Screenhot taken from kin.kik.com

Kin’s ICO: Decentralization-as-a-Promise

Examining the (fuzzy) details of Kik’s cryptocurrency Kin

In my former piece on Kik and the launch of its cryptocurreny Kin, I looked at the situation from a long-term, strategic perspective. My goal there was to shine a light on the thinking that led to the decision. However, I didn’t cover several other aspects worth mentioning (and it still turned out to be a 3,500 word piece!).

I ended on the notion that I would prefer more transparency. That’s where I’ll pick up on today. But before, let me eat my own dog food first and give a full disclosure: I haven’t and don’t plan to invest in Kin nor do I own any ether or other cryptocurrency. I’m obviously not a Kik investor and have no financial relationship with any of the involved parties. Moreover, I’m not giving investment advice; I analyse and write about companies, their strategies and interesting developments at the intersection of tech, media and digital business.

With that said, I noticed a couple of noteworthy things during my research. Some of them would instantly raise red flags with me in most ICO cases. Kik, though, has an important advantage: its own as well as its investors’ reputation— among which you’ll find well-regarded firms like Foundation Capital, Union Square Ventures or Tencent. This reputation grants them the benefit of the doubt. Thus, read the following as via negativa kind of advice: What not to do when ICOing (unless your reputation guards you).

Blockchain System Layers

When I examine blockchain projects, I think of them as a layered system. The layers are:

The technology layer: the technological implementation and architecture of the blockchain/distributed ledger. Some of the key aspects to evaluate are the hard-coded incentive mechanisms (e.g. mining), the validation procedure (e.g. proof-of-work, proof-of-stake), scalability (influenced, for instance, by energy consumption), security (on the code and smart contract level), and, if applicable, the chosen platform (e.g. Ethereum, BigchainDB; which handles some of the other technical aspects)

the technological implementation and architecture of the blockchain/distributed ledger. Some of the key aspects to evaluate are the hard-coded incentive mechanisms (e.g. mining), the validation procedure (e.g. proof-of-work, proof-of-stake), scalability (influenced, for instance, by energy consumption), security (on the code and smart contract level), and, if applicable, the chosen platform (e.g. Ethereum, BigchainDB; which handles some of the other technical aspects) The token system: The particularities of the crypto asset aka token that the blockchain handles. Does the token represent a real value? Is it useful and necessary for the service? How is the value flow within the system designed? How are tokens distributed and/or created? Are they well integrated in the user interface? (I find William Mougayar’s framework quite useful)

The particularities of the crypto asset aka token that the blockchain handles. Does the token represent a real value? Is it useful and necessary for the service? How is the value flow within the system designed? How are tokens distributed and/or created? Are they well integrated in the user interface? (I find William Mougayar’s framework quite useful) The governing body: Whether it’s formalized (e.g. Ethereum) or informal (e.g. Bitcoin), even a decentralized blockchain system has human stakeholders (though some techno-positivist proponents would like to get rid of them) who need to make decisions at some point in time. The most prominent model today is the formation of a foundation, but there are other models as well, e.g. co-ops. This point goes beyond the formal organization (the legal entity), though. Just like any other organization, decentralized networks, too, need intelligent governance and processes to operate successfully. Since they are rather new systems there aren’t any proven standards. What I’m looking for, thus, is a deliberately designed and adaptive system that clearly states how token-holders can participate in the governance and decision-making process.

Obviously, the layers are heavily intertwined. Design choices in one dimension usually need to be reflected in the others as well.

When it comes to Kin, the depth and detail of the provided information varies across the three layers.

Unless otherwise mentioned, all quotes in the following parts are taken from Kin’s official whitepaper.

Token System & Rewards Engine

The token system is the most clearly outlined layer of the three.

Kin is an ERC20 token (which is Ethereum’s standard). The basic value proposition is rather straight-forward since Kin is intended as a currency (initially focused on digital services and content). The allocation of the overall amount of 10 trillion tokens (I covered the details here) is clearly defined in the whitepaper. During the ICO, 1 trillion tokens go to investors, 3 trillion are reserved for Kik to cover operational costs and the remaining 6 trillion are going to be managed by the Kin Foundation. The latter is going to distribute it among ecosystem participants over time.

To that end, Kik designed a mechanism which they call Kin Rewards Engine. According to the whitepaper, it “is scheduled to release 60 percent of the supply over time at a rate of 20 percent of the remainder per annum and in perpetuity”. That quote is not completely accurate though. At another point, the whitepaper mentions that “up to 5 percent” of the foundation’s tokens will be used for marketing and operations, with no further details on the expected split:

The Kin Foundation’s allocation will be used for three purposes: to administer the Kin token supply and Kin Rewards Engine, for marketing, and for operational costs. Twenty percent of the remaining reserve will be unlocked and distributed every year to the Kin Foundation in perpetuity.

That’s probably just a minor imprecision. Still, given the scale of Kik’s ICO, I certainly think that the more details provided, the better. (I should note that the marketing budget also includes the tokens “used for generating a starting balance for users” so at least a certain amount of that allocation is going to be distributed.)

