Token vs Equity Battle: on-chain Sovereignty vs Regulatory Constraints, how does the encryption economy reconstruct?

Original authors: Jesse Walden, Variant Partner; Jake Chervinsky, Variant CLO

Original compilation: Saoirse, Foresight News

Introduction

Over the past decade, entrepreneurs in the cryptocurrency industry have commonly adopted a value distribution model: assigning value to two independent carriers, tokens and equity. Tokens provide a new way for networks to expand at an unprecedented scale and speed, but the prerequisite for releasing this potential is that tokens must represent the genuine needs of users. However, the ongoing regulatory pressure from the U.S. Securities and Exchange Commission (SEC) has greatly hindered entrepreneurs from injecting value into tokens, forcing them to shift their focus to equity. Now, this situation urgently needs to change.

The core innovation of tokens lies in achieving "self-ownership" of digital assets. With tokens, holders can independently own and control funds, data, identities, as well as the on-chain protocols and products they use. To maximize this value, tokens should capture on-chain value, which is transparent, auditable, and directly controlled only by the token holders.

Off-chain value is different. Since token holders cannot directly own or control off-chain income or assets, such value should rightly belong to equity. Although entrepreneurs may wish to share off-chain value with token holders, this often involves compliance risks: companies controlling off-chain value typically have fiduciary duties and must prioritize asset retention for shareholders. If entrepreneurs wish to direct value to token holders, then this value must exist on-chain from the very beginning.

The basic principle that "tokens correspond to on-chain value, while equity corresponds to off-chain value" has been distorted since the inception of the crypto industry due to regulatory pressure. The SEC's broad interpretation of securities law has not only led to an imbalance in the incentive mechanisms between companies and token holders but also forced entrepreneurs to rely on inefficient decentralized governance systems to manage protocol development. Today, the industry has ushered in new opportunities, allowing entrepreneurs to re-explore the essence of tokens.

The SEC's old regulations stifle entrepreneurs

During the ICO era, cryptocurrency projects often raised funds through public token sales, completely ignoring equity financing. When they sold tokens, they promised that the protocol being built would increase the value of the tokens once they were listed, making token sales the only fundraising method, and tokens the only value-bearing asset.

However, the ICO failed to pass the review of the U.S. Securities and Exchange Commission (SEC). Since the 2017 "DAO Report," the SEC has applied the Howey test to public token sales, determining that most tokens qualify as securities. In 2018, Bill Hinman (former Director of the SEC's Division of Corporation Finance) defined "sufficiently decentralized" as a key to compliance. In 2019, the SEC further released a complex regulatory framework, increasing the likelihood of tokens being classified as securities.

As a response, companies have abandoned ICOs and instead adopted private equity financing. They develop protocols supported by venture capital funds and only distribute tokens to the market after the protocol is completed. To comply with SEC guidelines, companies must avoid any actions that could potentially drive up the value of the tokens after they go live. The SEC's regulations are extremely strict, and companies are almost required to completely sever ties with the protocols they develop, even being discouraged from holding tokens on their balance sheets to avoid being seen as having financial motives to inflate the token's value.

Entrepreneurs then transfer governance rights of the protocol to token holders and focus on building products on top of the protocol. The core idea is that a token-based governance mechanism can serve as a shortcut to achieve "full decentralization," while entrepreneurs continue to contribute to the protocol as ecosystem participants. In addition, entrepreneurs can create equity value through the business strategy of "complementary goods commercialization," which involves providing open-source software for free and then generating profits through products built on top of or below it.

However, this model exposes three major issues: misalignment of incentive mechanisms, low governance efficiency, and unresolved legal risks.

First, the incentive mechanism between enterprises and token holders has become misaligned. Companies are forced to direct value towards equity rather than tokens, both to reduce regulatory risks and to fulfill their fiduciary duties to shareholders. Entrepreneurs no longer pursue competition for market share, but instead develop business models centered around equity appreciation, and may even have to abandon commercialization paths.

Secondly, this model relies on decentralized autonomous organizations (DAOs) to manage protocol development, but DAOs are not competent in this role. Some DAOs operate based on foundations but often fall into issues such as misalignment of incentives, legal and economic constraints, operational inefficiency, and centralized access barriers. Other DAOs adopt collective decision-making, but most token holders lack interest in governance, and the token-based voting mechanism leads to slow decision-making, chaotic standards, and poor outcomes.

