Creating a blockchain startup is legally and technically complicated.
Everyone needs to plan all the steps to implement the product.
Choosing the blockchain
Before creating a project, choose which blockchain the product will run on. The most popular blockchains are Ethereum and Polygon.
It has a complete financial infrastructure; the advantage is the speed of transactions. According to BitInfoCharts, the number of transactions per day in the Ethereum network is about 539000 (compared to 241000 in the Bitcoin network). Ethereum will switch from the Proof of Work consensus to Proof of Stake. Ethereum will be able to process between 25000 and 100000 transactions per second instead of today's 15 transactions per second now.
For comparison, Visa's international payment system processes up to 24000 transactions per second, while the fastest blockchain Solana is 50000.
It is a blockchain scalability platform, an infrastructure solution designed to improve Ethereum. Polygon resolves Ethereum's disadvantages, especially the high commissions. Based on Polygon, the market can offer users lower fees and faster calculations without sacrificing security or decentralization.
Polygon is the best blockchain for launching a project with high-frequency, low-cost transactions. Ethereum is the best blockchain project with low-frequency and high-cost transactions.
Forming a team
The foundation of a promising startup is a strong team. Without such a team, the founder can't solely launch a promising blockchain startup. Consider rewards for everyone, from programmers to lawyers.
Firstly, pay attention to the intellectual property of the product, privacy and non-compete clauses.
Secondly, the startup may fail because there is no management structure and no distribution of responsibility between the team and the founders.
We recommend setting out the functions in the business already at the stage of negotiations with the blockchain startup's founders and investors.
Creating a legal entity and choosing a jurisdiction for a startup
When it comes to selecting the most favorable jurisdiction, lawyers evaluate the following:
the perspective of the jurisdiction
and many other factors, which we will talk about in a special video
Everyone must conduct blockchain-based activities only through legal entities. By creating an LLC (Limited Liability Company), the founder will only be liable to the extent of their contributions. As a general rule, no one will infringe on private property.
In most blockchain-friendly jurisdictions, if founders pay taxes as a company, they can get more favorable tax rates than if they would pay taxes as an individual.
There are two of the most flexible forms of conducting business for blockchain startups:
The first option is a classical one. LLC
The second option is gaining more and more momentum: DAO — a decentralized autonomous organization and a unique form of LLC. Blockchain technology allows a DAO to function without centralized management, significantly increasing data security, trust, and transparency
However, while a founder can set up an LLC in basically any country, a DAO can only be set up in a limited list of countries.
The countries where it works:
British Virgin Islands
the Marshall Islands
Bahamas and Panama
Preparation of the legal aspect of the project
Before launching a project, it is necessary to work on the legal aspect of the project and to draft and sign agreements for all participants in the project.
How to formalize the relations with investors?
There are two options:
Simple Agreement for Future Equity (SAFE)
Simple Agreement for Future Tokens (SAFT)
Typically, under a SAFE, an investor is entitled to a certain number of shares in a company in exchange for an upfront investment that allows it to be converted into capital upon the occurrence of a specific event, such as an acquisition or financing. A SAFE is virtually identical to a convertible bond, except that a SAFE has no maturity term and no interest charges.
SAFT is derived from SAFE and means a simple agreement for future tokens. The idea of SAFT refers to a specific class of utility tokens. It is almost identical to SAFE, except that SAFT can be converted into future-issued tokens as products, whereas SAFE can be converted into capital.
I recommend signing shareholders' agreements between the founders of the startup. I also recommend signing Master Service Agreements or Employment Contracts with other team members — hired individuals. Today's blockchain industry, in most cases, chooses the first option due to its simplicity and better tax rates on personal income in many jurisdictions.
The Roadmap and the White paper are among the company's internal documents, which will not have legal force but will help in the project's development. Unlike the white paper, which is made once, the roadmap can be changed over time if necessary.
AML (Anti-Money Laundering) verification of funds must be introduced to comply with anti-money laundering legislation. The procedure involves identifying, storing, and exchanging information about users, their income, and transactions between organizations and agencies.
KYC (Know your customer) procedures are equally important as verifying the customer before providing financial services. Such customer identification is part of AML. Whereas in KYC, it is essential to check the user's documents, in the case of AML, the first thing that happens is to check the transactions for legality. The link between AML and KYC must be constant and reversible. The founder can use KYC modules to adapt the AML program to the unique needs of a blockchain startup.
But what is most important is the verification of the token. Defining a token as a security token (the digital equivalent of security) entails complying with strict securities laws, so this is a scenario that everyone should avoid.
The Howey Test, which the U.S. Supreme Court developed, determines the token type. According to the test, a token is considered a security if the transaction involving it includes the following four elements:
an investment of money
in a common enterprise
with the expectation of profit
to be derived from the efforts of others
It applies to any contract, scheme, or transaction, regardless of whether they have any characteristics of specific securities. Therefore, do not take the four questions in the test literally; the court interprets it broadly and treats each situation individually.
Token valuation should be handled by a lawyer with expertise in this matter. Only accredited (qualified) investors can legally buy tokens if tokens are subject to U.S. securities laws.
Since 2017, the Securities and Exchange Commission (SEC) has been actively initiating proceedings related to unregistered securities offerings. In 2021, 14 of 20 such proceedings involved initial public offerings of ICO coins under which Utility tokens are used.
Attracting investment and launching the project
Blockchain-based tokens are created to launch the project. It is possible to develop NFT tokens for which existing trading platforms are used. With them, founders can turn their work into NFT in minutes. To create an NFT token, there is a need to connect a cryptocurrency wallet to an NFT-enabled trading platform and change token features.
