Token Generation Events Guide: Part 1

Token generation events (TGEs) play an important role in web3 ecosystems. During a TGE, the project issues its native token on a blockchain and makes it publicly available for market participants.

It enables the project to raise funds via crowdfunding, expand its ecosystem, compensate investors, reward early contributors, attract new users via various incentives, and achieve other goals.

The role of a web3 CFO involves meticulous accounting and tracking of each transaction and asset tied to token generation events. Through precision-focused and accurate reporting, it becomes possible to extract key insights into the organization's financial health while ensuring compliance with relevant regulations.

Crypto is a complex market, and many find it challenging to achieve the aforementioned goals on their own. This guide was created to help web3 accountants and CFOs navigate TGE’s.

By the end of the guide, readers will learn everything from preparation and accounting to tracking and taxation of TGEs. To ensure comprehensive coverage, the content is broken into two parts, with the first piece focusing on the following key points:

• An overview of TGEs and their key differences from initial coin offerings (ICOs)

• The recommended preparations prior to a token generation event

• How to properly account for a TGE and associated processes

What Are Token Generation Events (TGEs)?

In the evolving industry of web3, Token Generation Events (TGEs) are a crucial element, warranting a clear understanding of their fundamental concept and functionality.

An International Financial Reporting Standards (IFRS) staff paper describes Token Generation Events as a similar type of transaction to initial coin offerings (ICOs) but with different timing. Other sources refer to token generation events as a form of rebranded fundraising campaigns by issuers seeking to avoid regulatory issues.

In practice, TGEs refer to when a web3 project issues its native asset for the first time and makes it available to the public. It is a token launch that takes place in a blockchain network and distributes the newly-issued asset to market participants.

Ultimately, the project's native token will be available to be utilized on its platform after the TGE.

What Is the Difference Between TGEs and ICOs?

Understanding the distinctions between TGEs and ICOs is an essential step in navigating the landscape of blockchain-based financing.

An initial coin offering (ICO) is a form of fundraising that enables blockchain startups to raise capital by selling tokens to investors.

As both ICOs and TGEs involve transactions of Wweb3 projects' native tokens, they may seem to refer to the same things at first. However, there are some key differences between the two.

First, fundraising is a crucial element of every ICO. While a TGE may include the sale of a certain portion of the token's supply to various market participants, it is not a necessary component. Instead, the issuer's primary objective is to introduce the asset into its ecosystem. 

In many cases, TGEs take place when an issuer already has a functional platform. In contrast, ICOs have been commonly utilized to acquire funding for the future development of the ecosystem.

Despite the above differences, accounting standards like the IFRS and the GAAP treat the accounting of TGEs and ICOs similarly.

What Preparations Are Needed Prior to a Token Generation Event?

Engaging in a TGE requires groundwork to ensure a smooth execution and to maximize its potential benefits for the organization. Insufficient preparation for the TGE can lead to  fines and legal repercussions for organizations.

Before a project's TGE, it's essential to consider the legal structure and potential incorporation of the entity that is planning to launch its token. This is a necessary topic to explore to protect stakeholders and ensure their rights during the event.

The above step is necessary due to DAOs, which are excellent for governing Wweb3 ecosystems in a decentralized and trustless way. However, many jurisdictions don't recognize them as legal entities, making some aspects of the token generation process complicated for participants.

Example: The Index Coop opted to incorporate their DAO as a subsidiary in the British Virgin Islands. This decision came in response to the liability concerns raised by conducting their TGE prior to formal incorporation.

Without a judicial entity, the project would have to appoint a community member to execute all the DAOs' off-chain activities (e.g., form partnerships with non-crypto companies). This person would be personally liable for every action taken on behalf of the organization.

The potential personal liability of INDEX native token holders for claims against the DAO before its formal incorporation is a consideration. Hypothetically, if the Index Coop were to collapse and the value of INDEX fell significantly due to a tokenomics failure, it could lead to a complex situation regarding who the token holders could direct their legal actions against.

Another challenge with unwrapped DAOs is that the lack of incorporation provides more room for tax authorities to determine their tax treatment. This could not only lead to more issues with liability but could also come with an increased tax burden for token holders.

As illustrated with the Index Coop's example, the first preparation for every issuer before a token generation event should be to consider incorporation or DAO wrapping prior to the TGE.

How Can Issuers Properly Account for Token Generation Events?

Having delineated the fundamentals of TGEs and their differentiation from ICOs, it is now applicable to explore how to properly account for a TGE and associated processes.

Throughout this guide, reference will be made to IFRS guidelines, given the absence of specific GAAP regulations pertaining to TGEs or ICOs.

