No Sitting at the Table if You're Bringing Nothing to It

In the deep bear market of 2018, crypto Twitter was fun, hostile, and bleak. Disillusionment from the ICO bubble led to the entire idea of tokens being rejected by a large portion of crypto. “Cool project, but doesn’t it have a token?” Cynical energy was rampant at the time. This whiplash emphasis on no-frills building and protocol minimalism cauterized the bear market in a way we haven’t experienced this time around.

Uniswap became the darling of the 2018 bear, as it had organic usage, a lot of users, and seemingly no reason to ever launch a token. It wasn’t until Sushiswap’s vampire attack that Uniswap was provoked into launching UNI. Despite this, Uniswap still made their mark on tokens, establishing airdrops as the dominant launch method and toying with bold uses for its fee switch.

I find it interesting to think of Uniswap’s fee switch as the polar opposite of a gauge voting system. Gauge voting = positive reinforcement, fee switch = negative punishment. Same objective (directing liquidity), very different method.

Uniswap v3 has been knocked for its poor LP experience. In the face of emerging DEXs like Infinity Pools and Trader Joe that seek to compensate LPs with higher fees, Uniswap explores a path to benefit traders potentially at the expense of LPs. I find Uniswap’s willingness to entertain a design that seems so counterintuitive from a bizdev perspective to be admirable, and likely a key factor in their sustained success.

Fee Switches and the Role of Tokens

Spoiler alert from our report – Uniswap’s Fee Switch progression has always been one step forward, two steps back.  The report sparked some passionate discussion in our PRO members telegram chat.

  • What is the role of tokens in crypto?

  • Do token holders have a right to protocol earnings?

  • If the token does not earn fees, how is it valuable?

Open source, community owned, community governed. If there is excess value extracted by a protocol, it should be the property of the community. If token holders are providing value to the protocol/users, they should be compensated. However, it is not the responsibility of the protocol to generate value for token holders.

If Uber were created in the metaverse, would there be a stock/token for it? Of course not. Uber would just be there. Well, Uniswap is really just Uber for token swaps. There’s a strong case to be made that the application layer eventually becomes a public good. There’s also a strong case to be made that spot swap fees on DEXs trend to zero.

Therefore, Uniswap’s valuation isn’t a question of “Will UNI holders get a portion of LP fees?”

“No?! Worthless token, way overvalued.”

“Oh it will? Cool, what multiple should I slap on this? Oh, that’s not that much yield, seems fairly priced.”

A Valuation Framework Without Cash Flows? *gasp*

I don’t think UNI token holders have a claim on LP earnings, but I believe the UNI token has value.

UNI’s current valuation is likely derived from a combination of several prediction markets:

  • Probability that in the current version of Uniswap, the UNI token will earn fees from LPs – I believe this is near 0%

  • Probability Uniswap remains the premier DEX in crypto and challenges centralized exchanges in the coming years – I believe this to be >60%

  • Probability that in future versions of Uniswap, there may be a role for the UNI token that earns token holders a small share of a much larger pie. – This is the big question in my opinion and likely determines one’s overall stance on UNI.

The Case of Lido

Lido has been in the news recently with its own fee switch proposal. For what it’s worth, LDO stakers would at least be acting as an insurance fund against slashing, meeting the “earning compensation” criteria.

Can Lido’s business currently support distributions?

~$30M of revenue, ~$30M of non-LDO expenses. No profits, no chance. Case closed.

But even if Lido were profitable, why distribute revenues at this stage?

The proposal suggests 20-50% of revenue distributed to LDO stakers. This would mean anywhere from $6-15M in distributions for for a ~$1.7B mkt cap token. This is even less impressive than our underwhelming projections for Uniswap’s Fee Switch. Check out Joo Kian’s recent feed post for more detailed projections and thoughts.

Meanwhile, this trivial amount of token holder value comes at substantial cost for an early stage business. This revenue could otherwise be saved or put towards high ROI ventures. It is highly uncommon for a business in this stage to distribute profits. Take Amazon (or almost any tech stock) for example.

In 2017, AMZN was on a tear, finally breaking through the mentally significant $1K mark. In their Q2 earnings release, Amazon beat on top line revenue ($38B/$37.2B est.), with impressive YOY growth (25% sales/42% AWS). However, significant investments in developing areas of the business, including the Whole Foods acquisition and media arm,  saw Amazon miss by 72% on earnings ($0.40/$1.42 est.) and the stock falling ~10%. Unlike many other instances of reactionary price action following earnings, AMZN stock remained flat for the rest of the quarter, failing to retrace losses from the earnings release.

“It’s energizing to invent on behalf of customers, and we continue to see many high-quality opportunities to invest.” – Jeff Bezos

For some reason, the decision to go for market share and horizontal expansion over a better looking P/E ratio was an unpopular one. In reality, AMZN was already a slam dunk, generationally easy bet. But many Buffet-style investors missed the forest for the trees. We all know the story from there: $3,500 AMZN was programmed, and the stock doubled over the next year as the company’s investments filtered through to top line revenue in subsequent earnings releases.

Let’s not miss the forest for the trees.

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