Thirdly, the compliance design has failed to truly avoid legal risks. Although this model aims to meet regulatory requirements, the SEC is still investigating companies that adopt this model. Token-based governance also introduces new legal risks, such as DAOs potentially being regarded as general partnerships, which exposes token holders to unlimited joint liability.

Ultimately, the actual cost of this model far exceeded the expected benefits, weakening the commercial viability of the protocol and damaging the market appeal of the associated tokens.

Tokens carry on-chain value, while equity carries off-chain value

The new regulatory environment provides an opportunity for entrepreneurs to redefine the reasonable relationship between tokens and equity: tokens should capture on-chain value, while equity corresponds to off-chain value.

The unique value of tokens lies in the realization of autonomous ownership of digital assets. It grants holders ownership and control over on-chain infrastructure that has global real-time auditable transparency. To maximize this feature, entrepreneurs should design products so that the value flows on-chain, allowing token holders to directly own and dispose of it.

Typical cases of on-chain value capture include: Ethereum benefits token holders by burning transaction fees through the EIP-1559 protocol, or by directing DeFi protocol revenue to an on-chain treasury via a fee conversion mechanism; token holders can also profit from intellectual property used by authorized third parties, or obtain returns by routing all fees to on-chain DeFi frontend interfaces. The core idea is that value must be transacted on-chain, ensuring that token holders can directly observe, own, and control without intermediaries.

In contrast, off-chain value should belong to equity. When income or assets exist in off-chain scenarios such as bank accounts, business partnerships, or service contracts, token holders cannot directly control them and must rely on enterprises as intermediaries for value circulation, which may be subject to securities law. Furthermore, enterprises that control off-chain value have fiduciary duties and must prioritize returning profits to shareholders rather than token holders.

This does not deny the rationality of the equity model. Even if the core product is open-source software such as public chains or smart contract protocols, crypto companies can still succeed by leveraging traditional business strategies. As long as there is a clear distinction between "token corresponding to on-chain value and equity corresponding to off-chain value," actual value can be created for both.

Minimize Governance, Maximize Ownership

In the context of the new era, entrepreneurs must abandon the mindset of viewing tokenized governance as a shortcut for regulatory compliance. On the contrary, governance mechanisms should only be activated when necessary and must be kept minimal and orderly.

One of the core advantages of public blockchains is automation. Overall, entrepreneurs should automate all processes as much as possible, reserving governance rights only for matters that cannot be automated. Some protocols may benefit from the involvement of "humans at the edges" (referring to DAOs being "automation-centric, with humans in a peripheral role"), such as executing upgrades, allocating treasury funds, and supervising dynamic parameters like fees and risk models. However, the scope of governance should be strictly limited to scenarios exclusive to token holders. In short, the higher the degree of automation, the better the governance efficiency.

When full automation is not feasible, delegating specific governance rights to trusted teams or individuals can enhance decision-making efficiency and quality. For example, token holders can authorize the protocol development company to adjust certain parameters, thus avoiding the need for consensus voting by all members for every operation. As long as token holders retain ultimate control (including the ability to monitor, veto, or revoke authorization at any time), the delegation mechanism can ensure the principle of decentralization while achieving efficient governance.

Entrepreneurs can also ensure the effective operation of governance mechanisms through customized legal structures and on-chain tools. It is recommended that entrepreneurs consider adopting novel entity structures such as the DUNA (Decentralized Autonomous Nonprofit Association) in Wyoming, which grants token holders limited liability and legal personality, enabling them to enter into contracts, pay taxes, and seek judicial protection; additionally, governance tools like BORG (Blockchain Organization Registration Governance) should be considered to ensure that the DAO operates under a framework of transparency, accountability, and security on-chain.

In addition, it is necessary to maximize the ownership of token holders over the on-chain infrastructure. Market data indicates that users have a very low recognition of the value of governance rights, and very few are willing to pay for voting rights for protocol upgrades or parameter changes, but there is a high sensitivity to the value of ownership attributes such as income distribution rights and control over on-chain assets.

