Tokens for next-generation protocols, including Polkadot, are circulating on a semi-liquid secondary market at a deep discount, The Block has confirmed.

Major crypto funds and investors say they have been approached by over-the-counter (OTC) desks offering large volumes of tokens bought in private sales from the protocols' managing foundations. The tokens are distributed (and redistributed) in the form of SAFTs —Simple Agreements for Future Tokens—which gives funds the rights to tokens startups issued in the future, when they launch.

There are at least four separate sellers offering between 15,000 and 60,000 in Polkadot DOTs, according to multiple sources. At least one deal has gone through, with each DOT sold at a 50% discount to the $120 private sale price (which gave Polkadot its rumoured billion-dollar valuation). Polkadot has not yet closed its private sale of DOTs but sold its pre-sale DOTs at $30, hoping token holders would "contribute in some meaningful way to the system" and also be diverse enough to avoid collusion, Jutta Steiner, Parity's CEO told The Block earlier this year. The token will also be used for staking.

There are also at least three Dfinity SAFTs being floated "at vastly different prices and discounts." There is also believed to be an "active" FileCoin SAFT market, although no specific deals have been sourced.

Details of the tokens sellers remain murky, as parties often reportedly sign NDAs before engaging in negotiations. However, it is possible they are early investors from the pre-sale who are now trying to sell at a profit or are in need of capital after the price drop.

"Some funds have been trying to sell their [token] positions," one source confirmed, saying a liquidity squeeze meant funds were eager to convert positions into cash.

They added foundations often sell below market-price to those building on their protocols, or to funds buying large volumes. That means selling at a small premium on secondary markets could be profitable.

Playing with fire

There are three major potential repercussions around the existence of this noteworthy albeit small market.

First, the billion-dollar valuations of the protocols could be bought into question if tokens are falling into lower price-bands. Second, the sellers could be in breach of the agreements in place for buying a SAFT, which often forbid third-party sales. And third, those buying SAFTs from third parties may be exposing themselves to significant counter-party risks, given the nature of the deals.

Indeed, the risk arises because the deal involves paying upfront with the promise of getting the private key with the tokens later. However, there is no guarantee the seller will ever send the tokens. Moreover, there are fears the seller might keep a copy of the passphrases for the private key. Alternatively, as these tokens have not yet been physically issued, there is the risk of non-assignment from the relevant foundation.

"It's the most risky OTC trade in crypto," said one Asia-based analyst, noting the greatly reduced price makes sense because the risks are so high.

One way to mitigate that risk is by sending the USD funds to a lawyer who holds them in escrow until the token has been transferred. Or, the OTC desk themselves can promise to absorb the risk at a fee.

Still, investors remain wary albeit interested.

"I'd only ever buy SAFTs from an OTC desk at a very severe discount, maybe 50-70% off the market price," said a partner at one investment firm.

He added that he was approached by DOT sellers twice in the last year - including once by a "legitimate" fund offering large volumes. The partner pursued but eventually cancelled both deals - which he believes are still on the market - citing concerns about the sellers' credibility and the "enormous counterparty risk."

"The seller did not seem to be somebody who does what they say...It was very heavily shopped. I don't know if they are even real."

As a result, he added, legitimate token sales on the secondary market are still very rare.

“It’s incredibly hard to find DOTs on sale," he said, adding that some of the U.S.' largest OTC desks, which include Cumberland, Genesis, and Galaxy, told him they had "never seen a Polkadot SAFT, ever" when he inquired.

Another prospective buyer also said he turned down the deal on DOTs after the seller failed their due diligence process.

Indeed, the risks are real. Nevin Freeman, CEO of Reserve - a stablecoin firm - said that an internal investigation found "scammers" had created a fake OTC market of their RSR tokens on Telegram, taken advantage of the token's delayed delivery clause.

"I want people to know about the dangers of some of these second-hand token sales," he said. "I want to warn them."

He added nonetheless that some peer-to-peer brokers were legitimate, selling at an inflated price rather than a discount due to limited supply.

In breach?

Another important feature of these secondary markets is they take place behind closed doors. For one, protocols like Polkadot do not allow public sales of tokens to U.S.-based funds or investors. The purchase of SAFTs also have strict rules around them.

"These OTC deals are usually in breach of contract because most of these agreements have clauses that restrict sales before genesis [the launch]," said one source familiar with SAFTs. Still, arguably if investors' confidence in protocols peaks before they launch, they may well take the risk.

Nonetheless, Aragon CEO, Luis Cuende, explained that the rules were there because secondary sales are a nuisance to foundations that haven't yet concluded their private sales.

"These OTC desks and secondary markets make it very hard to raise a traditional funding round, where normally everyone has the same price," he said, with the project having stayed clear of an OTC offer on DOTs themselves.

The Web 3 Foundation, which manages the sale of DOTs and oversees Polkadot's development, declined to comment. Dfinity could not be reached for comment by press time.