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

Can the tokens “bound hand and foot” by the SEC break free from the regulatory fog and redefine the autonomous ownership of digital assets?

Written by: Jesse Walden, Variant Partner; Jake Chervinsky, Variant CLO

Compiled by: Saoirse, Foresight News

Introduction

Over the past decade, entrepreneurs in the crypto industry have generally adopted a value distribution model: attributing 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 unleashing this potential is that tokens must represent the real needs of users. However, the increasing 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. Today, this situation urgently needs to change.

The core innovation of the Token is to achieve “self-ownership” of digital assets. With Tokens, holders can independently own and control funds, data, identities, and 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 Token holders in terms of income and assets.

Off-chain value is different. Since token holders cannot directly own or control off-chain income or assets, this type of value should rightfully belong to equity. Although entrepreneurs may wish to share off-chain value with token holders, this action often carries compliance risks: companies that control off-chain value typically have fiduciary obligations 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 pressures. The previous broad interpretation of securities laws by the U.S. Securities and Exchange Commission not only led to an imbalance in the incentive mechanisms between companies and token holders but also forced entrepreneurs to rely solely on inefficient decentralized governance systems to manage protocol development. Today, the industry has ushered in a new opportunity, allowing entrepreneurs to re-explore the essence of tokens.

The SEC’s old regulations constrain entrepreneurs

In the ICO era, crypto 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 after the Tokens went live, making Token sales the only fundraising method, and Tokens the only asset carrying value.

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.

In response, companies have abandoned ICOs and turned to private equity financing. They develop agreements supported by venture capital funds and only distribute tokens to the market after the agreements are completed. To comply with SEC guidance, companies must avoid any actions that could potentially inflate the value of tokens after they go live. The SEC’s regulations are extremely strict, requiring companies to almost completely sever ties with the agreements they develop, and they are even discouraged from holding tokens on their balance sheets to avoid being perceived as having financial motives that could inflate token values.

Entrepreneurs subsequently transfer the governance rights of the protocol to token holders, focusing instead on building products on top of the protocol. The core idea is that a token-based governance mechanism can serve as a shortcut to achieving “full decentralization,” while entrepreneurs continue to contribute to the protocol in the capacity of ecosystem participants. Furthermore, entrepreneurs can create equity value through a business strategy of “complementary goods commercialization,” which involves providing open-source software for free and then monetizing through products built on top or below it.

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

First, the incentive mechanism between enterprises and token holders has become misaligned. Enterprises 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 on 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 suited for this role. Some DAOs operate based on foundations but often fall into their own incentive misalignment, legal and economic constraints, operational inefficiencies, and centralized access barriers. Other DAOs adopt collective decision-making, but most token holders lack interest in governance, and the token-based voting mechanism results in slow decision-making, chaotic standards, and poor outcomes.

Third, the compliance design has failed to genuinely 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 could subject token holders to unlimited joint liability.

Ultimately, the actual cost of this model far exceeds the expected benefits, undermining the commercial viability of the protocol and damaging the market attractiveness of the related 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 achieving autonomous ownership of digital assets. It grants holders ownership and control over on-chain infrastructure, which possesses globally real-time auditable transparency. To maximize this feature, entrepreneurs should design products to channel value on-chain, allowing token holders to directly own and manage.

Typical cases of on-chain value capture include: Ethereum benefits token holders by burning transaction fees through the EIP-1559 protocol, or by diverting DeFi protocol revenues to on-chain treasuries via fee conversion mechanisms; token holders can also profit from intellectual property used by authorized third parties, or earn returns by routing all fees to on-chain DeFi front-end 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 companies as intermediaries for value transfer, a relationship that may be subject to securities law. Moreover, companies controlling off-chain value have fiduciary duties and must prioritize returning profits to shareholders rather than to token holders.

This does not deny the rationality of the equity model. Even if the core products are open-source software such as public chains or smart contract protocols, crypto companies can still achieve success by leveraging traditional business strategies. As long as the distinction between “token corresponding on-chain value and equity corresponding off-chain value” is clearly defined, actual value can be created for both.

Minimize governance, maximize ownership

In the context of the new era, entrepreneurs must abandon the mindset of using 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. In general, entrepreneurs should automate all processes as much as possible, reserving governance authority only for matters that cannot be automated. Some protocols may benefit from the intervention of “humans at the edges” (referring to DAOs as “automation-centric, with humans in peripheral positions”), 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 level 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 protocol development companies to adjust certain parameters, thus eliminating the need for consensus voting by all members for each 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 frameworks and on-chain tools. It is recommended that entrepreneurs consider adopting new entity structures such as the Wyoming DUNA (Decentralized Autonomous Nonprofit Association), which grants token holders limited liability and legal personality, enabling them to have contracting, tax-paying, and judicial rights; in addition, governance tools such as BORG (Blockchain Organization Registration Governance) should also be considered to ensure that DAOs operate 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 they are highly sensitive to the value of ownership attributes such as income distribution rights and control over on-chain assets.

Avoidance of 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 associated with a legal entity, including economic benefits, voting rights, the right to information, or legal enforcement rights, 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 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 conferred by the tokens will persist. Unlike securities holders, token holders typically do not enjoy protections under fiduciary duties and do not possess statutory rights. The assets they hold are defined by code and are economically independent of their creators.

