Imagine for a moment that OpenAI is going public.

Further, imagine that OpenAI has a special deal: every early user of ChatGPT, its flagship product, will receive free shares in OpenAI when it IPOs.

Even those who have never owned a stock in their life would be signing up for ChatGPT, just to get the free OpenAI stock. Easy decision.

Now, imagine this idea catches on, and every AI company might be offering “free shares” in the future. There are thousands of AI platforms: all you have to do is create an account on each platform, use it once, and you’re eligible.

The AI startups would all get an initial influx of users, but we’d have to question whether they’re “real” users. Will they ever come back? And will they sell their shares immediately after the IPO, driving down the price – possibly forever?

And the users also would have to question whether the effort is really worth it. After all, using all these AI platforms for the potential shares is a good way to learn about them, but it is a lot of work.

What I’ve described is what has happened in the crypto industry with airdrops.

Shares vs. Airdrops

Airdrops are crypto’s workaround for the SEC.

Because selling outright shares in a company is illegal without registering with the SEC, the industry has created “airdrops,” where early users of a crypto “company” are rewarded with free tokens down the line.

As excitement builds around a crypto company that “might do an airdrop,” it attracts more users, driving more momentum. If and when the token launch finally happens, all those early users get rewarded with tokens.

Then, of course, they can immediately sell those tokens on decentralized exchanges, creating an overnight market for the new token. (No NASDAQ needed!)

It’s like owning shares in the company, with some important differences.

The last part is important. In both models, the founders get rich.

I know you were worried about this. If an IPO is a way for the founders to cash out their shares and buy a house in the Hamptons, how will the founders of these crypto companies get their matching houses? Also, how does the crypto company continue to run?

Don’t worry, the majority of tokens will be “reserved” (or airdropped) to the founders, and some kind of company treasury that can be sold to pay for future company expenses.

Because U.S. Congress has not better defined how crypto companies should operate, we have this weird workaround that functions like an IPO, but without any oversight or regulation – the opposite of what the SEC is trying to achieve.

And we have to question this model. Are airdrops good for the industry?

Airdrops Create Marketing Buzz

Airdrops are good at attracting new users, especially for crypto companies that already have a little bit of traction.

Airdrops work on rumor: “so and so might be having an airdrop” is code for “sign up for an account now to get those free shares down the line.”

But because the airdrop is over when you launch your token, all those users might dry up and cash out, never to be seen again.

This makes airdrop users much lower quality than real users. They’re in it for the money.

From a crypto company’s perspective, you’re simply paying for early users. There’s nothing wrong with this: in marketing, we call this expense a Cost Per Customer (CPC). But with airdrops, you’re paying by diluting your own company shares.

And airdrops do seem to be effective at getting a groundswell of early users, which can drive up your initial token price, which helps you get your house in the Hamptons.

Less cynically, airdrops are a powerful incentive to create a product that people actually want, so those early users will come back again and again. If they really believe in your company, maybe they’ll even hold onto those early tokens.

IPOs Create Owners

But let’s contrast airdrops with the traditional IPO model, where shareholders are rewarded for investing in your company. Shareholders are literally owners, so your incentives are aligned.

It should be obvious that shareholders are higher quality users than “airdrop hunters.”

Where airdrop users have bought their shares with time, shareholders have bought their shares with money.

That’s why the IPO model is probably better for the company, the markets, and society as a whole. But it is extremely expensive and inefficient to do an IPO.

This is why so many crypto companies don’t want to do it, especially when you can get a similar result for a fraction of the cost.

After all, to most investors, owning tokens in a crypto project looks the same as owning shares in a company. The difference is, now they’re being rewarded for early usage, rather than buying the tokens after launch.

Both models have their pros and cons. But what would be great is a way to legally do a blockchain IPO, at a fraction of the cost and bureaucracy of a traditional IPO. That’s where Congress needs to get its act together.

Are Airdrops Legal?

Airdrops were invented to get around securities laws. Because the tokens are given away for free (rather than selling them in an initial token launch), they are supposedly exempt from SEC oversight.

As Bloomberg Law points out, this may not be true.

If the SEC eventually decides to go after airdrop cryptos as well, you can kiss those token prices goodbye. And the airdrop market will likely dry up overnight.

Fortunately, the SEC is here to protect investors, so it’s the companies they will go after, not the tokenholders.

For investors, then, “airdrop farming” is generally safe, though you still have the usual potential for scams and hacks, especially when you’re interacting with lesser-known crypto platforms.

If you have the time and interest, then airdrop farming on reputable platforms can even be viewed as an educational investment. (After all, you will learn something, even if there’s never an airdrop.)

But your time will probably be better spent farming as a hobby, rather than viewing it as a full-time occupation. Because farming – even airdrop farming – is a lot of work. That’s why they’re paying you to do it.

When Congress updates our securities laws to bring clarity to crypto, we’ll be able to legally buy shares in crypto companies, just like an IPO, which is what most of us really want. And then we can finally drop the airdrops.

Health, wealth, and happiness,

John Hargrave

Publisher, Bitcoin Market Journal

Thanks to Bryon Gilliam’s excellent newsletter for inspiring this column.

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• Source: https://www.bitcoinmarketjournal.com/airdrops-vs-ipos/