By Jamie Burke
This is an idea I’ve been kicking around Outlier Slack whilst on the road and at various panels the last few weeks that I just wanted to get up even in a rough and very crude draft form to kick-off the debate online. Over the coming months the intention is it will be formalised into something more substantial and nuanced by the wonderful folk at Outlier from across both: Token Design + Market Research Departments.
Quick recap: in Sept 2017, we published a report called The Community Token Economy (CTE) which introduced the concept of ‘Token Gravity’: the idea that a protocol token can increasingly dominate an ecosystem by looking to collaborate with and co-opt apps, competing protocols and / or tokens early on. Almost a year on we believe we are now seeing this reality unfold as a new generation of well financed tokenised protocols look to deploy their funds aggressively to gain network effort and traction at the market layer. This post proposes it will become an increasingly common theme over the coming years something I have started call: The Hungry Protocol.
The Hungry Protocol is obviously in reference to, and an extension of, Joel Monegro’s ‘Fat Protocol’ thesis: the idea that unlike Web 2 value in Web 3 will primarily be captured at the protocol layer rather than the application / market layer. So in effect, The Hungry Protocol Thesis is: how a protocol gets / stays fat.
As such, this post will explore the different ways a tokenised protocol might look to acquire value to accelerate it’s network growth including:
- Talent (acqui-hire)
- Market Share (multiple verticals)
- Network (nodes, dapps)
We might think of these as types of mergers & acquisition the significant difference with conventional M&A being it might not always involve a direct equity purchase of a company. Also whilst most decisions are currently made in a fairly centralised way today we may see the use of a foundations funds become more participatory and decentralised over time making the process more complex.
So firstly, when & why acquire? In the context a CTE: absorb another into your orbit.
This may be the first type of M&A a young project might carry out as they look to accelerate the development of their technology stack and deliver on promises of utility made during a token sale. There are still many equity based gen one protocols that have not yet tokenised, but have developed a stable technology stack that will become increasingly competed over. This is especially relevant in a nascent market where good developer talent is both scarce and in high demand and expectations high.
Linked to technology, equity based proprietary protocols may be acquired as much for their development teams as their technology as an aqui-hire. However we are also seeing this across in a wider range of broader skill sets including: research, marketing, design and UX. Great usable product is an industry wide problem in crypto so expect loads of M&A here.
For Market Share:
In parallel to accelerating a protocol’s technology roadmap we believe we will see projects look to acquire businesses who are executing well in a given market, who may or may not be tokenised, but are protocol agnostic. This will likely be the single most common type of m&a because there are so many use-cases a generalised protocol might be pursuing, and simply a much larger pool of equity-based acquisition targets. In fact, you can imagine this being something silicon valley VCs will be actively encouraging the zombie companies in their portfolio to do for much needed liquidity events.
For The Network:
The least developed and most complex. We believe this could happen in the later stages of the Web 3 cycle when two competing protocol networks seek to assume dominance over the other. This will include to acquire a networks compute power/nodes and various stakeholders including dapps.
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Currently ‘blockchain’ startups are generally either executing at the market layer building dapps (on whatever protocol base half meets their immediate needs) or they are building the underlying protocol technology. Success is when both of these innovations combine into ‘network market fit’ (to borrow Lean Startup terminology). For a generalised protocol this may happen several times. Whilst occasionally DApps may have to build down in the stack, in the absence of the appropriate solutions for their needs, its harder for them to build complex generalised technology. Furthermore, they can’t acquire open source protocols with it being more likely the newly emerging cash-rich tokenised protocols will move upwards more rapidly.
Based on the different types of value being sought and the activity we are currently seeing/expect to see in market, I have begun to try to categorise common themes for discussion. My hope is the Outlier team will begin to build this out with more data and eventually create another great tracker just for M&A similar to: https://outlierventures.io/token-tracker/
Likely the most common scenario where a protocol uses it’s surplus capital to finance/support an incubator (probably ran by a 3rd party supplier) to invest in and develop early stage dapps that build on it’s protocol.
This is where a protocol looks to replace a planned token (be that protocol or dapp) before token launch likely by using a proportion of it’s own token supply (rather than fiat) binding the two initiatives (perhaps with a lock-in or vesting period).
This is where a protocol acquires and then looks to roll a non-tokenised equity businesses into the acquirers token network (again likely by using a proportion of its own token supply rather than fiat) binding the two initiatives (perhaps with a lock-in or vesting period).
This is where a protocol looks to absorb an app token (likely most relevant to ERC20 projects) where the ‘acquired’ token is redeemed in the live protocol network for a product or service (likely at a fixed price / discount to the acquirer’s token)
This will likely be rare but we could imagine a situation where one protocol publicly proposes a hard-fork of another to be absorbed into their network with the promise of profits for both holders as network value is aggregated (perhaps fixed conversion + margin for a swap)
This could be similar to a hostile takeover only explicitly where the network is failing for some reason (most easily with poor governance) and where there is the explicit support of community (through some kind of network voting mechanism or miner backing)
Considerations & Implications:
- Gen 1 / 2 Protocols could become very difficult to catch-up if they have a large enough capital endowment and strong in-market token price
- This may even mean it might not be those who can build the best tech that win out but those that can best manage capital
- Each acquisition could see a marked increased in the acquirers network token price almost immediately, potentially allowing for the acquisition to pay for itself (especially given take over rules for now won’t apply)
- Will this likely only be true for the acquisition of smaller to medium protocols (based on Sigmond Function ~ S Curve)?
- This could lead to growing concentration of value into a handful of networks… which is why how decentralised a project will become important
- As this becomes increasingly common the pressure to join in the frenzy on open source protocols will become too much to resist
We will try to add examples to each M&A type
We will try to quantify each type and begin to track on an ongoing basis
Our crypto economics team will try to model out a few formulas for discussion