends, and entitled each member to only one vote. In holding that the stock was not a security, the court found that the “distinguishing feature of a security transaction is that the investor is motivated solely by the prospects of a return on his investment from the efforts of third persons. However, when a purchase is motivated by a desire to use what he has purchased, the securities laws do not apply.”

The courts in both decisions evoked the “efforts” test of Howey, and found that “investments in a cooperative do not reflect investments of money in a common enterprise with profits to come solely from the efforts of others. It is the efforts of the membership itself that sets the course of the cooperative.” (source). Where members have an appropriate level of control over an organization (i.e., the expectation of profit depends on the members’ own efforts, rather than the efforts of others) it supports the argument that they were not investing in securities. 

For further insight on judicial treatment on the “efforts of others” prong of the Howey Test, see Foxfield Villa Associates LLC v. Robben. While this case explores LLC interest, the key conclusions and use of the Schaden Test should apply equally to co-ops. 

Crypto networks may not need to formally become co-ops to benefit from favourable securities treatment

Your project may not need to incorporate as a cooperative to benefit from the favourable securities analysis courts provide to co-ops. Instead you may just need to incorporate elements of the co-op structure, such that the economic substance of the sale of your tokens is analogous to that of co-op stocks.

In B. Rosenberg, the court held that in “searching for the scope of the word ‘security,’ name or form should be disregarded, and the emphasis placed on economic reality.” This principle is often discussed and applied by courts and regulators in the context of cryptocurrency. For instance, in discussing cryptocurrency, SEC Director William Hinman provided “…I recognize that the Supreme Court has acknowledged that if someone is purchasing an asset for consumption only, it is likely not a security…But, the economic substance of the transaction always determines the legal analysis, not the labels” (source)

As mentioned previously, we have by no means completed an exhaustive legal analysis of this topic, and we welcome others to dive deeper and fill us in on their learnings.

(d) How should token projects apply these lessons?

Founding teams of projects that are launching tokens should consider whether their organizations have incorporated, or can incorporate, enough features of a cooperative to benefit from its unique structure and securities treatment. In this context, their tokenholders would be entitled to membership in a network, to a certain amount of use of a cooperative, and/or other benefits. Below are brief explorations of how some features of cooperatives might be applied in the context of crypto projects: 

Democratizing decision making could include allowing tokenholders to have equal votes in selecting management, board members or making decisions about protocol upgrades. Many networks already allow for tokenholders to contribute to network governance but the decision-making rights of those tokenholders is usually proportionate to the number of tokens held, rather than equal voting rights for each person/entity regardless of the number of tokens they hold. 

While democratic, cooperatives can still operate efficiently when members elect professional and effective leadership, whose day-to-day roles can be similar to executives at corporations. Founding crypto team members could maintain formal leadership roles by being elected to board positions or appointed to managerial positions, or informal leadership as members of the cooperative. 

Cooperatives likely require some form of KYC protocol, so you can verify the unique individuality of your users (KYC may also potentially solve other problems with governance, such as Sybil attacks).

(2) Limit token transfer and focus on utility, not price

Crypto projects could structure and market their organizations such that tokenholders have no expectation of profit, and are only incentivized to buy tokens in order to receive a service. This would likely include making tokens non-transferrable, except to other members who intended to use the co-op. In practice, this could be achieved in the same way Nexus Mutual has done it—by using a whitelisted DEX or AMM (Automated Market Maker) that only allows verified members to trade. Presumably this enables liquidity to scale with the size of the network and membership base.

In both Union Housing and B. Rosenberg, the courts held that the stocks representing membership rights in co-ops were not securities in part because they could not appreciate (at least materially) in value, and that they could only be transferred to others who would use the services of the co-op. However, in practice, it is unlikely that the value of the assets held by co-ops will remain stable, and changes in value will ultimately be passed on to members. 

