Cryptocurrency Airdrop: What Is It and How Does It Work

What Is a Cryptocurrency Airdrop?

A cryptocurrency airdrop is a marketing strategy that involves sending coins or tokens to wallet addresses. Small amounts of the new virtual currency are sent to the wallets of active members of the blockchain community for free or in return for a small service, such as retweeting a post sent by the company issuing the currency. The ultimate goal of a crypto airdrop is to promote awareness and circulation of a new token or coin.

Understanding Cryptocurrency Airdrops

A crypto airdrop is a promotional activity typically performed by blockchain-based startups to help bootstrap a virtual currency project. Its aim is to spread awareness about the cryptocurrency project and to get more people trading in it when it lists on an exchange as an initial coin offering (ICO).

Airdrops are generally promoted on the company's website, social media, and cryptocurrency forums. Coins or tokens are sent only to specific wallets based on the blockchain network or coins held in existing wallets.

To qualify for the free gift, a recipient may need to hold a minimum quantity of the crypto coins in their wallet. Alternatively, they may need to perform a certain task, such as posting about the currency on a social media forum, connecting with a particular member of the blockchain project, or writing a blog post.

Types of Crypto Airdrops

Standard Airdrop

In a standard crypto airdrop, participants interested in receiving an airdrop simply express their interest in order to receive the airdrop. The individual must provide a valid wallet address, and some airdrops require no additional information beyond this.

Standard airdrops often have a set amount of tokens to distribute with a limit on how many tokens each individual may receive. Therefore, some standard airdrops are time-sensitive. Though these types of airdrops are popular due to their simplicity, there is nothing stopping a single user from creating multiple wallets to quickly drain the airdrop amount, so these may be more difficult to obtain.

Bounty Airdrop

Bounty crypto airdrops occur when users perform certain tasks. These tasks often entail raising awareness of a project by posting on social media and tagging the company or retweeting a recent tweet about the project. There may also be referral bonuses or finder's fees for individuals who recruit other users, sign up for the project's newsletter, or join the company's Discord channel.

In exchange for performing tasks, users often receive points that correspond to how large of bounty airdrop they receive. Users may also be required to earn a certain amount of points before they qualify for their airdrop. For example, a user may be eligible for an airdrop after earning 300 points with each item mentioned above is worth 100 points each.

Holder Airdrop

Holder crypto airdrops occur automatically based on who is holding existing tokens and how many tokens they hold. Because wallets and blockchain information are part of a publicly distributed ledger, all users of blockchain have full transparency into the wallets and distribution of tokens.

The downside to holder airdrops is individuals who may be holding tokens may not want an airdrop. Alternatively, holder airdrops ensure that only the largest, most invested individuals receive the benefit. Some holder airdrops may only award an airdrop if members are holding a certain amount of tokens; otherwise, they may pro-rate the award amount.

Exclusive Airdrop

A more specific type of holder airdrop, an exclusive crypto airdrop occurs when specific people are individually selected for the airdrop. The difference is they may be selected not based on the amount of tokens they have but based on other elements such as time spent on a project, most money spent on non-token activity, or number of posts in a forum. An exclusive airdrop is an even more centralized way of rewarding those closest to the project and may give airdrops to wallets that may not hold any tokens at all.

Raffle Airdrop

Some of the types of airdrops above may be combined with a raffle airdrop. Often, a project will state the number of airdrops they intend to give and encourage individuals to earn a raffle ticket. This ticket may be earned by holding tokens, earning points, or simply expressing interest.

Ultimately, the number of individuals interested in the airdrop often exceeds the number of airdrops the company wishes to deliver. Therefore, a raffle occurs and a limited number of wallets are randomly selected to receive the airdrop.

Crypto Airdrop Process

The crypto airdrop process begins by the project or company deciding the need for an airdrop. This may be in response to market strategies, a hard fork in the network, or to incentivize existing investors. The initial step is to select how the airdrop will be facilitated and who is eligible.

