Confused by the OpenSea Drama? Understanding the IPO vs. Tokens Debate
On December 6, former Lyft CFO Brian Roberts announced he was joining OpenSea as its first CFO. While communities in most new industries would likely have viewed this moment as a major win — a well-respected, mainstream executive joining one of the industry’s most important companies — Crypto Twitter cried bloody murder. The community interpreted this new hire as OpenSea’s first steps in pursuing an IPO (and therefore NOT pursuing a token launch), and felt betrayed.
At first, we felt this way too. But, then we started to wonder: why the knee-jerk reaction? Does everyone understand the trade-offs of an IPO vs. a token launch or do we all just have ingrained in our minds that it’s “token or die”? Also, if OpenSea did pursue an IPO, would that definitely mean that it’s forsaking us — its community? We had to explore this further.
“OpenSea: A Two-sided Marketplace”
Before we go into the pros and cons of IPO vs tokens, let’s quickly understand OpenSea’s business model. OpenSea is a classic two-sided marketplace with creators on one end and collectors on the other. Creators and resellers come onto the platform to sell their art, music, domain names, etc. for collectors to browse and buy.
With such a model, OpenSea relies on two critical pieces to succeed (as explained by Li Jin below):
- Bootstrapping network effects: attracting enough creators and collectors
- Maintaining network effects: making enough revenue while ensuring that the creators and collectors don’t leave the platform
As it stands today, OpenSea has already bootstrapped its network. It is a clear leader in NFT marketplaces with more than $13 billion of NFTs sold to date. To balance making money and maintaining network effects, OpenSea only charges a 2.5% commission (or “take rate”) on every purchase made through the platform — much less than traditional marketplaces such as Uber and Airbnb (20–40% take rate) or Instagram (100% take rate).
From a funding perspective, OpenSea has raised $127.5 million to date (and is rumored to be raising another $1 billion) from investors like a16z and Y Combinator.
So far, OpenSea has followed the classic two-sided marketplace playbook, following in the footsteps of most of its pre-crypto predecessors (e.g., Uber, Lyft, Airbnb, etc.):
- Raise capital to subsidize market participants, grow users, and build network effects
- Rely on large user bases and networks to create a strong moat for demand and supply
- Charge either side a take rate to earn money (although as noted, OpenSea’s take rate is much lower than that of most marketplaces)
Now that we understand OpenSea’s business model and existing funding structure, we can explore the impact of an IPO and a token launch on the platform and its community members.
“Wen IPO?”
An initial public offering (“IPO”) is the moment a formerly private company’s stock becomes publicly listed, so that “retail investors” like you and me can buy its shares. Once the shares are public, the share price is determined by supply and demand in the market. Supply is determined by the company (it can issue or remove shares). Demand is typically derived from the stock’s “fundamentals” like its cash flow and business model. Thus, assuming supply remains relatively fixed or decreases, holding the stock allows shareholders to receive value (i.e., share price goes up) as the company (and its cash flow) grows over time.
Once the company is public, most big decisions are made by the CEO, who, in turn, reports to a Board of Directors. The Board of Directors’ main job is hiring and firing the CEO, and approving key corporate decisions like selling the company. For almost all public companies, there is an annual shareholder meeting in which every shareholder gets to vote to elect each Director. In this way, most public companies are representative democracies, in which shareholders vote to appoint the Directors, who oversee the CEO. Shareholders don’t have direct say on most corporate decisions (except for large mergers or a sale of the company).
What this means for OpenSea:
Let’s assume OpenSea launches an IPO tomorrow (stock ticker $OPEN). Initial IPO buyers of $OPEN are likely large institutions, but then retail investors like you and me (and the rest of the OpenSea community) could buy $OPEN shares in the market.
For the founders, team members and existing investors, this IPO is great, because they get liquidity for their equity without relinquishing meaningful decision-making power. Centralization of decision-making may actually meaningful benefit both the company and community, because OpenSea can continue to rapidly innovate on its product. Crypto — and NFTs, in particular — moves extremely quickly. Maintaining centralized control may allow OpenSea to stay ahead of innovation in the industry and continue to provide the best offerings to its users.
A centralized structure also may allow the company to more easily cater to the needs of both mainstream and crypto-native users, as a more regulated entity (think Coinbase vs. Uniswap).