Transaction Recording and Revenue Recognition

To record transactions and recognize revenue related to the TGE, determining the accounting for the issued token is required. This will be on the credit side of the journal entry and will be based on the nature of the asset and the applicable accounting standard's guidance.

While determining the above can be challenging for web3 accountants, the debit side of the journal entry includes the consideration received by the issuer. These are the contributions of TGE participants (if the event involves the sale of tokens) as part of an exchange transaction with an arrangement that does not create joint control.

It is crucial to understand the issuer's responsibilities as outlined by various IFRS standards. As per these regulations, a TGE token could fit into several categories, as detailed below:

Financial Liability

Under IAS 32, the issuer should determine whether the definition of a financial liability applies to the TGE token. As per the IFRS standard, a financial liability is any liability that is a:

• Contractual obligation:

  • To deliver cash or another financial asset to another entity; or

  • To exchange financial assets or financial liabilities with another entity under conditions that are potentially unfavorable to the entity; or

• A contract that will or may be settled in the entity’s own equity instruments, including assets that violate the principle stated in paragraph 11 of IAS 32.

Based on the above, we should determine whether the TGE token is a financial liability. If it is, the issuer should follow the guidance in IFRS 9.

In many cases, the definition of a financial liability does not apply to TGE tokens. Exceptions occur when the token generation event's condition refunds a certain amount of contributions up to the point of achieving a particular milestone, and the contract creates a financial liability.

In the case of a financial liability, our journal entry for a TGE with $10 million of proceeds from contributors would look like this:

Non-Financial Liability

In addition to financial liabilities, the issuer should also assess whether the definition of a non-financial liability applies to the TGE token under IAS 37. Except for those resulting from executory contracts or covered by another standard, IAS 37 applies to all provisions and contingent liabilities.

A provision is defined as a liability of uncertain timing or amount. At the same time, a contingent liability is defined as:

• A possible obligation that arises from past events and whose existence will be confirmed only by the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the entity; or

• A present obligation that arises from past events but is not recognized because:

  • It is not probable that an outflow of resources embodying economic benefits will be required to settle the obligation; or

  • The amount of the obligation cannot be measured with sufficient reliability.

The definition of a non-financial liability would apply to a TGE token when the issuer has an obligation to build and launch a cryptocurrency exchange that enables holders to trade with others on the platform. In this case, we should then add the below journal entry:

Equity

Under IAS 32, an equity instrument is any contract that evidences a residual interest in an entity's assets after deducting all of its liabilities. A case when this definition could apply to TGE tokens is when holders are entitled to receive distributions from the issuer's distributable reserves. These payments can be in the form of residual profits, dividends, or entitlement to liquidation proceeds.

In most cases, TGE tokens are not equity instruments, which have to meet the following conditions under paragraph 16 of IAS 32:

• Includes no contractual obligation;

  • To deliver cash or another financial asset to another entity, or

  • To exchange financial assets or financial liabilities with another entity under conditions that are potentially unfavorable to the issuer

If a TGE token is recognized as an equity instrument, then the following journal entry should be added:

Revenue Transaction

Proceeds from the TGE token may also be considered revenue under IFRS 15.

IFRS 15 applies if:

1. The TGE token's recipient is a customer who is defined as "a party that has contracted with an entity to obtain goods or services that are an output of the entity’s ordinary activities in exchange for consideration",

2. A contract exists for accounting purposes, and

3. The performance obligations related to the TGE token are not within the scope of other standards.

To fulfill the second condition in the above list, the issuer must determine whether enforceable rights or obligations are created in its purchase agreement, whitepaper, or other related documentation. Contracts with customers under IFRS 15 must include legally enforceable rights.

Holders may fulfill the definition of customers under IFRS 15 if the issuer, for example, utilizes the consideration received from TGE contributors to develop and host a platform to which the token could offer access. Similar cases include the issuer offering its products or services for free or at a discounted price to token owners.

If IFRS 15 applies to the issued asset, the token generation event's proceeds could be considered the issuer's revenue. The latter will likely be initially deferred. In such a case, the following journal entry should be added for a TGE where the issuer has raised $10 million of funds from contributors:

After fulfilling its performance obligation (e.g., by developing and launching the platform token holders can access), the issuing organization should add a new journal entry:

Other guidance

If none of the above definitions apply to the issued asset, the issuing entity should consider other relevant guidance to determine the accounting for token generation events.

An example case includes when the issuer has no further obligation to holders following the TGE token's issuance, and the ordinary activity of the issuing entity is not the issue of new cryptocurrencies. In other words, token generation event contributors do not meet the definition of a customer under IFRS 15.

When no specific IFRS standard can be applied to a TGE transaction, the issuer should refer to paragraphs 10–12 of IAS 8.

