Crypto meets SPAC. Bullish?
Photo by 2 Bull Photography on Unsplash
As always, disclaimers apply: this note is for informational purposes only and should not be construed as a solicitation to buy or sell any of the securities or instruments mentioned within. This is NOT financial advice. This is an opinion piece, and we’re very happy to hear your thoughts on it (especially if you disagree or spot any mistakes in our work).
Last Friday, Bullish, a new cryptocurrency exchange to be launched by the team at Block.one, announced plans to go public via a SPAC, Far Peak Acquisition Corporation, for a total valuation of about US$9bn. The confluence of crypto and stocks is an intersection that fascinates us, so we relished the chance to dig deep into this.
Let’s start with the story that’s on sale here.
The narrative is truly bullish: while retail investors have had unfettered access to crypto markets over the past few years through the likes of both “less”-regulated exchanges (e.g. Binance) and more regulated ones (e.g. Coinbase/Gemini), along with equally unrestricted access to the decentralised web and the likes of Uniswap, this time it is the institutional investors that have been left out of the party.
Enter Bullish – it holds itself out as a solution for institutional managers to gain access to a compliant and regulated trading venue for crypto which contemporaneously solves for all the other restrictions and hurdles institutions face: from accessing the architecture of DeFi, to earning yields on liquidity provision, to accessing deep and constantly available liquidity that is appropriate for a large-sized institution.
As an investment, surely this must be the holy grail which brings salvation and relief to institutions, flagging from their heavy regulatory burdens? Looking through their SPAC presentation on their investor relations website (link here – presentation video and slides at the bottom of the page), things aren’t so simple.
Firstly, a bit of recent history.
EOS and Block.one
In 2017 the world had just caught on to the potential of crypto in earnest. Every man and his dog had a coin (especially one particular dog!) It was the time of Ethereum-killers – protocols which were built to challenge Ethereum on the path to most dominant layer one chain. Block.One, the entity now behind the Bullish exchange, was formed in 2016 with the aim of developing EOSIO, a protocol which would underlie one or more EOSIO-based blockchains. EOS was the token that would ultimately fuel activity on EOSIO-based blockchains, much like Ether powers the Ethereum blockchain.
Unfortunately, the ICO frenzy very quickly got out of hand. In the wild west, with no regulation lots of peculiar things went on in this frenzy. Ultimately the SEC found that Block.One was in breach of SEC rules through its offering of the EOS token. Block.One subsequently settled with the SEC for US$24m, but the damage had been done – despite raising almost (if not more than) US$4bn in EOS’s ICO – one of the biggest ICOs of the era - those funds were effectively held in suspended animation from the commencement of the SEC investigation in 2017 till settlement in 2019.
EOS, a seemingly failed experiment, found itself with abundant cash but nowhere to deploy it. By the time 2020 came around, EOS was bleeding developers – according to this report by Outlier Ventures from back in 2Q 2020, EOS had lost almost 85% of its developers building on the protocol in the prior year. Things have scarcely improved in 2021 so far, as the latest Outlier Ventures report shows EOS code commits continuing to fall.
The importance of community in securing the success of a protocol is sacrosanct – without it, there is code that no one uses.
To top things off, EOSIO’s former CTO Dan Larimer announced earlier this year that he was resigning, dealing a further blow to its sustainability.
Of course, a blockchain is never truly dead and EOS may yet have its day in the sun. That said, the list of dApps running on EOS remains rather sparse:
On the bright side, Block.one still has access to the enormous funding it raised back in 2017-2018. The pitch to EOS tokenholders is that this funding is now finally being put to use in a way that benefits them.
We’re not convinced that this is a win for EOS.
Unlocking stranded value
But first, let’s turn our focus to Bullish’s SPAC deal.
Without reproducing any part of their presentation materials (available on their investor relations website here), mindful of the regulatory requirements in play, here’s our take on their value proposition.
To be clear, we’re NOT saying that we expect Bullish to be an abject failure. On the contrary, we would expect that with such an all-star cast of management and advisors, they will achieve significant success. However, this success may come in a shape and form that is much more similar to a traditional Centralised exchange, leaving us sceptical that the “DeFi” angle that has been tagged onto their pitch is opportunistically capitalising on the crypto zeitgeist for publicity value more than anything else.
As always, we strongly recommend all our readers take a proper look at their official materials – do your own research!
This podcast featuring Tom Farley, formerly the president of the NYSE and incoming CEO of Bullish, is worth a quick listen to get a feel of what the plans for Bullish are.
In it, he succinctly states Bullish’s value proposition: that it will be very much like a traditional centralised exchange, but with liquidity pools funded by their own proprietary capital underpinning liquidity in the assets on offer, in the same way liquidity pools work in DeFi.
The cynic in our heads cannot help but look at this SPAC as an ingenious bit of financial juggling, in order to take the stranded ICO proceeds from 2017-18 and move it into the real world. Very much in line with the current zeitgeist of broad, albeit fading, crypto bullishness, Block.one have chosen to weave the dominant narratives around DeFi, regulation and institutional adoption aka “The institutions are coming!” into the story of launching an exchange.
Yet we are in no shortage of exchanges: the world’s largest regulated crypto exchange, Coinbase, is already listed. Its offering is both retail and institutional, not to mention the commercial solutions (e.g. payments and custody) it also provides. And Bakkt, the exchange seeded up by NYSE’s owner, the ICE, is also due to go public via a SPAC. Regulated, compliant environments for institutions to gain exposure to crypto aren’t exactly a rarity.