On the value side, OpenSea community members are able to purchase $OPEN, so they can participate in the upside of the stock as the company continues to grow. However, early users receive no compensation for being early adopters and value drivers. They need to invest in $OPEN to get upside.
Moreover, the largest potential downside of an IPO is that public companies have inherent misalignment between shareholders and users of the platform. OpenSea’s public shareholders want to maximize cash flow and profit (which drives share price up). Therefore, the CEO / Board feels pressure to focus on profit. As described above, profit for marketplaces is determined by transaction volume and take rate. If transaction volume plateaus, the main lever to increase profit is to increase the take rate.
On the flip side, users want OpenSea to charge the minimum sustainable take rate (i.e., the lowest possible rate that still allows the company to operate successfully). Lower take rate means lower cost to transact.
If users want lower take rates and shareholders want higher take rates, who will the CEO and Board agree with? The CEO & Board can be fired by shareholders (indirectly and directly, respectively), which provides a powerful incentive for the CEO / Board to cater to shareholders’ desires.
Public companies are intentionally designed to incentivize their leaders to listen to shareholders. This is generally a good thing, as it prevents CEOs from damaging shareholders’ investment. The problem is that most public shareholders are not necessarily users of the company’s products.
If OpenSea’s shareholders were also its users, then perhaps this incentive gap could be at least partially closed.
“Wen Token?”
To understand tokens, let’s briefly discuss Web3. One of the best ways to understand Web3 is through Chris Dixon’s mental model comparing the different eras of the internet (see below). Web3 is all about ownership, and token’s are the digital primitive that make this possible.
We are just scratching the surface of potential use cases for tokens, but we have already seen incredible innovation in the space. Using tokens, holders can now “own” part of anything online — digital art, access to digital communities, protocol decision-making or even part of the U.S. Constitution.
Moreover, tokens not only transfer ownership and value to token holders, but also can align incentives within networks (like marketplaces).
The first task when creating a new marketplace is getting people to join the network (“bootstrapping the network”). However, the value to any user of the network grows as more people join it, so initially the network has limited value or incentive for anyone to join (“low application utility”). Typically, platforms like Uber have solved this problem by raising lots of money from VCs to subsidize one side of the platform (e.g., paying drivers even if they don’t have any riders).
However, another way to solve this problem is through utility tokens. When the network is small and has limited value, platforms can give users token rewards. Receiving tokens allows users to receive financial upside as the network grows over time (“financial utility”). For example, when Uber started, there were limited drivers on the platform. Why would riders join Uber if there was no one to drive them? On the other hand, imagine if riders were given Uber tokens each time they used the platform — tokens that will grow in value as more people join the network. Now, riders are financially incentivized to withstand long wait times for drivers in order to earn more tokens. Moreover, riders might also tell all their friends to join as well, since everyone will benefit financially from Uber’s success.
Once you get folks on the platform, the next phase is keeping them there. That’s where we can add a new token concept: governance tokens. Governance tokens give users of the platform voting rights on all critical decisions. In contrast to the IPO scenario, in which shareholders elect representatives to make key decisions, with governance tokens, users vote on all key decisions directly (“pure democracy”).
If we combine both utility and governance tokens, we can actually create a new type of organization that is owned and led by its community of users. Utility tokens give users “Value” as the platform grows, and governance tokens give users a “Voice” in the direction of the company. Below is a diagram to help you understand the spectrums of “Value” and “Voice”.
Well, great — tokens can provide users with Value and Voice, but how do users actually get these tokens? A popular option is through an “airdrop” in which the company gives tokens away (for “free”) to early users of the platform (like Uniswap or ENS), while maintaining a portion of tokens for the team and investors. Airdrops reward early users of a platform while allowing newcomers or non-community members to purchase tokens in the market.
Another common alternative is an Initial Coin Offering (ICO). ICO’s are similar to the traditional IPO, in which users can buy tokens at a predetermined rate. This mechanism is particularly relevant for projects that require a token at their outset to achieve their full potential (e.g., Ethereum).
Now that we understand what a token is and how it might be launched, let’s explore token options for OpenSea.
Utility Token
Let’s imagine OpenSea launched a utility token ($OPEN) tomorrow. After launch, utility tokens become the tickets for users to access OpenSea’s platform. Participants must use $OPEN to interact with the platform, transact and more.