The next step for broad, general airdrops is to launch the public campaign. This includes collecting information for interested parties; this is often limited to just wallet addresses, though companies may also gather e-mail addresses to grow their contact list.

Other types of airdrops may rely on a snapshot, a capture of an instance that identifies who possesses certain criteria. For example, the project may perform a snapshot to identify all addresses that held at least 1,000 tokens as of midnight on December 31st. Any transactions occurring after the snapshot will not impact the results of the airdrop; therefore, coin or token prices often experience volatility in response to when snapshots are taken.

Once the list of airdrop recipients is selected, the airdrop is facilitated often through the use of smart contracts. The company may choose to use their Treasury wallet to facilitate the airdrop, and the company often publicizes the transaction block to demonstrate the equitability of the airdrop. The transaction will show the airdrop leaving the company's wallet and distributing to the recipients.

Airdrop recipients often directly receive the coins or tokens without having to accept the tokens. Some may need to add the token or coin along with its address to their wallet to appropriately view their wallet balance of the token.

Crypto Airdrop Scams

A legitimate crypto airdrop never seeks capital investment in the currency. Its aim is purely promotional. On other hand, some crypto scams involve sending micro amounts of bitcoin or other cryptocurrencies to unsuspecting recipients in what is known as a dusting scam.

Many airdrop scams rely on directing an investor to attach their wallet to a phishing website in order to claim their airdrop. Often, the web3 address will prompt a user to connect their wallet using common and popular wallet services such as MetaMask, Trust Wallet, or Oasis. After a user connects their wallet by providing their secret phrase or keys, the scam is complete.

Airdrop scams may also occur by enticing market participants to invest in a specific security in hopes of being airdropped a different item. For example, a project may boast that holding certain NFTs in a wallet will cause owners to receive a rare airdrop. Though the airdrop may be legitimate, the project owners may have enticed market activity of the NFT so they could sell theirs at a higher price.

How to Avoid Airdrop Scams

Users should always be vigilant about unsolicited deposits into their crypto wallets. In addition, users should be aware of the projects they are investing in or attempting to claim assets for. The common phrase among cryptocurrency explorers is to "do your own research".

It's advised that crypto-enthusiasts not connect to websites they are not familiar with. This includes ensuring external links they click on come directly from the project. Consider bookmarking common sites you plan on visiting frequently to ensure you're always connecting to the right site.

Companies often publicly communicate airdrops and other promotions. Consider following the project on social media, forums, or Discord to follow upcoming events, and be mindful that complex scams may replicate or imitate project social media profiles.

If you don't want airdrops associated with primary investments, consider creating a new wallet specific to airdrops. After receiving the tokens, you can then transfer the tokens to different wallets. Though not a form of traditional diversification, keeping crypto in different wallets does spread and reduce overall risk.

Crypto Airdrops and Taxes

Whether or not an airdrop counts as a taxable event depends on the jurisdiction of where the token holder is living in. In the United States, crypto airdrops are considered income as part of one's Federal income tax return.

The difficulty of reporting taxes on an airdrop is the token may not yet have liquidity or an easily assessable fair market value. An airdrop should be recognized as income at its fair value when it is received. In addition, airdrops are not considered taxable income until an individual has control over the token. If the airdrop is locked or on a vesting schedule, it is not taxable income until it is received and can be traded.

Should the price of the airdrop drop after receipt and then later sold, this transaction creates a second, unrelated transaction that occurs in a capital loss. The taxpayer would recognize income for the amount of the airdrop, then recognize a loss equal to the different between the airdrop price and sale price. If the price should appreciate, a short-term or long-term gain may be taxed based on the holding period.

Advantages and Disadvantages of Cryptocurrency Airdrops

Advantages

Given the extreme competition among cryptocurrency startups, an airdrop is an attempt to stand out from the crowd. Some businesses devoted to crypto airdrops offer alerts to users and listing services to startups, plus a range of marketing services to fine-tune their airdrops. As always, there are good businesses and bad in this space.