If there’s a possibility of gains from purchase of the token, you may still be in the clear. Federal courts have recognized that a cooperative’s stock is not necessarily a security where there is a possibility of gains from appreciation in the value of a member’s stock because the possibility of such gains may be incidental to the member’s primary purpose of obtaining goods and services from the cooperative. (source) Moreover, the SEC has granted favorable “no-action” letters to several cooperatives whose stock has the capacity to appreciate or depreciate in value. (source) 

This requirement does not preclude cooperatives from running efficient marketplaces, or allowing for members to benefit financially from their participation in a cooperative. For instance, while Nexus Mutual has a clause in its Articles of Association that prevents the mutual from making a profit when considered across all members over time until it shuts down, individual members can profit by underwriting coverage in the Nexus Mutual marketplace. On average, members buying coverage take a loss and members underwriting coverage make a profit, but the class as a whole does not realize a profit.

An obvious note on the above is that the members may collectively benefit if the assets held by the cooperative appreciate in value against other assets (e.g., the cooperative holds ETH, and the price of ETH goes up against the USD). 

(3) Allocate earnings to tokenholders on the basis of their patronage of the network

Many networks already allow for a variation of this principle by, for instance, allowing tokenholders to be compensated by lending or staking their tokens. One of the best examples of patronage in the context of crypto may be UMA’s Developer Mining, where developers are rewarded based on the total value locked in the financial contracts they design. Said differently, developers are rewarded based on their use of the network.

Crypto offers cooperatives the opportunity to improve on legacy approaches to patronage. For instance, a crypto network will likely be able to more easily track patronage or launch a token with an inflationary supply, aimed at rewarding those members who use their tokens earlier.

(4) Rely on financial contributions from members, debtholders, preferred shareholders… and others?

Cooperatives can raise financing through member contributions (a distant cousin of crowdfunding), debt financing, and sales of preferred shares.  For instance, Nexus Mutual raised capital through a sale of its NXM token to members, which those members could use to stake smart contract coverage and participate in the marketplace. A similar approach has not been tested in the U.S., but it’s encouraging to see innovation that has the potential to bring the cooperative model into the digital age.

(5) Provide consistent disclosure of project information

Transparency and consistent disclosure of project information to tokenholders may also be favourable in a securities analysis, which is convenient for open source crypto projects. In Minn-Dak Farmers Cooperative’s successful 2012 request for a no-action letter from the SEC, their counsel argued that that the cooperative should be exempt from securities registration, in part, because the cooperative already provided sufficient information to members. 

Further, the most important factor in the Schaden Test, which is employed by courts when considering the “efforts of others” prong of the Howey Test, is whether investors have “access to information.” The more accessible the information, the better the argument that the instrument in question is not a security. The logic here is that the “principal purpose of the securities acts is to protect investors by promoting full disclosure of information necessary to informed investment decisions.” (source)   

For a further discussion of co-ops and crypto, see Jesse’s previous post Past, Present, Future: From Co-ops to Cryptonetworks. For a further discussion of compliant token distribution see Connor’s previous post Compliant Decentralization?: Exploring a Novel Approach to Token Distribution. DMs are open for anyone thinking creatively about building projects using these structures (@c_spelliscy and @jessewldn).

Thanks to Brian Brooks for prior conversations that inspired this post and to Jonathan Dotan, Nathan Schneider, Jake Chervinsky, Marvin Ammori, Hugh Karp, Jelena Djuric, Addison Cameron-Huff, Jason Somensatto, John Neufeld, Sam Zadeh, and the Blockchain Association team for their contributions and input. 

This content is provided for informational purposes only, and should not be relied upon as legal, business, investment, or tax advice. You should consult your own advisers as to those matters. References to any securities or digital assets are for illustrative purposes only, and do not constitute an investment recommendation or offer to provide investment advisory services.

Where a network is sufficiently similar to a cooperative, its possible that a team could launch a token and decentralize ownership, while continuing to lead their project—without fear of violating securities regulations.

Leadership in The Ownership Economy—Scaling Decision Making while Minimizing Securities Risk – Variant

Leadership in The Ownership Economy—Scaling Decision Making while Minimizing Securities Risk

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Podcast: Bankless: The Ownership Economy | Jesse Walden

One of the most stunning things about the technology we consume everyday is the degree to which it is built, operated and even funded by its users.

The device you’re using to read this post, the software that’s displaying it, the server hosting this content and so much else on the internet are built with open-source code contributed by a global community of developers. Platforms like Wikipedia, YouTube, Twitter, Facebook, and Airbnb all operate around content and products sourced from individuals, not corporations. And increasingly marketplaces like Kickstarter, Patreon, Substack, and many other Passion Economy platforms enable users to directly fund the products, information, and services that they consume.

