Token Mergers
Maybe we need investment banks for these.
Hey there!
It seems to be a merger (rebranding) season in crypto. Earlier in July, Polygon announced a new token, POL, due to its architectural overhaul. The old MATIC token will be swapped in a 1:1 ratio to POL. The Polygon ecosystem is currently home to multiple chains such as Polygon POS, Polygon zkEVM, and Supernets.
The new architecture allows validators to vote on multiple chains. The image below summarises how they think of it.
The architecture demands an upgrade of the token contract since all these chains can now be staked in one place and used to validate on multiple layers. The new ticker is also a rebranding exercise to signal significant changes in the ecosystem
It is not just a technical change but also an organisational restructuring. Before this, Polygon had completed two significant acquisitions,
Hermez Network ($250 million) and
Mir Protocol ($400 million) to expand its zero knowledge (ZK) capabilities.
These mergers got us thinking about general mergers and acquisitions (M&A) activity and how it applies to the cryptoasset industry.
Let’s begin with an understanding of why mergers occur in the first place. The goal of any enterprise is to create value for its stakeholders. Companies typically do this by selling products or services, but sometimes they merge with or acquire other companies. The logical reasoning behind a merger is that the value of the whole is greater than the individual parts of the two or more companies merging together.
During periods of market turbulence or consumer apathy, firms are incentivised to merge to reduce competition and increase margins on the remaining customers. Fewer resources are spent on battling for the same consumer subset. An early instance of this on the internet was between X and Confinity.com - which eventually became known as Paypal and was acquired for $1.5 billion in 2002 by E-bay.
Consolidation leads to better unit economics and value accrual for shareholders. It seems a win-win for most parties except consumers with limited choices and employees who often get laid off in such processes. A different way mergers occur is when a dominant player acquires multiple smaller ones because of their ability to have better unit economics. Standard Oil’s steady acquisition of oil companies leads to the firm owning 90% of the market in the US. AT&T played a similar move with telecom networks in the 1920s.
Now for the fun stuff.
How does any of this apply to crypto?
M&A In The Age of Digital Assets
There are two kinds of M&As we see in Web3. First is that of centralised firms acquiring other centralised firms. The other is networks partnering to co-build a new narrative. We have not yet reached sufficient levels of market maturity to support a network acquiring a centralised business.
Amberdata’s acquisition of Genesis Volatility (GVol) is an example of a good acquisition in the crypto industry. Amberdata is an institutional data provider with many capabilities. But they lacked sophisticated options for market analytics. GVol had built its product in the options analytics niche. Since Amberdata’s existing institutional clientele requires options analytics, integrating GVol into its offerings was not difficult. In this instance, the firm seems to be expanding its product suite to retain users longer.
Binance’s acquisition of CoinMarketCap (CMC) can be seen as a product extension and user acquisition strategy. Since Binance is primarily a B2C company, CMC acts as the top of the funnel for the exchange. Although CMC didn’t have robust monetisation methods, it was among the applications with the most number of users.
OpenSea’s acquisition of the NFT aggregator Gem in April 2022 has proved ineffective. Almost a year after the acquisition, OpenSea unveiled OpenSea Pro, a platform aggregating NFT marketplaces for traders. This was supposed to be OpenSea’s answer to Blur, but the delay has probably forced OpenSea to cede a lot of ground.
A part of the reason can also be because the user is forced to go to a different website, pro.opensea.io, instead of opensea.io. The latter doesn’t show any listings from other marketplaces, whereas Blur, by default, shows all the listings and has the power of incentives to ensure that Blur listings often give the best prices.
(Caveat: Part of what may have made the acquisition outcome bad may have been OpenSea’s inability to release a token without exposing themselves legally. When you have a valuation of $13 billion, you do not want to do anything that may affect it or the probability of an IP)
When it comes to tokenised networks, mergers are a bit more tricky because you have a very diverse set of decision-makers, each with very different views on how a merger should look.
Founders - Founders of protocols or applications with tokens expose themselves to heightened volatility (and possible depreciation) of the tokens they are entitled to.
Investors - May have less of a say in what the new merged token should do. In fact, they may even sell in response to a merger and push prices lower.
Holders - Cultural mismatches between two networks with live tokens would mean it takes a while for people to align around what are shared goals.
And so, if you look historically, there's only been two kinds of mergers
A centralised fund takes over an almost dead network and rebrands it into something new for the narrative. Omisego’s rebrand into Boba fits that bucket.