As per paragraph 11 of IAS 8, issuers should consider the applicability and refer to the following sources in descending order:

1. The requirements in IFRSs dealing with similar and related issues; and

2. The definitions, recognition criteria, and measurement concepts for assets, liabilities, income, and expenses in the Conceptual Framework for Financial Reporting.

Token Value Calculation and Distribution

To account for token generation events, issuers must determine the value of the issued assets. IFRS 13 offers proper guidance for the measurement of fair value. The latter is defined as "the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date."

Based on IFRS 13's guidance, fair values are divided into a hierarchy consisting of the following three levels:

1. Level 1: Prices quoted in active markets for identical assets or liabilities the entity can access at the time of measurement

2. Level 2: Observable inputs other than the ones included in the first level

3. Level 3: Unobservable inputs

Following IFRS 13, issuers must first prioritize level 1. If market data is not available for measurement, observable inputs should be considered before assessing the asset's value through unobservable inputs. That said, the overall goal of the process is to estimate the exit price of the entity's position at the valuation date.

Despite initial measurement, an asset's hierarchy might change over time. For instance, a token issued by a web3 project may initially be valued via level 3 inputs. But later on, it may rank at the top of the hierarchy after getting listed on multiple exchanges and trading in an active market.

For level 1 analysis, issuers should take into account the following:

• The reliability of the data: Market data should be sourced from reliable sources. In general, a regulated exchange is considered more reliable than an unregulated provider.

• Available trading pairs: In most cases, an active market for a cryptocurrency exists only when a reliable source provides data on crypto-to-fiat exchanges.

A token minted during a TGE isn't likely to trade against fiat currencies immediately after issuance. In that case, alternative valuation methods should be considered under IFRS 13, such as:

• The market approach: Values the TGE token by using prices and other relevant information generated by market transactions involving identical or comparable assets.

• The cost approach: Reflects the amount it would cost to replace the asset's service capacity.

• The income approach: Coverts future amounts (e.g., income and expenses, cash flows) to a single current (discounted) amount.

Besides calculating the token's value, it's also important to take distributions into account. When the TGE involves a sale of assets to contributors, issuers have two options in this field:

1. The issuer sells crypto assets to contributors and receives proceeds in fiat currency

2. The issuer sells crypto assets to contributors and receives proceeds in another cryptocurrency

If the assets are not produced for the own consumption of the issuer but to sell to TGE contributors, IFRS 15 can be applied to account directly for the sale price.

Regarding distribution, issuers should account for a variety of related expenses, such as salary costs, blockchain transaction fees, and licensing fees.

Expense Allocation

Web3 projects should also account for and allocate their business expenses to get a clear picture of the financials behind token generation events. The main goal of the process is to identify, accumulate, and assign costs related to the TGE to cost objects to manage expenses efficiently and gather insights into profitability.

Before allocating costs to their respective cost objects, TGE issuers must define different types of expenses, including:

1. Direct costs: Costs that can be directly attributed to a specific product or service of an organization.

2. Indirect costs: Unlike direct costs, indirect expenses are not tied to the creation, development, or release of a specific product or service. Instead, they are incurred in the day-to-day operations of the business.

3. Overhead costs: Everyday operating costs that are not tied to production. Organizations incur overhead expenses regardless of producing goods or providing services.

 To visualize how expense allocation would look for a web3 project that recently completed its token generation event, consider this scenario:

A web3 organization launched a TGE for its first blockchain platform and has incurred the following costs throughout the year:

• $100,000 for renting office space

• $1 million in employee salaries

• $50,000 to research and develop a new token standard that is used to launch and distribute the project's native digital asset

• $1,000 in commissions for selling $10 million of Bitcoin

• $5,000 was spent on gas fees related to the token generation event

• $200,000 for listing the native token on a crypto exchange a month after the TGE

• $5 million of tokens were airdropped to users as part of the TGE

Based on the above, the project's expenses would look like the following after allocating them to the appropriate cost objects:

In total, $5,055,000 of costs was allocated to the TGE. The rest are either overhead expenses or costs related to other cost objects.

Seek Expert Help When Necessary

Token generation events offer issuers a way to launch their native assets, raise funds from contributors, and achieve other business goals. At the same time, they also place a burden on web3 CFOs who are preparing and accounting for TGEs.

Consulting with a web3 accounting expert like R3gen finance is an excellent way to relieve some stress from your organization's accounting team before token generation events. This way, compliance and accuracy of your financial records can be ensured. In the next part of the article, we will also introduce a solution TGE issuers can leverage to simplify their accounting and tax matters.

Want to see a demo of how Integral can help? Book here.