As the role of the individual in value creation becomes more commonplace, the next evolutionary step is towards software that is not only built, operated, and funded by individual users—but owned by users too.

Ownership, via employee stock option plans, has been a powerful tool for incentivizing talented people to dedicate their skills to building startups in Silicon Valley. While this model has been extremely successful, it hasn’t been accessible to all, constrained by geography and legacy financial infrastructure, among other factors. One result is that the economic interests of the biggest internet platforms are concentrated and often poorly aligned with their most valuable contributors, their users. Now, new technologies are shifting work and value distribution to be accessible online, resulting in a new generation of platforms that thrive on contributions from a permissionless and global talent pool.

Ownership is a powerful motivator for users to contribute to products in deeper ways, be it with ideas, computing resources, code, or community building. This more cooperative economic model helps ensure better alignment with users over time, resulting in platforms that can be larger, more resilient, and more innovative.  This is the Ownership Economy, and beyond being a positive social endeavor, the platforms building it are able to leverage the strongest form of market incentives to grow network effects.

While most prevalent in crypto today, The Ownership Economy is expanding to other areas in tech. To understand why, we can look to recent history and observe how protocol innovations often expose disruptive new models that, when productized, influence broader trends and go on to impact billions.

Identifying Disruptive Models Through Protocol Innovations

The history of protocol adoption fits a pattern: first, early-adopters use new protocols to do things that were impossible before the new technology empowered them to do so. Very often, this new behavior involves breaking the rules. Then, a winning strategy for founders is to build products that make these new models more accessible to a wider audience. 

Consider the early web protocols: IP, HTTP, standards like HTML, then RSS. At first, popular websites used these protocols to create carbon-copies of physical analogues, like newspaper cover pages or classified ads. But as internet adoption went mainstream, users began publishing their own content: independent blogs, podcasts, newsletters and forums paved the way for the user-generated content platforms that dominate publishing today.

Another example is BitTorrent, a protocol innovation of packet distribution, but a disruption that underpinned the streaming revolution. When BitTorrent first became popular, Netflix was still mailing DVDs in the mail. Meanwhile, the peer-to-peer technology enabled consumers to access music, movies, software, and video games instantaneously, as if the files were already on their hard drives. By 2004, BitTorrent comprised one-third of all internet traffic.

Consumers’ passion for torrenting signaled that they wanted to access the world’s media at their fingertips, but for many, BitTorrent wasn’t a user-friendly experience; trackers were moving targets, cluttered and difficult to navigate. 

One person who saw an opportunity through the noise was Daniel Ek, founder of Spotify. As CEO of µTorrent, one of the most popular BitTorrent clients, Ek understood that piracy wasn’t about stealing—it was about access. The winning formula was providing access to the world’s music in a clean, well-designed product.

Today, crypto tokens are the latest protocol innovation to expose a disruptive new model. Just as BitTorrent allowed us to exchange packets of information instantly and without an intermediary, crypto tokens let us distribute value in the same way.

The protocol innovation of tokens is akin to packets for value, but the disruption is in the way new software platforms can be built and gain adoption. The breakthrough of early crypto networks is a new model for market-driven networks, where users build, operate and own a piece of the products and services that they use everyday.

The Ownership Economy, Pioneered by Crypto

The idea of user ownership is at the core of the success of Bitcoin and Ethereum, the first user-owned and operated networks at scale. Bitcoin arrived in 2009, the year that marked a rapid acceleration of economic inequality and the role of the internet in people’s daily lives. Bitcoin promised a new economic means to participate in modern technology history, simply by running open-source software on your computer. Rather than needing to live in a specific place and pursue a specific career in order to reap the benefits of the new economy, anyone with an internet connection could participate by “mining” or securing the network. In return, they earned newly minted Bitcoin, an ownership stake in the network itself.

Ethereum’s 2015 launch expanded the type of computation possible on blockchain networks, enabling a broader range of applications and allowing developers to experiment with new ways of expressing ownership in code. The best-designed Ethereum-based applications leverage a business model similar to traditional Web 2.0 marketplaces, but encode them in autonomous “smart contracts” run by Ethereum’s network of miners. This means these applications have no central operator. Rather than a platform’s inner circle of founders and investors taking home the value, users are able to earn the majority of value generated from their collective contributions. 