A liquid token takes over a centralised entity with IP and tech and merges it internally for the narrative. Polygon has been exceptionally good at this.
The common theme? Narratives. Yearn Finance went on an M&A spree in late 2020. It merged with protocols like Cream Finance, Pickle Finance, Acropolis, and Hegic. The goal was to collaborate with these protocols and expand Yearn’s offerings.
These were not token mergers but the cooperation of developer resources of these protocols. Since tokens were not involved, the total value locked (TVL) is probably the best metric to judge whether Yearn benefitted. Yearn performed better than its peer yield aggregators and led the pack in TVL terms. Narratives can meaningfully drive actions. And sometimes, in crypto, that’s all mergers are about. Driving narratives, which can drive actions.
Crypto has seen a fair share of M&A, but there’s often an added motivation of rebranding involved. For example, why does the token need a new name when Polygon wants to upgrade the MATIC contract? Remember ETHLend? Aave, erstwhile ETHLend, started as a peer-to-peer lending protocol for ETH and ERC-20 tokens. Later, the protocol was upgraded to the current pooled capital model and rebranded to Aave.
Strong brands attract a premium because they signal quality. As a result, building a brand is always one of the objectives for companies or projects. But at the same time, brands also get a bad rep.
Our minds somehow seek comfort in associations while navigating the world around us. It is difficult to change those associations quickly. So, instead of changing, it is often easier to create new associations. For some reason, my first reaction to Matic is “the Ethereum sidechain that just about worked when other scaling solutions were not ready”, but when I hear Polygon, it is “an ecosystem that aims to scale Ethereum with zk rollups at its core”.
The people developing the network are the same, but the messaging has changed as they pivot to better technology. M&A or organisational restructuring often allows teams to change branding and create new associations with their brand. We want to retain strong brands; if the older ones are weak, we want to move to stronger ones.
There are a few attributes that make these kinds of mergers interesting.
If the merger is paid for in the native asset of the network, the costs incurred are not borne by management or investors as in traditional mergers. It usually happens from the network's treasury or minting of new assets.
Minting a new asset (like POL) helps retain traders' attention in the market, especially at the beginning of a new market cycle. Too often, networks are not pivoting in their strategy but simply rebranding their core story for the new cycle.
If two large networks merge, it could possibly mean more users. But the incentives are generally not aligned, as I explained earlier.
All of this made us wonder what would even be the ideal merger!
The Dream Merger
Networks with live tokens have only one good reason to merge. It is about the community. As we covered in our article yesterday, communities can be a moat if done right. Looking through this lens, a merger would require community members of multiple protocols to wonder why they are competing against each other for a limited user base. This questioning is unlikely to happen as everyone's incentives are aligned with tokens. One way to build a wedge here would be through service providers like Reverie or Gauntlet.
Currently, these are businesses that operate as service providers for DAOs. But given sufficient capital (by an external hedge fund?), they could be the ones proposing networks with little usage merge. The first task for such a venture would be to identify networks with huge treasuries that can benefit from more users.
Currently, multiple DAOs from the early 2018 era hold treasuries that are in the millions. Many of them often see "raids" asking for the ETH to be distributed among token holders. Instead of being targets for such raids, what they should be doing is merging with products that have large user bases and limited treasuries. Keeping the theatrics of such decentralised mergers aside, there is a need for firms that can assist and advise on such collaborations. It would require an intermittent party that can align VCs, traders & founding teams for such mergers.
This is, of course, a hypothetical example that requires an imaginary market participant. A clearer use of mergers would be to improve the efficiency of capital locked up in different DeFi products. For example, the product will significantly improve if a perpetual futures protocol like dYdX merges with an options protocol like Ribbon.
Why? Capital efficiency is the Achilles heel of DeFi. Currently, Ribbon doesn’t understand dYdX positions and cannot use them as collateral. But when they merge, an ETH long on dYdX can be used as collateral instead of new ETH to open a covered call position on Ribbon. The capital efficiency such a product brings does not exist elsewhere. (It does on centralised exchanges, which is why traders often stick to them instead of a decentralised alternative).
Additionally, sophisticated traders are used to creating their strategies combining futures and options. So both protocols can sell the new product to the union of their customer base. There is a lot of work to be done when it comes to mergers. In the past, none of it could occur because the tooling (for DAOs) or the environment (in the market) was simply not there.
With suppressed prices and next to no customers, many teams in the industry may well consider merging to improve their odds of survival.
Off for the weekend,
Saurabh