In some cases, on-chain value may partially depend on the off-chain operations of enterprises, but this fact itself does not necessarily touch upon the scope of securities law. Although the definition of securities has broad applicability, the law does not intend to regulate all relationships where one party relies on another to create value.

Many transactions in the real world have a return dependency but are not regulated by securities laws: consumers purchasing 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 a large number of commercial contract scenarios: for example, a landlord relies on a property manager to maintain assets and attract tenants to generate income, but this cooperative relationship does not make the landlord a “securities investor.” The landlord always retains complete control over the assets and can veto management decisions, change the operating entity, or take over the business independently at any time. The landlord’s right to dispose of the property is independent of the manager’s existence and is completely detached from the management’s performance.

Tokens designed to capture on-chain value are closer to the aforementioned physical assets rather than traditional securities. Holders are clearly aware of the assets and rights they possess and control when acquiring such tokens. They may expect the continuous operation of the enterprise to drive asset appreciation, but there is no legal rights association with the enterprise, and the ownership and control of digital assets are completely independent of the business entity.

The ownership and control of digital assets should not constitute a securities regulatory relationship. The core applicable logic 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 there is no such dependency relationship, token trading centered on property rights should not be classified as a securities issuance.

Of course, even if securities laws should not apply to such tokens, it does not rule out the possibility that the SEC or private plaintiffs may claim their applicability, and the court’s interpretation of the legal provisions will determine the final judgment outcome. However, the latest policy trends in the United States have released 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 fall under the scope of securities regulation.

Single Asset Model: Fully Tokenized, No Equity Structure?

Although some entrepreneurs tend to create value through a dual-track system of tokens and equity, others prefer the “single asset” model, anchoring all value on-chain and belonging to the token.

The “single asset” model has two core advantages: first, it aligns the incentive mechanisms of enterprises and Token holders, and second, it allows entrepreneurs to focus on enhancing the competitiveness of the protocol. With a minimalist design logic, leading projects like Morpho have already taken the lead in practicing 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 Tokens. To avoid securities-like relationships, Tokens must grant direct ownership and control of digital assets. Although legislation may gradually institutionalize this model, the current challenge lies in the uncertainty of regulatory policies.

Under a single asset architecture, enterprises should be established as non-profit entities without equity, serving only the self-developed protocol. When the protocol goes live, control must be transferred to the Token holders, ideally through a blockchain governance-specific legal entity such as the Wyoming DUNA (Decentralized Autonomous Non-Profit Association) to achieve organization.

After going live, enterprises can continue to participate in the protocol construction, but their relationship with Token holders must be strictly distinguished under the “entrepreneur - investor” paradigm. Possible paths include: Token holders authorize enterprises to act as agents to exercise specific powers, or agree on the scope of cooperation through service contracts. Both roles are part of the conventional setup of decentralized governance ecology and should not touch upon the applicability of securities laws.

Entrepreneurs need to 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 over digital assets, tokens like FTT represent a claim on the company’s off-chain revenue, with their value completely dependent on the issuing entity: if the company operates poorly, holders have no recourse; if the entity goes bankrupt, the token becomes worthless.

The company’s endorsement of tokens precisely creates the rights imbalance that securities law aims to address: holders cannot audit off-chain income, veto corporate decisions, or change service entities. The core contradiction lies in the asymmetry of power; such holders are entirely subject to the enterprise, forming a typical quasi-securities relationship, which should be included in the regulatory scope. Entrepreneurs adopting a single asset model must avoid such structural designs.

Even with the “single asset” model, enterprises may still need off-chain revenue to maintain operations, but the related funds can only be used for cost expenditures and must not 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 remain in the hands of Token holders.

Entrepreneurs may raise several defenses, such as “no public sale of coins means no capital investment” and “without an asset pool, there is no joint enterprise,” but these claims, including “non-securities relationship,” cannot ensure avoidance of the current legal applicability risks.

Open-ended 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: Can we avoid securities law regulation while completely abandoning governance mechanisms? Theoretically, token holders can hold digital assets without exercising any control. However, if holders are completely passive, this relationship may evolve into the realm of securities law applicability, especially when the enterprise retains some control. Future legislation or regulatory rules may recognize a governance-free “single asset” model, but entrepreneurs still need to comply with the current legal framework.

Another question 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 available for sale? 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 these tokens in a decentralized environment, which could otherwise leverage public chain infrastructure to unlock value. Ideally, Congress or the SEC should promote the modernization of securities laws so that traditional securities such as stocks, bonds, notes, and investment contracts can operate on-chain and achieve seamless integration 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 structure design of tokens and equity; it is only a comprehensive trade-off 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 initial 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, ambiguous legal boundaries and a harsh regulatory environment have always constrained entrepreneurs from unleashing the potential of blockchain Tokens. The current regulatory environment has opened up a new exploration space for the industry.

We have built a navigation map above to help entrepreneurs explore directions in new fields and proposed several development paths that we believe have great potential. However, it should be 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 application boundaries of Tokens.

Acknowledgment

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 on this article.