Essentials Of Token Warrants
By Laxmikant Khanvilkar
The crash of Terra’s native token – LUNA – and its algorithmic stablecoin – UST – in May last year revealed the level of uncertainty as well as insecurity of tokens. Hence, it is essential to take precautionary measures.
Smart investors such as venture capital investors in blockchain companies prefer formal rights to receive tokens or other digital assets created by those companies. Typically, these rights are provided through an instrument called a “token warrant.” While token warrants are most frequently issued in priced rounds, they have become increasingly prevalent in connection with SAFE or other convertible rounds.
Here are few essential things to know about token warrants.
Companies and investors are required to pay close attention to the types of tokens that warrants entitle their holders to acquire. Token warrants may provide holders with rights to receive one specific type of token only, such as the first governance token issued by a company.
Token warrants often outline specific types of tokens that are not acquirable under the terms of the warrant. Often known as Excluded Tokens, they generally include tokens that are generated pursuant to mining, staking, or reward systems. Typically, the company and its investors will negotiate what is considered an Excluded Token based on the company’s business model.
Token warrants specify the share of tokens holders can acquire under the warrant. The set of tokens from which the holder’s share may be calculated from the number of tokens minted, from the number of tokens minted and issued to the company’s “insiders,” which includes the company’s stockholders and holders of its convertible or exercisable securities, or otherwise.
The holder’s share may be a hard-coded percentage, but it is more typically based on the holder’s fully diluted ownership of the company.
The time at which a holder’s share is calculated can make a difference in how many tokens the holder has a right to acquire. Token warrants typically specify the “lockup” restrictions that will prevent holders from transferring tokens acquired under the warrant for certain periods. Lockup schedules in token warrants may include provisions that prohibit any transfers of tokens for one year after the tokens are acquired, release some tokens from lockup at the one-year mark, and then release the balance over successive monthly increments.
Token warrants are not ideal instruments for compensating a company’s service providers (e.g. employees, contractors, advisors). The Internal Revenue Code subjects deferred compensation – including token warrants – to a variety of complex and generally unfavorable tax, vesting and exercise rules. Therefore, companies should generally limit issuing token warrants to investors.
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