When launching $OPEN, let’s assume the company airdrops tokens to early users, the team and investors. As discussed above, airdropping rewards early users of the platform with free tokens while allowing newcomers or non-community members to purchase $OPEN in the market. Similar to the IPO scenario, OpenSea’s founders, team members and existing investors receive some equity liquidity from the token launch as well.
By giving free tokens to community members, OpenSea is encouraging them to generate buzz for the platform (and thus drive up platform usage and the value of their tokens). This can further drive network effects as the platform continues to grow.
Moreover, since $OPEN is a utility token, the value of holding $OPEN is tied to the performance of the platform. OpenSea now requires buyers on the platform to pay sellers in $OPEN and does not accept $ETH or other currencies. This means that as the number of transactions increases, demand for $OPEN increases, because buyers need $OPEN to purchase. Assuming the supply of $OPEN is fixed or only expands minimally, increasing demand will cause the price of $OPEN to rise over time. Thus, holding $OPEN allows community members (and any future speculators) to participate in the platform’s growth.
However, pure utility tokens do not give any decision-making power to token holders. In fact, token holders have less voting power than shareholders in the IPO scenario above, because pure utility token holders don’t elect directors or any decision-makers. The voting framework of a pure utility token structure is a dictatorship, with the company / Board of Directors making all decisions (e.g., Chainlink). While this clearly has drawbacks, it also may enable OpenSea to innovate more rapidly and continue to drive product growth (similar to the IPO scenario above).
Governance Token
Let’s assume, instead, that OpenSea decides to launch $OPEN as a governance token (again via airdrop). The $OPEN token holders now have voting rights on all key decisions on the platform (you can think of this as “complete decentralization”). In this way, OpenSea’s decision-makers are now aligned with the users of the platform, because they are the same! For example, OpenSea can’t simply decide to increase platform fees to make more profits, because making such a change would require a majority vote of token holders, who likely wouldn’t want to increase the money they pay.
In terms of value distribution, by using an airdrop, OpenSea is again rewarding early users, while providing some liquidity to the founders, team members and existing investors. The rewards in this scenario are similar to those in the previous scenarios described above.
However, pure governance tokens have two clear downsides. The first is that the token’s price is not linked to any economic value. The price is determined by a supply-demand dynamic in the market that is purely speculative, since tokens are not tied to business performance (to see this in practice, check out the chart below with the fluctuations in the $ENS governance token price). So while the early users have decision making power, they don’t have economic upside in the platform, and hence are not as incentivized to grow the platform. (Note: this can be somewhat improved with certain policies like using protocol revenue / treasury to burn tokens.)
The second drawback is that decentralization could be less efficient for OpenSea’s performance. A company needs a product vision and speed of execution to succeed. Both of these things are harder to do with decentralization. Product vision is often the founding team’s view of how the market will evolve. Often this includes non-obvious perspectives that community consensus may not understand or agree with at first (think of Square’s rebrand as Block or Facebook’s rebrand as Meta). More broadly, needing permission for every critical decision could slow the team down, losing time that is so important early on.
Utility + Governance Token
A third token alternative is that OpenSea could combine the concept of a utility token with a governance token. This could either be done using two different tokens (e.g., Axie Infinity’s $SLP + $AXS) or a single token that combines the properties of both (e.g., Braintrust’s $BTRST). Combining both a utility and governance token would give token holders the combined rights described in the two prior sections.
Comparing Scenarios
As shown above, there are benefits and trade-offs to each structure. The more decentralized the platform, the more alignment between the community and the platform, but the less speed and flexibility to innovate. This trade-off is described well by Jesse Walden at a16z:
“This is a difficult challenge because much of what it takes to build a successful product at the outset — product leadership, rapid iteration, a managed go-to-market — complicates the path to community ownership and regulatory compliance, which guarantee long-term health.”
What multiplies this challenge is that tokens are so new that we still don’t fully know what optimal company structure looks like for all company types. Are there some companies that are better off not having tokens? Is there a hybrid structure that turns out better than any listed above? Will large institutions end up buying up tokens in the market, such that token ownership and shareholder ownership look similar as the company matures?
As it relates to OpenSea, itself, we remain excited about the company and hopeful that the team will find a structure that rewards the community and aligns incentives amongst the various groups of stakeholders.
We hope that we have now provided readers with the tools to make their own conclusions about what structure they hope to see.
Please feel free to DM us with any questions or comments.