Avoiding Securities Relationships

To address regulatory risks, tokens must be clearly distinguished from securities.

The core difference between securities and tokens lies in the rights and powers conferred by each. In general, securities represent a series of rights tied to a legal entity, including rights to economic benefits, voting rights, rights to information, or rights to legal enforcement, among others. For example, in the case of stocks, holders obtain specific ownership linked to the company, but these rights are entirely dependent on the corporate entity. If the company goes bankrupt, the associated rights will become invalid.

In contrast, tokens grant control over the on-chain infrastructure. These powers exist independently of any legal entity (including the creators of the infrastructure), and even if the enterprise ceases operations, the powers granted by the tokens will persist. Unlike securities holders, token holders typically do not enjoy the protection of fiduciary duties and do not possess statutory rights. The assets they own are defined by code and are economically independent of their creators.

In certain cases, on-chain value may partially depend on a company's off-chain operations, but this fact alone does not necessarily fall under the scope of securities law. Although the definition of securities is broadly applicable, the law does not intend to regulate all relationships where one party relies on another to create value.

Many transactions in reality have a profit dependency but are not regulated by securities laws: consumers who purchase luxury watches, limited edition sneakers, or high-end handbags may expect brand premiums to drive asset appreciation, but such transactions clearly fall outside the SEC's regulatory scope.

A similar logic applies to many commercial contract scenarios: for example, landlords rely on property managers to maintain assets and attract tenants for revenue, but this cooperative relationship does not make the landlord a "securities investor." The landlord always retains full control over the asset, can veto management decisions at any time, change the operating entity, or take over the business independently. Their control over the property is independent of the manager's existence and is completely disconnected from the management's performance.

Tokens aimed at capturing on-chain value are closer to the aforementioned physical assets rather than traditional securities. Holders of such tokens are clearly aware of the assets and powers they own and control when acquiring these tokens. They may anticipate that the ongoing operations of the enterprise will drive asset appreciation, but there is no statutory rights relationship with the enterprise, and ownership and control of digital assets are completely independent of the enterprise entity.

The ownership and control of digital assets should not constitute a securities regulatory relationship. The core logic of the applicability of securities law is not 'one party benefits from the efforts of another party,' but rather 'investors rely on entrepreneurs in a relationship of information and power asymmetry.' If such a dependency relationship does not exist, token transactions centered on property rights should not be classified as securities issuance.

Of course, even if securities laws should not apply to such tokens, it does not preclude the SEC or private plaintiffs from asserting their applicability; the court's interpretation of the legal provisions will determine the final outcome. However, the latest policy developments in the United States have sent positive signals: Congress and the SEC are exploring a new regulatory framework that will shift the focus to "control over on-chain infrastructure."

Under the regulatory logic of "control-oriented", as long as the protocol operates independently and the token holders retain ultimate control, entrepreneurs can legally create token value without touching securities regulations. Although the evolution path of policies is not yet fully clear, the trend is already evident: the legal system is gradually recognizing that not all value-added activities need to be included within the scope of securities regulation.

Single Asset Model: Fully Tokenized, No Equity Structure?

Although some entrepreneurs prefer to create value through a dual-track model of tokens and equity, others favor the "single asset" model, anchoring all value on-chain and attributing it to the tokens.

The "single asset" model has two core advantages: the first is aligning the incentive mechanisms of enterprises and token holders, and the second is allowing entrepreneurs to focus on enhancing the competitiveness of the protocol. With a minimalist design logic, leading projects like Morpho have been the first to practice this model.

Consistent with traditional analysis, the determination of securities attributes still centers on ownership and control, which is particularly critical for single asset models, as it clearly concentrates value creation on the token. To avoid resembling securities, tokens need to grant direct ownership and control of digital assets. Although legislation may gradually institutionalize this model, the current challenge still lies in the uncertainty of regulatory policies.

Under a single asset architecture, enterprises should be set up as non-profit entities without equity, solely serving self-developed protocols. When the protocol goes live, control should be transferred to token holders, ideally organized through blockchain governance-specific legal entities such as the Wyoming DUNA (Decentralized Autonomous Non-Profit Association).

