The past week has been one of the most interesting weeks in DeFi and I’ve certainly been very excited to write this piece. Before I continue I want to emphasise that none of the analysis/commentary here is a dig or criticism of any particular person or entity. We’re all figuring out this DeFi thing together and the objective of this article is to hopefully educate how we can improve the new financial system we’re co-creating together. I think that on-chain reputation for raises is going to be crucial to quantify how value-add investors truly are for the networks they participate in. Anyways, plenty to dig into so let’s get started!
Phantom Troupe
First of all, reading this entire governance proposal thread is one of the highest ROI things you can do in crypto right now to understand how fundraising dynamics play out behind closed doors… except this time it’s out in the open. To summarise the key events for those that didn’t nerd out about it:
- Sushi wanted to do a $60m strategic raise with about 21 private investors and at a 30% discount which would effectively sell 50% of the dev treasury
- The community was outraged that a large portion of the treasury was being sold to investors who have no defined value add, at a large discount during all-time lows of $sushi with no clear reason for doing so
- Investors and the community battle it out ferociously to contest the reasoning and logic about the terms of the sale and aggressively negotiate in the open
- Certain investors are for the first time being highly challenged as to whether they really do add value and whether they warrant a discount at all
- Arca, a private investor that owns 7%+ of xsushi, comes out saying they’re willing to buy $10m of sushi at a premium
- Any questions of discounts are thrown out the window and the new negotiating terms are much more favourable to sushi
- Lightspeed, Arca and the Sushi team speak together to figure out a raise structure that makes sense and balances out the interests of the community
- Most likely tokens will be sold at spot with a lockup and the community will have the chance to participate in the raise as well
Quite the timeline huh? There are so many implications to the above that it’s going to take a while to really unpack it all. I’m excited to get into it.
Selling at a discount
For those of you that aren’t familiar with regular venture dynamics, basically, the argument goes that if an investor is buying your tokens and “adding value” then they should receive a discount for compensating them for their value add. However, they are also willing to receive a lockup and take on a certain level of illiquidity on their investment. At a high level, the logic checks out, however, the devil is always in the details. When you typically as venture investors in what ways they add value the wrong answer goes something along the lines of:
- Network - “we have a wide network that you can tap into”
- Hiring - “we can help you hire A+ class talent”
- Product - “we can help you to improve your product”
Typically, what this means is they can’t really help you and it’s a pure capital deal — which is okay in some cases but you have to be clear on what you want. The best investors are already known for their work and excellence and are sought out after. So coming back to our Sushi proposal, we have a list of 21 investors of which there hasn’t been a clear outline to the community what the value add is which should be known if it is primarily being marked as a strategic raise. Now assuming the investors are value add, should they still get a discount? Here’s where there we get a little deeper into the nuance:
You see, when investors buy tokens in an open order book they’re basically exerting a lot of buy pressure and supporting the markets they’re buying into. Given the large sizes of these funds, it means they’ll be pushing the price of these tokens up and will have to pay a premium to acquire a large enough stake in the network. Now when tokens are sold directly, there’s a hidden consequence of the tokens which were never meant to hit the markets (given they’re held by the treasury) will be available on the market in the future. From that perspective, the deal is objectively worse for Sushi because they’ve now eliminated a ton of buy pressure that could have been exerted on the market and they’re selling them at discount! Not a very good deal to lose the upwards support and instead take a hit on the downwards.
Okay, so that’s the first point about discounts. The second I find more interesting is whether value-add investors can only come in if they’re sold to at a discount. Throughout the forum the following comment from FutureFund was particularly insightful:
This leads me to my next point that if an investor wants to truly be value-add or thinks they can do so, they can already demonstrate it through competence or building rock-solid relationships with the team and working alongside them beforehand. Capital is becoming increasingly cheap in an ecosystem where everyone’s bags have 10x’d and the community are equally well capitalised to help out with any financing needs.
Pricing Structures
Given there was an intense back and forth between the community and investors on how the deal should be priced. Eventually, there was a point in the deal about potentially using some sort of option structure to price and execute the deal.
This seemed to be reaching some form of support until we had an amazing tweet storm dropped by the one and only - mgnr. You should definitely give this thread a read but I’ll summarise it myself given it is high on complexity:
Options 101, when you purchase a call option you’re sold the option at a particular price (say $1) and you have the ability to buy the asset at the strike price (say $2) one year later. If the price one year later is above $2 (say $5), you can execute your right to purchase the asset at $2 and pocket the $3 difference. If the asset is less than $2, you can buy it on the market (you don’t have to exercise your right since you’d lose money). Now conceptually what this means is that the person selling the call option is literally betting that the price of the asset won’t go above a certain amount in the future. The longer the option the more beneficial it is for the buyer since they quite literally get extended optionality into how the asset may perform.
Now relating this back to Sushi, if a treasury is selling a call option to investors it’s quite literally betting against itself and creating extreme asymmetrical upside to the investor.
In case that went over your head the simple way of understanding it is that while the $sushi is being purchased at spot, there’s a free call option attached with a strike price of 2x the current price meaning this is actually an offering with a 59% discount (at least from what I understood but I’m not an extreme options whizz).
Overall when it comes to pricing I think this final tweet from the tweetstorm summarises it perfectly:
oh we can't agree on a price we both understand? then express it to me in a price i definitely don't understand, but you probably do
Closing Remarks
If there’s one thing that this whole incident shows us is that the power of the community has now risen to the point where they can openly negotiate with many institutional investors and won’t be taken along for a ride. The days of low value add and easy money isn’t as easy to come by as it was a few years ago. Users and contributors have a voice at the table and they’ll fight to ensure that the protocol’s best interests are guarded at all times. It’s hard to overstate how monumental this is.
One other key thing I’ve been thinking about is what does the future of venture deals look like if the notion that institutional investors should receive deep discounts on deals. Is there even a point of private rounds when there’s deep public market liquidity? Are these rounds just convenient structures for venture investors to invest compared to buying tokens on the open market and feeling the wrath from their LPs from being down on an investment that could be viewed as them picking tokens randomly and not justifying their carry fees? Some weird incentives going on here that I want to better understand since private markets are extremely hot while public market tokens don’t get as much love. Probably a post for another time.
What I loved about this whole Sushiswap saga is observing multiple investors and how public actions and words aligned/misaligned for certain ones. The days of tweeting bullish/long-term tweets while executing bearish/short-term trades will soon be gone. Very few investors will be able to hide their actions from words. Maybe we won’t even need to know the brand of the firm but rather what their on-chain reputation says about them… #defipassport
Until then, Sushi’s Phatom Troupe is setting the foundations for how future DeFi deals will be negotiated and we’re all privileged to be in a spot to get a front-row seat of the future.