The next step after creating tokens is to distribute them. This practice provides users with unique tokens before the blockchain starts operating normally. One chooses the appropriate direction to benefit and raise funds to begin distribution. Among the basic directions are ICO, IDO, IGO, and STO.
Benefits of Initial Coin Offering (ICO)
ability to split tokens
low entry threshold for the investor
Disadvantages of ICO
no protection of investor's rights
Unlike ICO, where investors buy project coins and then wait for the listing on the exchange, in IDO, the initial sale and listing happen almost simultaneously. An initial Gaming Offering (IGO) is a token offering in which some game tokens are placed and does not differ from IDO or ICO.
Another source of investment is business angels, similar to venture capital funds. However, angels invest their funds exclusively in projects, while funds attract and accumulate funds from institutional investors (pension funds, insurance companies, family funds, and high-net-worth individuals). Angels, when investing, get common shares, putting them in the same conditions as the project founders. The funds want preferred shares (with additional rights and liquidation privileges) and a place on the company's board of directors. In the early stages of the project, it is much more realistic to work with angels. They are the first mentors of startups.
An Accelerator is a platform that picks up startups and accelerates their development. More often than not, venture capital funds participate in all stages of a startup's life. On the other hand, accelerators help with the startup but are not involved in further development.
To summarize the different ways of investing, I recommend using IDO, in which founders can sell tokens centrally. In such a model, the initial sale and listing occur almost simultaneously. Avoid ICO because the purchase of tokens does not provide a stake in the project and, consequently, dividends.
Specifically, think through investment rounds.
Investments in a startup are considered risky, so project financing is divided into stages — this minimizes risk and allows everyone to assess the intermediate results.
It usually goes like this:
First Stage. Pre-seed/Seed, during which founders invest their resources into business startups. At this stage, it is essential to test the hypothesis of the business idea, choose a vector of activity and turn the theory into a product.
When the product is ready — it’s an opportunity to look for seed investment, the task of which is to find a product-market fit (the product solves a real problem of the client, for which the client pays real money).
Next stage. Private sale. This stage is focused on a narrow group of investors. At this stage, the project sells its tokens, and the price is the lowest. The private sale round is often limited in time and ends after the token limit is reached.
Next stage. Public sale. It involves the sale of tokens to comers at a value close to the market price; it is the final round, which is limited in time. Tokens left over from previous rounds are sold.
Determine what amounts will be needed for each of the rounds.
For example, the investment at the Seed stage can be from $25 thousand to $1 million. At the Private sale stage, the investment amount will grow to $500 thousand. At the Public sale stage, the investment amount may exceed $1 million. The typical difference in the amount of investment between financing rounds is 10-15%. Determine the hard cap — the minimum investment required in the project. We recommend thinking over a marketing plan for the more effective formation of rounds. Everyone needs to determine what assets they want to attract in each round.
I recommend working out the tokenomics of the project. This plan should provide for the distribution of rewards according to the basic "apple pie" principle. Determine who gets which part — creators, team, investors, or users.
Create a lock-up liquidity plan. It is important to define when investors cannot sell stocks or securities. Lock-up periods are used to preserve liquidity.
For the project's final launch, evaluate the options for listing on the stock exchanges. Being listed on an exchange significantly expands the company's capabilities, but willingness alone is not enough to get listed.
When it comes to listing, a cryptocurrency is added to the list of exchange assets, and then it is an opportunity to open, buy or sell transactions with it; deposit and withdraw funds from it using external wallets. For the listing, it is necessary to conclude a partnership between the exchange and the startup.
Launching Mainnet or Main Network
An equally important step for a startup to become fully operational is the launch of Mainnet or Main Network. This fully functioning blockchain provides functionality for transferring digital assets. Launching a project on Mainnet proves that the project can be considered fully functional. Running a project on Mainnet is more credible than running a project without running Mainnet. It's confirmation that the project has a working product, not a theoretical one, that participants can test.
This list of things everyone should do to make their project as functional as possible is partial. So everyone can envision other options as well. After the startup, future maintenance and improvement of the project will be just as necessary.
Getting the most out of a startup anyone can't do without networking and marketing. Simply put, a startup needs to be known to be in demand.
How can this be achieved?
Crypto-influencers are people who have a large number of social media followers and whose content focuses on promoting cryptocurrencies, NFT tokens, or other blockchain projects. In the blockchain world, Influencers are people whose views can influence the price of cryptocurrencies. A loyal audience gathers around such people. The founder can interact with such people by promoting their blockchain startup.
Never underestimate the importance of social media in crypto projects, as it can make or break an entire campaign, as a startup thrives on product credibility. Use Discord and Telegram ads to promote a product.
Another marketing tool is Ask Me Anything sessions (AMA sessions).
It is possible to perform an airdrop procedure — important point: airdrop does not involve security tokens. In the US, this would require complying with securities laws. For such an airdrop of security tokens, the founder will need permission from the Securities and Exchange Commission (SEC).
Before founders start making a profit from a startup, they have to determine in advance where they will keep these funds. They have to choose between hot and cold wallets. A hot wallet is a wallet connected to the Internet, and a cold wallet is a wallet that is not linked to any network. Hardware wallets are the safest way to store funds. They are physical devices with software installed. Their private keys are generated locally and are not transmitted anywhere.
When choosing a wallet, pay attention to the fees charged for transactions. Founders can select a blockchain with low commissions, but remember the reliability of the service.
All I have mentioned is the basis for successfully implementing all blockchain startup ideas. I highly recommend: holding a brainstorming session with a team and putting out in writing all the steps step-by-step. At least partial planning and application of the tools I mentioned will help to start successfully. Put out all your thoughts and work on them.
Author: Viacheslav Ustimenko, Partner