The likes of Bakkt and Coinbase have taken years to get to where they are, built by the best operators in the industry. Bullish have assembled an all-star cast of advisors and management to execute on delivering on its plan, and they reportedly have already developed the software matching engines needed to power the exchange – perhaps one could be convinced to give them the benefit of the doubt.
That assumes, of course, that Bullish’s value proposition of bringing the best of both worlds, coupling the functionality of DeFi with compliance and regulation, making it accessible to the billions and trillions of dollars of institutional capital that has been hitherto locked out of the DeFi economy, all works out.
Call it centralised, regulated, permissioned DeFi.
Does that make sense? Not to us, unfortunately. The entire ethos of Decentralised Finance is that it is permissionless, with no centralised counterparties. As a result, participants in DeFi make use of innovative technological solutions which permit permissionless transactions, but with a trade off in terms of capital efficiency, transaction costs or speed. Re-centralising the functionality of DeFi completely defeats the purpose of decentralising it in the first place, negating the need for those very technologies that create yield, cashflows and returns for its participants.
The very nature of the returns and turnover that we see in DeFi is, in our view, a function of its permissionless, decentralised nature, and not of the underlying technology. Technology was just a means to an end.
Replicating the technology is easy – just do a google search for the white paper of any of these protocols and all the details are there. In fact, just go to Etherscan and the underlying code is there for anyone to copy.
That just shows how starkly different DeFi is from a traditional business. DeFi operates in an open-source world, where the competitive edge isn’t necessarily technological as much as being able to engage and build a strong community of users, typically by leveraging a first mover advantage. Would Bullish expose the code of its internal matching engine to public review? Probably not.
Replicating the success of DeFi is much more than simply porting functionality over and wrapping it with a compliance wrapper. Institutional investors engage with counterparties in very different ways from individuals and have vastly different transaction requirements. US$6.4bn of dedicated liquidity pool capital sounds like a lot – but to support a sufficiently broad range of assets, that liquidity gets whittled down quite quickly.
Given their all-star management cast hailing from traditional finance backgrounds, the risk is that Bullish disappoints by being “not DeFi enough”.
It probably won’t be, only because it probably can’t be centralised, regulated and decentralised all at once.
That doesn’t necessarily stop it from being a successful centralised exchange with good management and execution, but it does bring us back to the initial question: do we need another centralised exchange in the mix, making things even more competitive?
And what of EOS?
Just as it is said that a man cannot serve two masters, that he will either hate the one or love the other, or hold to the one and despise the other, so too a business cannot serve two masters. In this case, Bullish must necessarily serve the interests of its equity holders. EOS.IO may be a supplier of services and technology, but it is ultimately a cost item in Bullish’s income statement.
Is this bullish (small b) for EOS? On one hand, it does appear to impart a use case to a protocol which has to date struggled to find a use case, especially with a dwindling developer community. On the other, to believe that an entire regulated exchange will be run FULLY on EOS.IO and be able to satisfy its operational and regulatory requirements is a long stretch.
At the very best, we expect transaction logs hashed onto the EOS public blockchain to be a redundant “backup” for record keeping, although whether the regulators accept that as a viable backup remains to be seen. To facilitate the volume of trades that Bullish expects to do would require a much more robust, battle-tested set of infrastructure – perhaps AWS, Azure or an in-house data centre that is appropriately certified to ISO standards?
Without a doubt, the publicity will be positive for EOS in terms of sentiment, a much-needed boost for long-suffering token holders. But whether being integrated into Bullish profoundly improves the economics of EOS is a question that has no clear answer. We highly doubt that the dreams of an exchange being run exclusively on the existing EOS blockchain, with transactions verified and hashed individually on-chain, will materialise – there are simply too many leaps of faith needed to get to that point.
In the end, Bullish can only serve one master, not two, and we’re squarely in the camp of expecting them to deliver for their equity investors as a top priority.
In conclusion…
To conclude, the idea of effectively rolling Block.one’s assets into a centralised DEX with CEX functionality is prima facie fascinating but intrinsically contradictory and oxymoronic once we dig a little deeper. We expect Bullish to be successful, but more as a traditional centralised exchange.
And while we won’t go through a deep dive on their earnings analysis and assumptions as published on their presentation deck in this note, it suffices to say that we found some of the inherent, unspoken basic assumptions (particularly on revenue drivers) being made to be quite aggressive. That said, Bullish have made no firm promises on turnover, user base, revenues or earnings, providing only a range of possible scenarios that may come to pass over time.
A quick point on valuations: Coinbase has a current market cap of around US$45bn, while Bakkt was expected to carry a valuation of US$2.1bn of enterprise value. True to its name, that makes Bullish’s targeted valuation of US$9bn rather bullish, especially for a company that hasn’t yet taken its product to market.
Furthermore, not only is there a potential conflict of interest between interest groups that are inherently adversarial to each other, where one group’s gain is the other’s loss, but the portability of operating metrics from the DeFi world to the centralised, regulated world is also a huge assumption leap which we believe has to be proven, rather than assumed. There is a big difference between a fully laissez-faire, permissionless ecosystem and something that is regulated and controlled - especially the size of the addressable market.
For Bullish as a company, taming these assumptions down very quickly ratchets up the valuation multiple they are seeking for their listing. We will continue to watch this with great interest as they complete their SPAC deal, start trading as a listed company and bring their product to market.
And as for EOS as a token, aside from the boost in sentiment, tokenholders seem to be on the wrong side of the fence as far as alignment of interests is concerned.
What is bullish for Bullish may not be bullish for them.
Then again, it may all just be a very headline-friendly name for an exchange.