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Utility Tokens: A new funding model for open source enterprise software startups

Mike S. April 18, 2018

What are utility tokens?

There are three types of tokens: Money Tokens (like Bitcoin, Ethereum, Ripple or Zcash), Asset Tokens (an instrument that promises future remuneration, such as a percentage of company profits), and Utility Tokens (which can be used to pay for goods and services).

In this blog, I propose that utility tokens offer a much needed new funding model for open source enterprise software startups.

Why open source enterprise software?

Open source is not a business model–it’s a way to develop software. For certain requirements (like the implementation of Internet standard services), it’s resulted in the best software available. There are four reasons why open source tends to result in better software:

  • Faster innovation;
  • More eyes on the code (better security);
  • More supply of engineers;
  • Long term stability (predictable cost).

Companies like Facebook, Google, Capital One, and Goldman Sachs are using and producing open source software because they recognize the overwhelming benefits.

When to use open source enterprise software?

The following diagram is adapted from Michael Porter’s value chain concept:

enterprise-competition-diagram

Open source works well for enterprise software which organizations don’t consider a competitive advantage. Internet standards like HTTP, SSL, and SMTP are good examples. One bank wouldn’t say to another bank: “we email better then everyone else!” It’s not part of the customer value proposition, and therefore isn’t an area where competition makes sense.

Information security falls into this category–everyone loses when hackers are successful.

Open source revenue streams

However you fund a company, it still needs to generate revenue. There are a few common strategies to monetize open source software: (1) corporate sponsorship; (2) paid version with extra features; (3) hosting; (4) support; (5) tools; (6) distributions; (7) donations. Which revenue streams are available depends to a large extent on a company’s capital situation.

A few thoughts on each of the potential revenue streams mentioned above:

  • Option 1 (sponsorship) is not generally available for startups.
  • Option 2 (commercial version) is a trap: over time, more features are put behind the paywall and the delta between “Community Edition” and “Enterprise Edition” widens. The community starts to smell a bait and switch.
  • Option 3 (hosting) requires a large amount of capital and well-defined operating procedures.
  • Option 4 (support) is not scalable. Also, many companies only buy support when they need it, so it’s not recurring.
  • Option 5 (tools) are great, but can also distract from the core software product.
  • Option 6 (supported distributions) requires a significant amount of capital and has not been particularly successful for many organizations other than RedHat and Canonical.
  • Option 7 (donations) generally results in a tragedy of the commons–businesses are not setup to “give”, so they usually freeload.

Venture Capital is toxic to open source startups

Developing open source enterprise software requires a large capital investment. However, if your open source startup takes VC money, it will likely kill the open source part of your business model (or the business itself!). There are a few common problems that arise when an open source software company takes VC investment:

  • 5-10 year VC timeframe is too short to build strong communities;
  • VC advice devalues the role of open source in the business model;
  • Startup leadership is replaced with commercial software executives (after missed milestones);
  • Startups abandon open source culture;
  • Startup mission becomes shareholder value, not great software;

The movie Print the Legend offers a great case study of an inexperienced entrepreneur (a teacher), who becomes the pawn of a VC firm that engineers a great outcome for investors (i.e. RIP open source).

Ideal funding model for enterprise open source?

The laws of business still apply–startups need capital! However, instead of killing the open source part of the business, capital should: incentive great software, fuel the community, ensure continued innovation and stability, enable community participation in financial success, and reward the startup culture of laptop-sticker-decorating open source zealots.

What do customers buy with the utility token?

As the name suggests, the utility token can be used to purchase goods and services of the startup. You don’t need currency to buy something that’s free. But presumably, the startup has aligned with one of the above revenue streams and offers something besides free open source software. Those products and services can be purchased using utility tokens.

What’s the benefit of utility tokens over cold hard cash?

Selling utility tokens allows you to:

  • Pre-sell your product or service in order to provide some of the up-front R&D capital needed to write great software. Why would customers want to buy your tokens? Either to support your project, or perhaps because they think it may be less expensive to buy now versus later.
  • Price smarter through supply and demand economics.
  • Provide liquidity for customers who don’t need all their tokens.
  • Reward people who contribute to the open source project, put up bounties, or raise more cash.
  • Create a valuable asset out of the unsold tokens you hold in inventory

The important thing here is that raising money via utility tokens aligns the company with users of the software–not outside investors simply looking for capital returns. The better your software, the more demand (and value) there is for your tokens.

The Takeaway

Utility tokens are not a panacea–startups still need to write great software! But tokens provide an alternative way to raise capital during the expensive R&D phase without undermining the future of the company or the community.

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Mike Schwartz

Mike has been an entrepreneur and identity specialist for more than two decades. He is the technical and business visionary behind Gluu. Mike is an application security expert and has been a featured speaker at RSA Conference, Gartner Catalyst, Cloud Identity Summity (now "Identiverse") and many other security conferences around the world.