This is another story of why Governance and Tokenomics is so important for the valuation of a DeFi project. Uniswap is a household name in the DeFi space. They are the Apple of the crypto industry. They have great investors, a great team, and they were the first ones who really brought DeFi to life.
In the past we had the issue that due to the low volumes and complicated and unusable user interfaces, DeFi applications weren’t really used much. When Uniswap came along, they turned the entire industry upside down and gave users what they’ve long been craving for: a beautiful and simple to use product. Just like an iPhone. A completely neat and seamless user experience. For people who have been trading cryptos in 2017, or even earlier, in 2013, it was like a dream came true. The painful experiences of arbitrary decisions of why centralized exchanges hold your funds, the many hacks and unwillingness of exchanges to refund your stolen funds, the many bugs and system outages, which led to loss of funds. Back then it really didn’t feel like you were actually dealing with a financial instrument. It seemed like you were playing a game and simply lost, and now you need to learn out of your mistakes and start at the beginning of the game again, just a little wiser. The new generation of crypto traders will never understand that early adopters pain we went through, and they probably will never understand why Uniswap became so easily the leading brand in the DeFi space. Seemingly easy, but if you have ever tried to build an application which is able to reach such a level of simplicity and intuitive design, you know how much sweat and endless testing that involves. An effort many entrepreneurs in the DeFi space weren’t willing to do. Until someone came along and just did it. That someone was Uniswap. For that reason alone it was no surprise to me that when Uniswap launched their token sale mid September, it immediately hit a valuation $730 million. Which was also a nice return for its investors. Uniswap just closed an $11 million Series A funding round, the month before their UNI token launched. With a 17.8% investor allocation of the one billion UNI tokens, i.e. 178,000,000 UNI tokens, investors could have cashed out a whopping $1.26 billion, if the allocated investor tokens would have been sold right after the launch at peak price ($7.10).
Even if all tokens were sold at the current low of $2.31, the total value would still be around $411 million. However, we don’t know if investors, which participated in the Series A round, received the total investor allocation or just a part of it. But the calculation makes a clear case how profitable VC investments for investors have become. Which brings me to the actual matter of this article – how Governance and Tokenomics influences the valuation of a Governance Token.
The impressive token launch and success of Uniswap as a business was greatly reflected in the market, and validated its strong position and hard work over the last years. However, continuous success comes from long-term determination and hard work, as UPenn Professor Angela Duckworth defines it. Same principles apply in a business environment. Getting it right in the past doesn’t automatically mean that you’re also getting it right in future, as we have seen it countless times in history, with great examples of Nokia, and currently with Intel. Since the token launch it has been really quiet around Uniswap. To a fair degree because attention of investors is shifting gears towards a bullish Bitcoin and some investors were enlightened that the endlessly yield promising DeFi projects actually fail to continuously return that promised yield. Reasons for that are simple, they fail to deliver upon expectations. We reached the peak of inflated expectations and find ourselves now at the trough of disillusionment.
Many investors have painfully learned what happens to their farmed tokens if projects fail to deliver upon made promises. On the other side, some of these projects simply couldn’t have foreseen that the short lived attention span of the large share of retail investors in the crypto trading community will be easily diverted to the next dominating topic in the crypto media landscape, which currently happens to be the bullish breakout of the long sleeping Bitcoin bull. For intelligent investors, it would be good timing now to invest in promising DeFi projects, which you can currently get at a discount. In the case of Uniswap, the token price has been depreciating since its peak from mid September. It shows that investors slowly lose trust in the project’s ability to deliver upon market expectations. After the token launch, the very first Governance vote failed. The protocol creators, namely the Uniswap team, coded the requirements for a proposal to change the protocol and for having votes upon these proposals, into the underlying protocol. Code is law in DeFi projects. And the law said that if you like to propose a change, the total amount of tokens, by all participating voters, need to reach a minimum of 40 million UNI tokens. And because the total amount of required tokens by all participating voters fell short by just 1%, no vote could be carried out. Ironically, the proposal was about lowering that quorum threshold.
See, for a Governance Token, the ability to propose protocol changes and being able to vote in a subsequent poll on these changes, is vital to the future of a project which is dependent on these votes. Without a vote, there is no change and without change, there is no progress. Other factors that also play an important role in the Governance of a DeFi project is how much weight the vote of a single constituent has. The Uniswap governance model does not distinguish between voters with a small or large balance of tokens, as long as the minimum threshold of required tokens is reached, a proposal submission or vote can be passed. That poses a risk of large token holders, or whales, having a substantial influence on elections. Such whales would simply have too much voting power. In Uniswaps instance, one of the largest token holders is Dharma, a DeFi project with clear business interests and plans to partner with Visa. Large token holders with goals of furthering their own business interests raises the question about how decentralised these DeFi projects really can be.
The vision of Satoshi was really to put the power back into people’s hands, but when a few are able to influence decisions that affect many, aren’t we then returning to a model of centralisation? To solve these governance issues, knowledge and skills are required which might not be in the possession of the current token holders. Knowledge and skills which you might only find with political science experts and historians. History might tell us which mistakes to avoid and scientists might be able to tell us which governance structure might solve the current misery. Technically seen, the Uniswap team could just come in and clean up the mess, but they promised to stay out of governance politics for the foreseeable future.
“The Uniswap team will continue to have no involvement in v2 protocol development, auditing, and other matters. Similarly, team members will not participate directly in governance for the foreseeable future, although they may delegate votes to protocol delegates without seeking to influence their voting decisions.”
Source: Uniswap Blog – Introducing UNI from September 16, 2020
All in all, we are still in the state of infancy for decentralised governance, or DAO’s, as it used to be called before the DeFi boom. Much testing and experimentation will be required to find the right governance and token distribution model for each and every single DeFi project. Because each and every project is unique and different in its own. An interesting adventure if we think about that human civilisation hasn’t seen yet an entirely self-governing community or organisation at scale. Which is all exciting and fascinating for visionaries, for investors though, uncertainty about the future of the largest and most well known DeFi project is less so exciting and fascinating.
Investors look for strong fundamentals and progress in a project. The failure of the second-ever governance proposal adds further uncertainty about the future projections of the protocol and ability to stay competitive in the market. It remains to be seen how these issues will be addressed in the time to come, but for the near-term, a quick solution seems out of reach.