DAR Crypto Weekly — 3/6/20

Hostile Takeovers in Crypto

Market Overview

Digital asset prices rose on the week after several nations announced support for cryptocurrencies with the global market cap up 2.8% to 253.1. Large-cap winners on the week were Chainlink (LINK +17.7%), Tezos (XTZ +15.9%), and Binance Coin (BNB 14.7%). Relative laggards in the large cap-category were Monero (XRM +1.4%), Stellar (XLM +3.9%) and XRP (XRP +4.1%). Other noteworthy positive movers across the industry were Hedera Hashgraph (HBAR +63.4%), Kyber Network (KNC +43.2%), and Bitcoin Gold (BTG +40.9%). Other notable laggards on the week included Synthetix Network (SNX -18.3%), Maker (MKR -0.9%) and OKB (OKB -0.6%).

DAR Research and Events

This week we published a report for clients examining the risk and returns for Bitcoin. Two of the most powerful characteristics of any investment, whether it be an asset class, investment fund or single asset investment, are its ability to diversify risk and amplify returns. In the past, investment managers have had a variety of asset classes (equities, fixed income, commodities, currencies, real estate), fund structures (open/closed-end, hedged, private, exchange-traded), and assets (individual publicly traded stocks, private companies both early (venture) and mature stage (growth or buyout), debt issuers, real estate projects or portfolios, commodities) from which to choose. While there has been an explosion in the past 10–15 years on the private company side of investing as well as innovations around fund structures (ETFs), the base asset classes and relationships (correlations) between them have largely been unchanged. However, our analysis shows that Bitcoin offers important characteristics for managers as a completely new asset class, one that offers the “Holy Grail” of investing — high risk-adjusted returns and non-correlation. Reach out to find out how to get access to our work here.

We were quoted in a recent Coindesk article regarding Coronavirus fears, the stock market sell-off, and declining interest rates. Our view on real rates is important and the distinction is subtle. It’s also a framework that we think is valuable as nominal 10-year rates hit 0.74%. Article link.

Hostile Takeovers in the Digital Asset Space

It’s common these days to hear about a company that is under pressure from “activist investors” who are looking to force change. Over the past 10–15 years, a new breed of shareholder — the activist hedge fund — has played a decisive role in interactions between corporations and markets. Recently, multinational conglomerate SoftBank, as well as social media giant Twitter, have come under criticisms from a well-known activist, Elliot Management. The investment firm has a history of shaking up board rooms and c-suite level management, but what happens if an activist takeover occurs in the blockchain ecosystem? How are they enacted? Who is affected? And what defense strategies do protocol communities have in their toolkits?

Before we delve deeper into the matter, let’s take a moment to explain activist investors in equity markets. Their game plan is usually straightforward: buy up large amounts of stock in companies they view as undervalued and pressure management to do things they believe will raise the value, often taking board seats along the way.

Typically, we see four main levers used by activists. The most frequently used lever is cost-cutting. This provides an immediate, but perhaps short-lived impact, on the bottom line. Second, is to look to spin off assets or divisions or shutter underperforming initiatives entirely. Whether they’re selling larger or smaller assets, both spin company and parent company will typically outperform in the longer term, the primary goal for the activist. As a third lever, focus shifts towards the firm’s strategy and operations, in an attempt to grow the business in a manner not previously explored. The fourth and final point that activists like to look at is capital structure, like debt issuance and stock repurchases.

TRON Makes of Move for Steemit

TRON, a digital asset company led by Justin Sun, recently acquired blockchain platform Steemit Inc — a content sharing platform that utilizes cryptocurrency to rewards users for sharing content. The platform employs a Distributed-Proof-of-Stake consensus model where 20 “Witnesses” serve as Block Producers and validate transactions across the network.

The purchase of Steemit Inc, which is responsible for the development of the Steem cryptocurrency blockchain and maintaining Steemit.com, means Sun wields considerable influence over the consensus protocol. To counter this power, some Witnesses initiated a soft fork targeted at limiting the influence of users with large positions (i.e., Sun), formally known as Fork 0.22.2. The soft fork was meant as a reversible code update to provide the community more time to analyze the recent events.

However, Sun with the assistance of major exchanges Binance, Huobi, and Poloniex (recently acquired by Tron) used their stake of STEEM (the native currency of the network) to prevent the soft fork as well as release the founders' fund of STEEM, which accounts for approximately 20% of the circulating supply. Moreover, the funds were utilized to take over the majority voting rights and replace the previous Block Produces with loyal ones. The funds deployed by exchanges were determined to be those owned by individual users, who face a 13-week lockup period. As a result, a huge community backlash ensured, with the departures of multiple Steem developers as well as the Head of Communications.

Lessons Learned

So, what do we learn from this? In what is arguably the first “hostile takeover” from an outside competitor in the space, did Justin Sun create value? Objectively speaking, since the announcement on February 14th, the STEEM token has declined 27%. As for the Steemit community, it has not only turned against Justin Sun, but also the very exchanges that aided in the takeover, despite Binance and Huobi citing misleading information.

Community is all that Matters

Which brings us to our final, most important point. Open-source software and decentralized communities can be purchased, technically, but that doesn’t mean the value of either asset can be retained or even improved. Like any social media community, the members of Steemit are free to vote with their feet and move on to one of the other social platforms, of which there are many. While we like to think that in software development tech matters, open-source software can be forked easily and updated with parameters suiting the needs of the disenfranchised. In that light, the tech matters very little. It is the community of supporters — developers, end-users, miners, exchanges, merchants, and other service providers — that matter most. Lose them and you lose the value of your asset.

That’s all the time we have this week. Please reach out with any questions, comments, or feedback on our work. Get our weekly wrap and daily news delivered directly into your inbox here.