A few months ago, we discussed what a token network hostile takeover could look like. Today, let’s tweak the premise and consider how a friendly takeover — an acquisition — could happen.
As previously mentioned, these are the early days for token networks interacting with each other. As more and more networks go live and gain traction, increased incentives will arise for corporate-governance-style interactions like takeovers, acquisitions, mergers, and partnerships.
Meltem Demirors has a great illustration of the current state of some popular token networks (shown below). Thus far, teams and networks have been focused on engineering work (creation), sales and/or airdrops (distribution), and marketing and community (speculation). Next up is utilization and finding their unique positions in the market (specification). As more networks move into those latter categories, it will make increasing sense for those networks to interact.
The nature of decentralized networks means that these interactions will happen in less straightforward ways than in traditional companies. Rather than the management teams simply coming to an agreement on a transaction and executing it, the teams need to design an incentive structure that encourages the stakeholders (users, miners, developers, and others) to act in a way that effectively produces the desired outcome.
Before we talk about how this could happen, we need to figure out what “this” actually means. We’re so used to the idea of an acquisition in the traditional institutional world that it’s easy to forget to consider crucial questions in the decentralized world. Here, I think those questions are:
- What does one network buying another one mean?
- Who can make these decisions?
What does one network buying another one mean?
The network itself owns no assets — at a high level, “buying” a network means buying its usage. Practically, it means buying the users and the miners. Once the activity on the network is transitioned over, we can consider the network to have been bought.
The only other assets associated with many token networks are the ICO proceeds and any hard assets purchased with those. But these aren’t held by the network — they’re held by the corporation (or foundation) that originally released the network. In its purest sense, a network acquisition would have no way of touching these assets. But we’re going to use them as a key part of the acquisition model, to be outlined shortly.
Who can make these decisions?
In the traditional world, it’s obvious who can make the “buy” and “be bought” decisions: the management teams, boards, and shareholders of the firms involved. With token networks, as alluded to above, no single party can actually make those decisions — all they can do is try to set up an incentive system to try to encourage the stakeholders on the network to migrate.
For the sake of this piece, I’m going to go through this with the definition of “friendly” acquisition being that the original development teams of the two projects are the ones that agree to enact the incentives and try to push the transaction through. They often have two things that separate them from other stakeholders on their networks: moral authority and ICO proceeds. While neither of these assets allow for any sort of formal network governance, they point to the original creators as the natural ones to decide.
That said — and this is perhaps a topic for another day — this calls into question the definition of “consensual” acquisition. Who actually has the right to speak for the network? What if the original developers want to do it but a large chunk of the network doesn’t? Sure, they could refuse to exit the network, but if the incentives are designed well enough for the acquisition, they might be penalized for doing so. This concept starts to blur the line between “hostile” and “friendly” takeovers — and you’ll see some real similarities between this piece and the hostile one as a result. More on this another time.
So, how does this happen? Here’s an outline, with more color on each step to follow.
- Announce as broadly as possible
- Pay to be bought
- Airdrop to exiters and drive the old network down
- Bribe the holdouts
Step 1: Announce as broadly as possible
Given that success in an acquisition scenario is represented by the stakeholders on the network migrating over, getting early buy-in is crucial. The two teams should jointly announce and justify the takeover and amplify the message broadly. Getting other key stakeholders (major miners, holders, developers, and others) on board — perhaps privately in advance of the public announcement — would be a huge help as well.
Especially in the early days of token networks interacting with each other, it will be important to be hyper-specific about how exactly the takeover is planned to happen. Laying out the steps so that nobody is surprised will likely increase compliance.
That said — the teams will also have to consider if announcing specific steps in advance could cause any adverse reactions or gaming. This will be very situational, but you can imagine some of the same things happening that do when a traditional world merger or acquisition is announced — the markets will adjust and there be an outcry.
While each acquisition will likely be messaged differently, there is a case to be made for leaning heavily on a virtuous drive towards decentralization and other messages that will resonate with the target community. Framing the discussion around becoming part of a larger, more decentralized network — as opposed to their “failing” network becoming more and more concentrated — would work well.
Step 2: Pay to be bought
This is one spot where this process might differ wildly from a traditional acquisition. Rather than the acquiring team paying out the acquirees, I think it’s likely that the acquirees will pay the acquirer a chunk of their ICO proceeds in order for their network to be purchased.
To understand this, we’ll break it down into two questions:
Why shouldn’t the acquiring team pay the target team?
Frankly, because there’s nothing for them to buy. All they’re seeking is the target’s help in setting up the incentive structure to move their users over — there’s no technology or other assets to be purchased.
The target will still cash out — “exit” — by keeping a (negotiated) percentage of their proceeds, so they’ll be rewarded for their work. But (absent some other agreement), they won’t actually have any sort of future responsibilities.
Ultimately, the acquirer should spend their acquisition capital on buying the actual users of the network, not the management.
Why should the target team pay the acquiring team?
Largely because, as we’ll outline in the next couple steps, the acquiring team and network will shoulder significant costs as part of the acquisition — very likely more than would otherwise be worth it — and the target team can help to defray these costs and enable the acquisition. And on top of that, those funds were intended for the development of the network, which will be newly owned by the acquiring network.
But secondarily — it seems important that the target team give up at least some of their funds. Otherwise there would be a meaningful incentive alignment problem in that issuers that raise funds from a token sale could quickly sell their network and then walk away with all the funds they raised to build it out in the future.