Michael J. Casey, Chair of CoinDesk's advisory board and an advisor at MIT's blockchain research initiative, argued in a post on a CoinDesk blog that some type of marketing is essential if a cryptocurrency is to succeed. "A currency is nothing if it is not widely used. And that can't be achieved unless people make some cost-incurring effort to encourage widespread usage," he wrote.

Certain crypto airdrops also have the advantage of rewarding loyal patrons of specific blockchain networks. In addition, sending airdrops to all wallet or existing token holders widely distributes tokens in a manner that may not happen naturally in an open market.

Disadvantages

However, there are several issues to consider in regard to crypto airdrops. The obvious concern is network safety, especially the nature of "redeeming" airdrops. For example, some airdrops may claim users must connect their wallet to suspicious websites; once the connection to web3 is made, the thief may now have access to the user's keys or password.

Crypto airdrops may also not be legitimate projects. Though enticing due to the nature of receiving free money, some projects lure stakeholders into increasing the stake of their airdrop by buying more tokens. Ultimately, the long-term goal may be to "rug pull" investors by dumping large amounts of tokens into the marketplace at once, crashing the price and making prior airdrops worthless.

Airdrops may be seen by some as low-quality projects. Some may prefer to instead focus on rewarding miners or other contributors of a network instead of releasing free tokens to non-heavy contributors of a project.

Last, since airdrops may lack liquidity, airdrops may literally be worthless if they can not be traded on an open exchange. Often the result of the infancy of a project, airdrops may claim to have a value of thousands of dollars. However, without the ability to openly trade the airdropped tokens, the free gift to wallet holders may prove to be worthless.

Crypto Airdrops vs. Initial Coin Offerings (ICO)

Crypto airdrops and initial coin offerings may appear to be very similar. Both are likely to occur at the start of a project, and both are intended to distribute coins or tokens.

Crypto airdrops may not require an investment, while initial coin offerings often require a transaction. Though the transaction may reward investors by offering coins or tokens at a discount, it is expected that investors buy the coins or tokens as opposed to airdrops which are free. ICOs are often initially offered first to venture capitalists.

In addition, the demographic for these two events are largely different. ICOs attempt to attract larger investors who are willing to infuse capital into a project. These users are more likely to pursue the project as an investment. Alternatively, airdrops are often intended to raise awareness among smaller users. Though users may not have much use for a small airdrop, the goal is to entice smaller users to transact with the digital currency.

Real-World Examples

At the end of 2021, Gas DAO was formed to distribute tokens to individuals who had paid a certain threshold of Ethereum gas fees. The concept was ownership of the DAO would be tied to the largest users of Ethereum. 55% of Gas DAO tokens were airdropped to 634,429 eligible wallets.

Also at the end of 2021, the OpenDao distributed tokens to NFT holders based on OpenSea trading activity. Ownership of OpenDao tokens would be airdropped based on NFT-ownership, forming an entity structure driven by the most ambitious collectors. At it's peak, OpenDao had a market cap of greater than $250 million. As of September 2022, its market cap had dropped to less than $11 million.

The Bottom Line

Crypto airdrops are a way for companies and projects to raise awareness of their token or coin. It is also a way to increase the liquidity of their security by giving it away to thousands of different wallets. Though airdrops have value and may be considered free money, there are also significant risks if users are not aware of potential scams related to crypto airdrops.

Investing in cryptocurrencies and other Initial Coin Offerings (“ICOs”) is highly risky and speculative, and this article is not a recommendation by Investopedia or the writer to invest in cryptocurrencies or other ICOs. Since each individual's situation is unique, a qualified professional should always be consulted before making any financial decisions. Investopedia makes no representations or warranties as to the accuracy or timeliness of the information contained herein.