Where it becomes more fuzzy, though, is the exact mechanism of the Kin Rewards Engine. A few key passages from across the whitepaper (emphasis mine):

The Kin Rewards Engine will use economic incentives to bring other digital services and applications into the decentralized Kin Ecosystem. Inspired by previous systems like Bitcoin’s block rewards and Steemit’s posting rewards, the Rewards Engine will create natural incentives for digital service providers to adopt Kin and become partners in the ecosystem. The ecosystem will not impose any unnecessary restrictions or tolls on monetization strategies, beyond ensuring common ethics and legality of content and transactions. … Periodically, the Rewards Engine will unlock and distribute a specific amount of Kin to be shared among digital service providers in the Kin Ecosystem. The reward that each partner receives will be proportional to a measure of the utilization of kin within that digital service. Such value will be assessed by a well-defined process that ensures the rewards are distributed fairly using an objective, performance-based methodology. Rewards will be transparent, auditable, and secure.

And later:

Sixty percent of the total supply of Kin will be secured in a smart contract, allocated to the Kin Rewards Engine, and introduced into circulation as periodic rewards.

The general idea behind the rewards engine is simple and makes sense. If a given partner integrates Kin into its service, s/he receives Kin based on performance. At least in theory, this should make it attractive for developers and third-party services to integrate Kin. As I wrote in my first piece on Kik and Kin, developing a healthy ecosystem around Kin is going to be critical for the currency’s success.

However, while the whitepaper is quite detailed when it comes to explaining the distribution schedule, it doesn’t precisely describe the criteria on which the decision is going to be made (i.e. publish the underlying smart contract). What is the measure of utilization? Is it going to be measured in terms of transaction volume? In number of transactions? Is it going to be a compound metric? And: What is the definition of an ecosystem partner? Who’s eligible and what are technical barriers? Getting all this right is going to be critical for Kin’s adoption. That Kik can’t (or doesn’t want to) provide a clearer description of the mechanic at this point leaves too much room for interpretation, at least for my taste.

Let me illustrate why:

The Kik app will in all likelihood be the biggest platform in the Kin ecosystem for the foreseeable future. Based on the information provided, we have to assume that Kik is going to be a major beneficiary of the rewards engine. There is no indication that this won’t be the case. Even worse, there’s no mention of Kik in the context of the rewards engine at all. Why? What is there to hide?

As the above paragraph shows, the lack of detail provides ICO stakeholders with an easy target. It’s a communicative failure at the very least. Because even if Kik is eligible for rewards, that’s not a bad thing per se. If their app indeed becomes the main driver of Kin’s overall value, it’s fair if they profit from it. Every investor and Kin holder will do so as well. But not being precise about the system’s minutiae can all too easily be interpreted as not being upfront.

The Kin Foundation & Governance

According to the Kin Whitepaper¹, the governing body of the Kin ecosystem is going to be a foundation. Which won’t come as a surprise as that is pretty much the standard M.O. in the ICO space these days.

However, the devil is in the detail. It is worth pointing out, that the foundation will be setup after the ICO happened — at a not clearly defined point in time. The whitepaper states (emphasis added:

Over time, Kik will work to structure and form the Kin Foundation, a nonprofit organization to oversee the fair and productive growth of the Kin Ecosystem. The Kin Foundation will administer the Kin supply and the Kin Rewards Engine. It will also provide support and tools for digital services to operate more easily within the ecosystem. Ultimately, the Kin Foundation will facilitate the entire ecosystem’s transition to a fully decentralized and autonomous network.

As I pointed out in Kik’s Pivot to Cryptocurrency, the money raised during the ICO is technically going to fund Kik which will then setup the foundation. Alas, the provided detail is, again, limited. There is no information on the particularities of the foundation. Where will the foundation be set up? What is the governance structure going to look like? How will “ecosystem partners” participate in governance and decision-making? All of that remains unclear. The only indication is to be found in the website’s terms which state: “ The Kin Ecosystem Foundation, a to-be formed not for profit corporation, will act as the governance body for the Kin Ecosystem.”

The following paragraph from the whitepaper is exemplary of a general pattern: The lingo sure sounds good and is clearly optimized to appeal to the blockchain community. However, the actual amount of information is superficial.

The Kin Foundation’s mandate is to grow an open ecosystem of digital services that consumers can easily explore and find value in, while giving developers an open and sustainable platform to develop, deliver, and enhance those services and attract users. As time goes by it is likely that the foundation will be replaced by other, more innovative governance methods such as a decentralized autonomous organization (DAO). However, creating a formal legal body is an important first step in this process.

There are several logical explanations for this wishy-washy. It’s possible that the whitepaper — basically a marketing instrument, mind you — was written with the intention to keep things as simple as possible in order to be accessible to the broadest possible audience (the exclusion of more complex technical aspects and simultaneous announcement of a separate technical whitepaper suggest that). It’s also possible that the people at Kik themselves might still be unclear about the particularities. Given the volatile regulatory environment and the newness of decentralized system governance, it wouldn’t surprise me.

But, as I said earlier, imprecision creates room for speculation. A combination of lacking details with well-sounding promises — instead of facts, e.g. a foundation with a clearly defined structure set up in advance—always makes me prick up my ears.