Needless to say, one of the most challenging problems any startup or new technology faces is adoption, especially where network effects are necessary—and even more-so when competing against the existing network effects of today’s dominant platforms. As the early Bitcoin and Ethereum communities came to realize, ownership is a tool to help surmount this problem. Those early communities were largely composed of technologists, developers, and enthusiasts who were naturally among the first to recognize the power of tokens as direct economic incentives. But today, founders are bringing the idea of ownership —  or at least, better economic alignment between platforms and participants — to new verticals in tech, from developer infrastructure, to financial services, and from consumer marketplaces to social.

How next-generation platforms are driving an ownership economy

The ownership economy doesn’t always mean a literal distribution of tokens, stock options, or equity. It also doesn’t necessarily mean that an application or service is entirely built on a blockchain. Rather, it means that ownership — which may manifest in the form of novel economic rewards, platform governance, or new forms of social capital — can be a new keystone of user experiences, with plenty of design space to explore.

Some examples: In payments, Celo is making digital dollars and financial applications accessible to anyone with an internet connection via a blockchain network that, like Bitcoin, is entirely user owned and operated. In finance, startups like Binance and Numerai have leveraged tokens to distribute revenue from the platform directly to their users, fueling brand loyalty and growth. Compound, a money market, recently completed its journey of progressive decentralization to become a community owned marketplace for borrowing and lending.

Uniswap, a crypto exchange, has a business model similar to Coinbase or Binance in that it imposes a fee on transactions. But rather than the company capturing that fee, it’s instead distributed to the market-making traders that provide liquidity and make the product useful. Since Uniswap is open source and user-owned, third-party developers can have confidence building on the platform and a rich ecosystem of integrations has grown around the project.

In social, Reddit recently announced that 300 million users will have access to tokenized community currencies through their mobile app. The platform will reward participants in the r/FortniteBR and r/Cryptocurrency subreddits with tokens that can be used to pay for membership, tipping, and badges in the Reddit app, giving them ownership over the economy of each subreddit.  

Consumer marketplace Foundation is transforming the Kickstarter model by allowing creators to tokenize their projects in a marketplace where tokens can be bought, sold or redeemed for goods or services. This programmable, digital representation of ownership unlocks new revenue streams that gives buyers and creators access to new value streams in secondary markets. 

Global talent marketplace Braintrust connects top tech talent with large companies looking to hire them.  Their marketplace transacts in USD but uses an Ethereum-based token as its core incentive and governance system to distribute value to contributors.  

In consumer products, the house-of-brands startup Arfa is rewarding customers who contribute to product development—The Arfa Collective—with a 5 percent share of company profits. They hope these direct economic incentives can help build a more loyal customer base with lower marketing costs over time. 

Other platforms like Bird and Dumpling are putting a new spin on the gig economy by allowing suppliers in their marketplaces to run independent franchises, which they own and operate. These platforms combine the scale of software-driven marketplaces with equity value accrual for operators.

The world increasingly understands that “software is eating the world,” so it’s no surprise that narratives around personal economic empowerment on the internet are resonating now more than ever. Just as the barriers to professional productivity online have fallen dramatically, so too have the hurdles that previously prevented the equitable and secure distribution of economic value. 

Introducing Variant: a firm dedicated to the ownership economy

Crypto exposed the power of ownership as a tool to drive users to contribute to protocols they use in deeper ways. Now, the opportunity is to follow the pattern, and build more accessible products (and protocols) that bootstrap adoption & participation through better economic alignment with users.

After building and investing in the space for nearly seven years, I am doubling down on the pursuit of a more equitable and innovative internet. In 2014, after starting my career in music as an artist manager, I cofounded Mediachain Labs. The company’s goal was to build infrastructure that would allow creators to capture more of the value they generated on media platforms. That project was acquired by Spotify, where I led blockchain R&D with similar goals in mind.