After going live, enterprises can continue to participate in the protocol construction, but the relationship with token holders must be strictly separated within the "entrepreneur - investor" paradigm. Viable paths include: token holders authorizing enterprises to act as agents to exercise specific rights, or defining the scope of cooperation through service contracts. Both roles are part of the standard settings of decentralized governance ecology and should not touch upon the applicable scope of securities law.

Entrepreneurs should pay special attention to distinguishing between single asset tokens and company-backed tokens like FTT, which are essentially closer to securities. Unlike native tokens that grant control and ownership of digital assets, tokens like FTT represent a claim on the off-chain revenue of the enterprise, and their value is entirely dependent on the issuing entity: if the business operates poorly, holders have no recourse; if the entity goes bankrupt, the tokens become worthless.

The company's endorsed tokens precisely create the rights imbalance that securities law aims to address: holders cannot audit off-chain income, veto corporate decisions, or change service providers. The core contradiction lies in the asymmetry of power; such holders are entirely subject to the enterprises, forming a typical quasi-security relationship that should fall under regulatory oversight. Entrepreneurs adopting a single asset model must avoid such structural designs.

Even with the "single asset" model, a company may still need off-chain income to maintain operations, but the relevant funds can only be used for cost expenditures and cannot be used for dividends, buybacks, or other value transfers to token holders. If necessary, funds can be obtained through treasury allocations, token inflation, or other methods approved by holders, and control must always be in the hands of token holders.

Entrepreneurs may raise several defenses, such as "no funds were invested since the tokens were not sold to the public" and "there is no common enterprise without an asset pool"; however, including claims of "non-securities relationships", these assertions cannot ensure the avoidance of current legal applicability risks.

Open Questions and Alternatives

The new era of the cryptocurrency industry brings exciting opportunities for entrepreneurs, but this field is still in its early stages, and many issues have yet to reach a conclusion.

One of the core issues is whether it is possible to avoid securities law regulation while completely abandoning governance mechanisms. Theoretically, token holders can only hold digital assets without exercising any control. However, if holders remain completely passive, this relationship may evolve into the realm of securities law applicability, particularly when the enterprise retains some control. Future legislation or regulatory rules may recognize a non-governance "single asset" model, but entrepreneurs still need to comply with the current legal framework.

Another issue concerns how entrepreneurs handle initial financing and protocol development in a single asset model. Although the mature architecture is relatively clear, the optimal path from startup to scaling remains unclear: How can entrepreneurs raise funds to build infrastructure without equity to sell? How should tokens be allocated when the protocol goes live? What type of legal entity should be adopted, and should it be adjusted as the development stage progresses? These details and more questions still await exploration by the industry.

In addition, some tokens may be better defined as on-chain securities. However, the current securities regulatory framework almost stifles the survival space of such tokens in a decentralized environment, which could have released value through public chain infrastructure. Ideally, Congress or the SEC should promote the modernization of securities laws to allow traditional securities like stocks, bonds, notes, and investment contracts to operate on-chain and achieve seamless coordination with other digital assets. But before that, regulatory certainty for on-chain securities remains out of reach.

Path Forward

For entrepreneurs, there is no one-size-fits-all standard answer to the design of token and equity structures; it is only through a comprehensive weighing of costs, benefits, risks, and opportunities. Many open-ended questions can only be gradually answered through market practice, after all, only continuous exploration can verify which model is more viable.

The original intention of writing this article is to clarify the choices currently faced by entrepreneurs and to outline the potential solutions that may emerge with the evolution of cryptocurrency policies. Since the birth of smart contract platforms, vague legal boundaries and a harsh regulatory environment have always restricted entrepreneurs from unlocking the potential of blockchain tokens. However, the current regulatory environment has opened up a new exploration space for the industry.

In the above text, we constructed a navigation map to help entrepreneurs explore directions in new fields and proposed several development paths that we believe have great potential. However, it should be made clear that the map is not the actual territory itself, and there are still many unknowns waiting for the industry to explore. We firmly believe that the next generation of entrepreneurs will redefine the boundaries of token applications.

Thanks

Special thanks to Amanda Tuminelli (DeFi Education Fund), John McCarthy (Morpho Labs), Marvin Ammori (Uniswap Labs), and Miles Jennings (a16z crypto) for their profound insights and valuable suggestions regarding this article.