Technology

Kin isn’t goint to run on fully decentralized architecture from the start. Instead it “will be built on the Ethereum blockchain, initially using a hybrid on-chain and off-chain technology solution” but, of course, with “the goal of eventually transitioning to a fully decentralized and autonomous system”. That’s a reasonable decision.

Based on the experience with its former virtual coins Kik Points, Kik expects a high usage and, thus, transaction volume. Scalability is still one of the major challenges for blockchains, including the Ethereum platform on which Kin will be built. According to the whitepaper, there were 109 million transactions of Kik Points in 2016 —that translates to just under 300,000 daily transactions. In comparison, the Ethereum Blockchain crossed the 200k daily transactions threshold for the first time in May 2017 and has been handling between 200k and 400k daily transactions since. If Kin takes off as expected, this would instantly (almost) double the workload on Ethereum’s blockchain.

The other reasons for not going fully-blockchain right from the beginning make sense as well. For one, Kik is concerned that the average time it takes to confirm a transaction (known as “block time”, currently more than 20 seconds) would negatively impact the experience of regular users who are used to instant response times. Eventually, the whitepaper states that “the Ethereum blockchain requires fees to be paid for every transaction. Fees are paid in Ether cryptocurrency, creating an adoption barrier for the average user”. Another fair point.

All in all, creating a hybrid model that is partially off-chain is an understandable design choice. Now, let’s look at the details. Here’s what the whitepaper says about the model Kin is going to use:

At the core, the transactions in Kin will be settled on the Ethereum blockchain. However, the Kin Foundation will develop and host a centralized off-chain ledger with an API available to all digital service partners. This will (1) improve user experience due to latency, (2) avoid network fees when transacting between users, and (3) avoid stress on the public network due to large transaction volumes. This hybrid solution creates a semi-centralized system in which end users will enjoy a standard user experience insulated from some of the complexity of blockchain systems. However, this approach also has the drawbacks typical of a centralized system, such as having to rely on trust between participants. In the long term, the Kin Foundation will move to migrate the transactional infrastructure to a fully decentralized system while retaining a low friction user experience.

As much as I understand the design choice, I’m again bothered by the lack of detail about the actual implementation. While the whitepaper promises a separate technical whitepaper, it will only be released after the ICO. Why do those details matter? First off, the technical implementation is critical when it comes to security. Therefore, it has become a common practice among the more legit projects to publish (some of) their code for review before ICOing. I would certainly prefer if some blockchain-savvy developers had given their stamp of approval. It’s not that I don’t trust Kik’s developer team to create a solid system — rather it’s a matter of principle.

Second, it is currently unclear to me when and how the Ethereum blockchain will come into play. When will transactions be settled on the blockchain? Who is going to pay the transaction fees (“gas”)? To what degree do users have to trust Kik/the Kin Foundation? Again, we are only left to speculate.

Conclusion

The Kin ICO is going to be one of the biggest ICOs as of yet. The fact that its conducted by an established company with a well-known product lends additional prominence to it. After all, it’s a compelling story. But once you take a closer look, you’ll be left guessing a lot. The lack of details on all levels — the technical implementation, the governance structure and the token distribution mechanism — makes it difficult to asses the particularities of the Kin system.

This likely isn’t going to stop the ICO from succeeding. For one, it’s a high-profile project that is happening at the height of what basically everybody agrees is a bubble (or are we past-peak already?). Moreover, the team has a reputation to lose and basically bet the future of its company on Kin. While the amount of money you can raise in the current climate might incentivize some young companies (and shady people) to try an ICO without any actual substance, the people at Kik have a unicorn company as well as the money and goodwill of their investors to lose. Getting this right is in their best interest.

My best guess as to why many important details are still so fuzzy is that the team approached the ICO with the typical Silicon Valley mindset: Build a minimum viable product and get it in front of the people as quickly as possible. Why figure out all the details if you can bank on your reputation? This urge might have been increased by the fact that bubbles are eventually going to burst. While a cryptocurrency crash would certainly hurt Kin’s valuation, a successful ICO would at least provide Kik with fresh liquidity (the pre-sale investors paid $50 million in cash, the public’s investment will be in Ether at the equivalent of $75 million; how quickly that’s going to be exchanged to cash will be a good indication of how Kik assesses the current market climate).

It might well turn out as a good strategy for Kik. But I wouldn’t recommend it to most companies trying to pull off an ICO. After all, Kik was in a pretty unique position to begin with.

The one question that remains open is how serious the Kik team is about building a truly decentralized system. The lingo is certainly there, alone the facts are not. For now, all they can show are (partially) centralized systems along with promises about future plans for decentralization. To be clear, that’s more of a philosophical and less of a business question. However, it’s a question that matters to many in the blockchain community. What Kin’s ICO will tell us, thus, is how much philosophy counts when weighed against expected profits.

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¹ The whitepaper and the ICO website are by the way published by a FinCEN registered Money Services Business called Kin Digital Services Inc. that was supposedly founded to handle the ICO in accordance with US regulations