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Around the Block #9: Dawn of the DeFi Protocol Wars

10/06/2020

Then it all started to unravel over the next week. The price began to drop as more and more tokens were minted to yield farmers who were only interested in selling them as fast as possible. The drop prompted the anonymous lead developer (“Chef Nomi”) to sell a $14M chunk of $SUSHI tokens to secure long-term funding. However this was a shock to the community and a betrayal of trust (he previously committed to avoid selling any tokens), and he was ousted from the project.

But the damage was done. While Sushiswap successfully migrated Uniswap’s liquidity and launched their exchange, the initial energy and enthusiasm had waned. To Sushiswap’s credit the project has now taken on a life of its own, targeting potential integrations with other blockchains like Solana, and charting their own path.

Interestingly, Uniswap didn’t take the attack lying down. While they previously didn’t have a native token, one could argue it suddenly became a critical disadvantage. So on September 17th, they unveiled $UNI as a governance token and promptly airdropped ~$1000 in $UNI to every previous Uniswap user, rewarding past contributions as well as continued loyalty by also distributing remaining $UNI through yield farming.

Today, Sushiswap sustains a respectable $400M TVL, $50M / day volume, and $150M market cap. Not bad for a one-month old project, but dwarfed by Uniswap with $2.2B TVL, $350M / day volume, and $400M market cap. The first battle belongs to the incumbent.

Other Attacks

Where Sushiswap pioneered the movement, others have quickly followed. As a few notable examples:

  • Swerve copied Curve
  • C.R.E.A.M. copied Compound
  • YAM and BASED copied Ampleforth
  • … and more

All these attacks occurred over the past two months, with varying degrees of success. But notably, none have been able to surpass the incumbent. However each project has managed to survive and take on a life of their own, with their own communities building new features to optimize their products to their market.

Implications: Protocol Wars and the Future of DeFi

The fact that none of these attacks have successfully overtaken an incumbent is reassuring. Consider the implications if Sushiswap succeeded — one could argue that they would simply be predicting their own demise by proving the model of a successful attack. It would give wind to the sails for another copy-project to simply attack Sushiswap in the same manner! But they were not successful, and it’s an early but important datapoint that true differentiation may be needed to win in the open market.

The deeper implication is that switching costs in DeFi are larger than perceived. While it’s simple to copy code, you cannot copy a community, a brand, or broader integrations and mindshare. In all of these things, Uniswap is superior, which helped retain their lead.

A few other observations:

  • Fair-launch yield farming may not be sustainable for long-term growth: Protocol war attacks are fueled by distributing the majority (and sometimes the entirety) of tokens directly to users of the protocol. But long-term sustainability requires long-term incentive alignment. Once your tokens are distributed, how can you incentivize developers to keep building? Will a community be able to properly shepherd and navigate these nascent protocols over time? It’s unclear today.
  • Community governance will be hard: Decentralized projects embracing token-based governance are new constructs and likely to come with many tradeoffs. This is exacerbated with protocol-war projects, which are by definition new and require rapid community formation to be successful. As such, they are likely to more naturally attract short-term stakeholders who may not be long-term aligned.
  • Plutocracy or Democracy? In the case of Sushiswap, a wealthy fund publicly announced their involvement, staking millions of dollars and obtaining a significant allocation of $SUSHI, enough to exert strong control over the protocol’s future. Many implications here, but these projects may end up resembling plutocracies rather than democracies.
  • Anonymity has a dark side: Many of these projects have anonymous founders (ala “Chef Nomi”), which can be both good and bad — enabling anyone in the world to contribute and own part of a new protocol, but also potentially enabling bad actors to create malicious projects that exit scam by stealing all the funds through a hidden back-door.

In the end, this new era will be fascinating to watch. They resemble a twist on blockchain forks, like Bitcoin vs Bitcoin Cash or Ethereum vs Ethereum Classic — but with applications rather than blockchains. Similar to forks, these applications must rapidly garner a community, demonstrate a superior product, and hope to overtake the incumbents. But just as we have seen with blockchain forks, you cannot fork a community, it’s developers, or it’s brand and mindshare.

This bodes well for the future of DeFi. It means founders who build unique projects and work hard to garner a lead in community and traction have some defensibility against protocol war attacks. Ultimately encouraging more builders to create new projects and push DeFi forward.

Product Group News

Coinbase

  • Coinbase launches Cosmos Staking Rewards
  • Coinbase Pro adds support for UNI, YFI, BAL, REN, LRC, UMA
  • USDC launches on Algorand
  • Coinbase celebrates USDC at $2B, issues Request for Startups

Retail

  • Coinlist adds $UNI mining portal
  • Gemini adds shielded Z-Cash withdrawals; leans into DeFi with 14 token listings; and launches in the UK
  • Square launches payroll feature through Cash App

Institutional

  • CFTC and DOJ file against BitMEX owners
  • Kraken wins Bank Charter approval to become first crypto bank, headquartered in Wyoming
  • Microstrategy buys $425M in BTC
  • Genesis launches Custody platform
  • Singapore based exchange KuKoin hacked for $150M
  • Bitfinex launches equity derivatives that settle in Tether
  • Baakt’s Bitcoin futures market hits all time high with daily volumes topping $100M

Emerging

  • Filecoin sets October 15 mainnet launch date
  • Keep’s tBTC network relaunches to bring Bitcoin to the Ethereum Network
  • DeFi protocols surpass $10B in TVL; Uniswap becomes first DeFi protocol with $2B in total value locked
  • Ethereum 2.0 transition gets closer, Phase 0 proposal submitted
  • DeFi protocol bZx hacked again for $8M; attacker caught and returns funds
  • DEXs continue strong growth, volume hits $23.5B in September

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