In 2018, I joined the investment team at Andreessen Horowitz to take a wider view of crypto networks, their capabilities, and their applications. And now, at Variant, I hope to work with this generation’s Daniel Ek’s: product-driven founders who understand how ownership can be a disruptive cornerstone of new products. 

To help build the ownership economy, I’ll partner with entrepreneurs and communities at the earliest possible stages.

If that’s you, please reach out — I’d love to hear about what you’re building.

Join the discussion on Twitter and subscribe for updates from Variant.

From crypto to consumer, ownership is emerging as a new tool for bootstrapping network effects in new software platforms that are increasingly operated by their users.

The Ownership Economy: Crypto & The Next Frontier of Consumer Software – Variant

The Ownership Economy: Crypto & The Next Frontier of Consumer Software

For a category that was unnamed and barely existed only two years ago, the growth in #DeFi is incredibly impressive. But within the crypto community I don’t think it is controversial to point out that DeFi is primarily used by insiders and enthusiasts, and mostly for speculation on crypto itself.

I say this without negative judgement. In fact, speculation is productive as it allows this nascent category to bootstrap something far more consequential. And yes, the next big thing usually starts out looking like a toy.

Still, this begs the question, how will DeFi cross the chasm?

No doubt, the UX needs to improve, but I don’t think thats all thats left to do. DeFi needs to solve a real problem (and do so 10x better than alternatives) in order to get mainstream users engaged.

Below are three popular narratives emanating from the crypto community as to how this might happen. Personally, I am less engaged by the first two, and most excited about the last. I’m curious to hear what other narratives excite you, and hope to kick the tires on this discussion on Twitter.

For years, crypto has embraced the narrative that it can bank the unbanked. Its true, a crypto wallet is a bank account for anyone with an internet connection. And a DeFi savings account is 10x better than nothing.

That said, it is unclear how and when the unbanked will arrive in DeFi en masse. To date, I haven’t seen any data indicating that this transformation is underway. All indications are that the bulk of the liquidity in DeFi today is from “whales” or large accounts.

Projects like Celo are making an effort to bootstrap use of crypto rails in the developing world by making stable, USD-pegged crypto assets easy to earn, save and transact. India’s recent reversal on its crypto ban is an encouraging new market to explore.

I am optimistic about the unbanked arriving in crypto, but unclear on exactly what the catalyst will be. Perhaps it is simply a trust gap to be filled by a combination of friendly user experience, word of mouth, and some form of insurance—all of which are happening, slowly but surely. I’m not the target user persona here, so its difficult for me to judge exactly where we are at in the development of this catalyst. I think a Gini Coefficient Index of DeFi may be a good indicator of long-tail, consumer adoption.

2. Institutional Adoption: DeFi as global casino; Welcome Wall St!

Proponents of this line of thinking tend view the most important DeFi metric as “AUP” or Assets Under Protocol. With this view, it doesn’t matter if there are relatively few users, so long as they are whales that pump liquidity into the system.

No doubt, liquidity is important to the bootstrapping process, but I do think there is a glass ceiling before Wall St wholesale pivots to DeFi. It seems unlikely that adoption will happen top-down from Wall St, and far more likely that institutional adoption follows bottom-up retail. I think that is generally true for any radically new technology platform.

3. A “Real” Crypto Economy: non-financial consumer apps lead the way

To me, the most exciting path to mainstream adoption follows from a “real” economy built on crypto rails. That is an economy that is not in service of crypto speculation itself, but rather related to real goods and services who’s economic layer is coordinated on-chain. Products like Foundation aim to bring mainstream creators and their audiences to crypto by allowing them to fund creative projects and earn new revenue streams. Reddit hopes to grow engagement by leveraging community currencies to make users actual owners of their sub’s internal economy. Imagine users taking a loan against a pair of tokenized Yeezys.  Or a Redditor exchanging their subreddit’s $BRICKS for dollars and opening a savings account.

All of this is possible because of the easy composability of smart contracts. Neither Foundation nor Reddit needs to go out of their way to build this functionality themselves. The open, user-controlled nature of blockchain computing allows any developer to plug into these ecosystems and offer their users financial services. The result could be a rapid move from non-financial applications into DeFi.

For a category that was unnamed and barely existed only two years ago, the growth in #DeFi is incredibly impressive. But within the crypto community I don't

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