Flare Network

Changes to the Spark Airdrop

There has been a growing concern over the tax implications of the Flare Network’s Spark airdrop distribution through the XRP community for certain jurisdictions (i.e. United States). The founding team has commissioned analysis on the possible ways to distribute the Spark airdrop to avoid burdensome income taxes for recipients in these jurisdictions. The name of the individual or group from which the analysis was commissioned has not been released, but described by Hugo Philion as being “high-brow” and “a respected tax scholar.” This analysis in effect states that if recipients were awarded the option to opt into future airdrops and pay for the right to receive them at a future date that this would in effect serve as a purchase of those tokens at a substantially low cost tax basis. This would mean there would not be an income tax burden, but rather a capital gains one when the Spark tokens are sold by a recipient. I would liken this to purchasing a call option; however, we will need to see who the tax consultation was performed by and what their analysis entails. Additionally, this analysis or the current understanding of it is entirely up to debate as seen across social media. Simply put we need to see the analysis commissioned by the Flare founding team.

The blog issued by Hugo Philion titled, Applying Governance to the Spark Distributionstates that many considerations should be taken into account by voting Spark token holders, which will not include Spark allocated to Flare Limited (see above screenshot on the left). These considerations include the impact on the mechanism design behind the Flare Network, the accuracy (or perceived accuracy) of tax advisory opinions on the delayed distribution model, and the perception of Spark airdrop recipients. I would like to add another consideration, which would be the impact on potential network participants that are not fortunate enough to receive the Spark airdrop. Additionally, as their is an argument to be made on whether this is the best decision by the Flare team, it actually does not matter as Hugo Philion has stated that once the network is launched the governance of Spark token holders could have changed the remaining distribution if enough votes were behind a proposal (see above screenshot on the right). The choice is now being forced upon the Spark token holders rather than being proposed organically.

Option 1: Buy through burn

This proposal is based on the tax advisory that the Flare team received and was mentioned above. Both f-asset rewards pools, Flare Limited, Flare Foundation, founding team, and eligible XRP holders will receive the same airdrop distribution as previously planned; however, with the caveats that airdrop recipients now have the option to opt in or out of the future airdrops and the future airdrops would start six months after launch. Every planned airdrop recipient will still receive their 15% Spark airdrop at launch along with a zero cost tax basis on income taxes as no market has been made for the price of Spark tokens. The opt in process requires Spark airdrop recipients to pay for their future Spark airdrops up front, which could suggest that the basis for income tax would be very low as you are purchasing the right to own the Spark tokens at some point in the future. Any planned airdrop recipients not performing the burn at launch would not receive the subsequent airdrops after the initial 15% is delivered.

Option 2: Distribution halt

The original supply of Spark would be decreased from 100B to 15B. Spark airdrops to be delivered to Flare Foundation, Flare Limited, founding team, and eligible XRP holders would be delivered in totality at launch. For example, if you had 100k XRP on the snapshot date, you would now only receive 15k Spark tokens at launch and no more. Additionally, the two f-asset rewards pools would see their size decreased by 85%; however, exact rates for their disbursement have not been defined at this time. The FTSO inflation rewards would utilize the 100B Spark token basis as planned. If this option were to pass, then the FTSO inflation rewards would adjust down to 10% of 15B Spark on an annual basis rather than the originally planned 10% of 100B Spark. Please see an estimated token distribution of the adjusted supply from this proposal to the left, which is pulled from a Flare Network blog post linked here.

Option 3: Retain the existing plan.

If this option is chosen, then the Spark airdrop distribution will go on as originally planned. However, the subsequent airdrops of Spark after the first initial airdrop of 15% would not start until the month following the month this option was voted through on. This would eliminate a supply decrease, the burn mechanism, and the opt out ability.

How do we reach consensus on this issue?

Options 1 and 2 will require a super majority vote to pass while option 3 will only require a simple majority. Super majority requires a greater than two-thirds vote to pass and the simple majority only requires a greater than 50% vote. Both majority types will only require Spark voter turnout to reach at least 30% of circulating supply. Additionally, as mentioned previously, only Spark tokens that are owned by non Flare-related entities will be voting and any accrued Spark from the FTSO inflation rewards can be used for every voting round. If a quorum is not reached after the first voting round, then the vote will continue to happen periodically over the course of five months. At the end of five months if the vote has not reached a required majority, then the original token distribution plan will be enacted. I would estimate based on the Flare blog mentioned earlier that around 4.5B Spark will be circulating and not held by Flare-related entities. Every Spark token held by an individual accounts for one vote. Spark token owners can also vote with all their Spark every time a proposal is put to a vote or delegate to some other party to vote on their behalf.

Considerations for Voting

This new governance proposal has certainly brought chaos to the launch of Flare Network as it seemingly came out of nowhere. My gut reaction after reviewing the options is that option 1 and 3 have the least likely negative impact on Flare Network in the long term. However, it is too early to finalize such a decision as the Flare Network is not live yet and all the information around the matter has not been presented. More than likely, by my own speculation, Flare Network will not launch until mid-July at the earliest which means we will not see a vote on this for a month or so. This leaves the Flare Community with a lot of time to start organizing discussion around this governance proposal. It is okay to have a certain opinion today and change it in the future as we are not locked into anything right now. Also, Spark will change many hands once the network is live, so this will bring in other communities and ineligible XRP holders not receiving the airdrop. As new parties enter the community, so to will new opinions and ideas. Therefore, I have outlined below many considerations in no particular order for the Flare Community to start taking into account before finalizing their voting decisions.

  • Option 2 eliminates any possible tax burden for unclear jurisdictions.
  • Option 2 eliminates long term reliability on centralized exchanges to deliver the entire Spark allocated to users of those exchanges.
  • Option 3 is easiest to pass, which will allow the community to move on in a quicker manner.
  • Option 3 can start the future Spark airdrop distributions quicker than the other two.
  • Option 1 allows users to opt out of the airdrop.
  • Option 1 allows users to purchase future Spark distributions up front, which may or may not eliminate future income tax burdens in some jurisdictions.
  • The Flare team has not weighed in on which option they believe is best for the long term success of the ecosystem.
  • The Flare team has not delivered the high-level tax consultation they received yet.
  • Token burns do not always equate to a directly proportional increase in price, see Stellar burn.
  • Is having 15B tokens low enough to consider the Spark token a scarce asset?
  • Has the issuance of FLR IOUs skewed market perception of the future value of the Spark token at launch?
  • Will any of the options negatively effect the adoption rate by outside communities not included in the Spark airdrop?
  • Does reducing the future supply and changing the distribution schedule negatively effect the Flare Network economic incentive design?
  • In the case of Flare Network, does a longer distribution schedule lead to more retained participants or long term significant selling pressure?
  • How much does psychology play into network interest through token supply and price?
  • Does issuing the entire Spark distribution at launch extend the time period of high market volatility pushing back the launch of the F-Asset System further?
  • Which parties does each option benefit the most?
  • What do business entities planning to participate in the Flare Network think on this?
  • Why exactly did the Flare team choose to switch up the way the token distribution works this close to launch?

As you can see, I left a lot of questions and really no answers. This is just a starting point for the community to begin shaping their opinions around this proposal. Ultimately, there is no one equitable decision for all, so there will be disagreements and debates. Now is the time for the future of the Flare Community to start building the foundation for how governance proposals will be discussed in the future. This network is ultimately what the Spark token holders make it, which will span retail and institutional. Let’s make this a community where all viewpoints are heard and then decided on in a decentralized manner like intended. I challenge anyone who is interested or cares enough to post analysis online for all to view. The DeFi Standard will be doing this over the coming weeks!