Step 3: Airdrop to exiters and drive the old network down
Now, it’s time to convince the stakeholders on the target network to migrate to the acquiring network. The most straightforward method here is for the acquiring network to airdrop tokens to users from the target network who get rid of their tokens there (I’ll define “get rid of” momentarily). That is, if you give up your stake on the old network, you get a stake on the new one.
Two bits we need to work out: where do the newly airdropped tokens come from, and what happens to the tokens on the old network?
Where do the newly airdropped tokens come from?
I see at least three options — and in practice, the answer is likely a combination:
- Paying out of the company/foundation pool. If the management team of the acquiring issuer values the takeover highly enough, they might take some of their own tokens and airdrop them to the immigrating users.
- The company buying back tokens on the open market. With a combination of their own capital plus the incoming “acquisition money,” the acquiring issuer’s team could buy back their own tokens on the open market and then airdrop those to incoming users.
- Issuing new tokens. If the acquiring network values the acquisition enough, they might decide to actually fork themselves and issue new tokens as “acquisition financing.” There is a high bar and some operational difficulty here, but it’s doable. This is most similar to how a corporation’s board might issue new stock to finance an acquisition.
What happens to the tokens on the old network?
The simplest case — as outlined in the previous hostile takeovers piece — is for the tokens to be burned. Once the users send the tokens to an unspendable address (equivalently, a smart contract without any ability to withdraw), they are given tokens on the new network. There would likely be some sort of UI created to enable this sequencing and prove ownership of specific addresses on both networks.
More interestingly — and there are certainly some other externalities here — it may be advantageous in certain cases for the old tokens to be unloaded on the open market, driving down the price and giving more proceeds to the acquirer. I’m not talking about the individual users selling their tokens for profit, but rather sending them to an address (on the target network) owned by the acquiring network’s management team, which would then sell those tokens and take the proceeds.
At a minimum, the tokens owned by the target management team should likely be sold, and the proceeds be part of the payment to the acquiring team.
This second option would likely both drive the price down (which is good in the case of a takeover, incentivizing more people to leave) and also provide more capital to finance token buybacks and airdrops on the new network.
Step 4: Bribe the holdouts
This step is optional, and likely should not be announced as part of the plan in the beginning, as it would introduce adverse incentives around early migration.
Once Step 3 is complete, if there’s still too much activity happening on the old network, additional measures will need to be taken (or the acquisition will need to be written off as a failure).
One option here is for the acquiring management team to directly pay important stakeholders — miners and developers — to migrate. Again, the acquirer will likely have some meaningful capital from the target team and perhaps from selling the “burned” tokens, so they may be able to afford large direct payouts.
Another option would be to simply increase the size of the airdrop and offer more tokens to those that move over.
This path introduces the risk of “holdouts” — users that wait on the old network, hoping for a better bargain. Of course, there’s a risk for these users, too — the airdrop might stop or slow down, and they could be left behind on a useless old network.
This circles back, though, to a core premise of this whole idea: the acquisition isn’t a final decision in the same way a traditional acquisition is. Rather, it’s an attempt to design incentive structures for the stakeholders so that they’ll go along with it. If the incentives aren’t good enough, the acquisition could fail. If they are, it will likely succeed.
Parameters and incentives
There are a lot of levers to be pulled and dials to be twisted in configuring an acquisition like this:
- How much does the target team pay the acquiring team? (and correspondingly, how much do they “exit” with?)
- How much gets airdropped on the acquiring network? How much of the incoming payment is spent?
- What’s the airdrop distribution and schedule on the acquiring network (linear, uniform, limited-time, etc.)?
- Where do the airdropped tokens come from?
- What happens with the tokens on the old network?
- What about the issuing team’s tokens in particular?
- Are there any final (or initial) bribes?
- Does the target team have any responsibilities after the acquisition?
- How is the plan announced? (and what exactly is announced?)
- And more…
The decisions on these questions form the basis for that incentive structure and the chance of success for the whole acquisition.
Where’s this all going?
I’m a broken record on this: token networks are only just barely starting to go live. Up to this point — and likely for awhile longer still — there has been essentially no incentive for token networks to interact with each other. Even if they’re live, they likely have few users worth acquiring.
As that starts to shift, we’ll see more and more of these sorts of interactions — acquisitions, mergers, and more (including interactions we’ve never imagined before in the traditional world). And it may happen earlier that we’d expect — given the low supply of token network users, there’s like a real premium on acquiring them, even if in relatively small numbers.
Power law returns will be a reality in crypto — and accordingly, teams should be willing to spend whatever they have to in order to win, particularly this early on.
It’s critical that teams begin to think about this future — from perspectives offensive, defensive, and strategic.
A few questions not addressed here:
- What does insider trading look like? If you know what’s going to happen, how can you benefit? Is it legal?
- More broadly, what happens to the markets for the target and acquiring tokens before, during, and after the acquisition?
- Is the combination of a smooth network transition for users (implying, perhaps, a lack of lawsuits) plus some cash enough to convince the target network issuer not to just run away with all of their ICO proceeds and leave their networks in the lurch?
- How is this “acquisition agreement” legally enforceable so that the acquiring team doesn’t take the target team’s money and run or refuse to airdrop to the users?
- What will happen to the old networks? Will they wither? Is there a high probability of it being forked and attempting to compete with the new netoork once a bunch of “traitorous” users exit?
- What can the teams actually do with their money based on the way they’re structured (foundations, etc.)?